In a recent testimony from Treasury Secretary Geithner to the Senate Finance Committee one major point was that when considering corporate tax reform: “Congress has to revisit this basic question about whether it makes sense for us as a country to allow certain businesses to choose whether they’re treated as corporations for tax purposes or not.” Secretary Geithner later went on to reference non-corporate businesses specifically.
Essentially, this means that Secretary Geithner is considering ending the pass-through tax treatment of businesses. This refers to partnerships, limited liability companies, S-Corporations, and any other type of business entity where individuals will report earnings on their personal IRS tax forms. Although this would radically change how businesses are taxed, it does not reflect the beneficial reforms that many House Republicans were hoping would come from President Obama’s State of the Union call for reform. This is exactly the opposite type of reform that Congressman David Camp, Chairman of the House Ways and Means Committee, is looking to enact. Camp wants to simplify the individual tax code to make it easier on those businesses that file through their individual IRS forms.
Small business is the true engine that drives the American economy. In his testimony to the Ways and Means Subcommittee on Select Revenues, Dr. Bob Carroll of Quantitative Economics and Statistics testified that flow-through businesses comprise over 90 percent of all businesses in the United States and employ over half of everyone in the workforce. The reason that the flow-through business structure is so attractive is because being taxed as a C-Corporation (distinct from flow-through/small business S-Corporations) is a form of double taxation; taxed once at the corporate rate, then again at the dividend level. By ending the allowance of the flow-through businesses the economy will suffer. This is because the engine that drives true economic growth will see their costs, complexity, and effective tax rates increase.
Another option put out by Geithner is to lower the corporate income tax rate (paid by C-Corporations) by as much as 6 to 12 percent, but then to “pay for it” by broadening the base. This is relatively harmless in and of itself, but get tricky when the base broadening includes raising the top individual rates while also disallowing more and more business tax deductions. This type of base broadening, while meant to be revenue neutral, is a double whammy to flow-through businesses that will see many deductions continuously disallowed while their tax burden rises. This double whammy would be delivered to businesses that produce the most jobs and drive the American economy.
The effects of this type of plan would include a loss of American jobs and loss of productivity for a large portion of the American economy. Despite some claims that flow-through businesses are very large companies, the facts are clear. In Dr. Carroll’s testimony, he mentions that 70 percent of flow-through businesses employ less than 100 workers each while 80 percent of C-Corporations employ over 100 workers each. It is clear that there are some outliers on both sides of this, but the real small businesses are indeed flow-through entities. While substantial reform is clearly needed, it is irresponsible to enact “reforms” that would cost American jobs and hurt the types of businesses that drive our economy.