Anyone who doubts the federal tax code is too complicated for its own good should pay attention to efforts underway in Washington to lower the corporate tax rate, which is the highest in the free world.
President Obama and Republicans in Congress seem to actually agree that the 35 percent corporate rate should drop, and they may even find agreement on ways to broaden the base of corporate taxpayers by ending some tax breaks, which would provide the revenue to pay for the reduction.
But the problem is many U.S. businesses are not incorporated. They operate as sole proprietorships, or as “pass-throughs,” meaning a business’s taxes are passed through to its owners. The owners of these businesses pay taxes through individual filings, and at the same rates as all individual Americans. These businesses can be as small as someone offering piano lessons at home or someone who freelances as a writer. But they also can be quite large. A study by the Tax Foundation, a Washington-based research group, found that such corporations account for most private-sector jobs in every state but Delaware and Hawaii.
In Utah, they account for 57.2 percent of private-sector jobs. Nationwide, such businesses paid a combined $1.6 trillion in wages and salaries in 2011. They dominate the service sector of the economy.
However, when it comes to helping these businesses, cooperation in Washington quickly falls apart along partisan lines. President Obama would like to raise taxes on wealthy Americans, but any increase in marginal tax rates would hurt these small-business owners as well.
The administration dismisses this by saying such businesses should simply incorporate to avoid getting hurt. But it’s not so simple. Many small businesses choose not to incorporate in order to avoid greater government scrutiny and other requirements. Others want to avoid certain costs.
For instance, as a Bloomberg report this week outlined, if shareholders in a corporation sell stock or earn dividends, that money becomes subject to a second layer of taxes that can be as high as 23.8 percent. Also, corporations that use equity to finance investments are taxed higher than pass-through businesses, but when investments are financed with debt, pass-through businesses pay more.
It’s easy to see how the U.S. tax code is a boon only to attorneys who steep themselves in its intricacies, and how it’s almost impossible for any one person to grasp all its nuances. In addition to the many rules and deductions, businesses also are dealing with the effects of the Affordable Care Act and its requirements.
As the head of the S Corporation Association said this week in the Wall Street Journal, “Businesses can’t prosper if they are forced to send too much of their income to the government.”
We’re encouraged that real dialogue is taking place in Washington over the 35 percent corporate tax rate. The reality is most corporations pay less than this because of other breaks and deductions, but fairness and simplicity ought to be drivers to any reform process.
Without including so-called “Main Street” businesses, however, the effect will be an even less fair system that stifles innovation and discourages entrepreneurs.