The press is making a big deal about the fact Wisconsin Senator Ron Johnson, who won re-election last year, is against the House and Senate tax bills. The Republican Johnson’s issue is the fact some “pass-through” businesses would pay way more than corporations on taxes. Legal Zoom says “pass-through” businesses are entities, “not subject to income tax. Rather, the owners are directly taxed individually on the income, taking into account their share of the profits and losses. This avoids double taxation.”
The Washington Post explains the House bill formula:
The House plan lowers the top rate from 39.6 percent to 25 percent for small businesses (excluding “service companies” like consultants and lawyers) and requires a complex formula where the 25 percent rate only applies to about 30 percent of the business income. But the reality is most small businesses — 85 percent — already pay taxes at rates of 25 percent or less. To help out the small “mom and pops,” the final bill has a 9 percent rate on the first $75,000 in income for business owners making $150,000 or less. But that tax break phases in, meaning it isn’t fully available until 2022.
That’s…a problem. I wrote last week I favored the House bill, but wanted to see more tweaking. This “pass-through” issue is one of those examples which needs tweaking. It seems rather stupid some businesses would be taxed at one rate, while another business gets taxed at another rate (I feel the same way about multi-leveled individual taxation too. The ultimate solution is to repeal the 16th Amendment, but that’ll take a lot of time).
The Senate version is obviously different, and Johnson’s claim (backed up by The New York Times) says the “pass-through” owners could be put into the 32% tax bracket, after a 17.4% deduction. But Tax Foundation’s Jared Walczak writes that’s not 100% true.
Imagine, briefly, that a shareholder owns stock associated with $1,000 in pre-tax corporate profits. Under the Senate plan, the corporate income tax immediately takes $200 off the top, leaving $800 in dividends or capital gains. The top rate of taxation on this income (let’s assume that the stockholder has other such income and is paying the top rate) is 23.8 percent, meaning that another $190.40 goes to the federal government. On that $1,000 in pre-tax profits, the federal tax wedge is $390.40, or 39.04 percent.
Now imagine $1,000 in qualified pass-through income. We’ll assume the owner of this pass-through stake has other income as well, and is subject to top marginal rates. Under the Senate plan, this income would be exposed to a top marginal rate of 38.5 percent, plus the 3.8 percent net investment income tax, yielding an initial rate of 42.3 percent. This, however, is where the 17.4 percent deduction comes into play. Because of the deduction, only $826 of the $1,000 is taxable income, yielding tax liability of $349.40, or 34.94 percent.
It is easy to see how, on the surface, pass-through income appears to face greater tax burdens than income from C Corporations. The reality, however, is far more nuanced.
It is true, of course, that some C corporation shareholders are tax-exempt, but owners of pass-throughs may also be tax-exempt, or in lower tax brackets.
So the tax burden on corporations, to a certain extent, is a bit more than what Johnson is claiming. One thing I do appreciate about Johnson is his willingness to present a potential solution (via NYT):
Mr. Johnson’s preferred approach to that imbalance would be to force all corporations to become pass-throughs, a move he says would equalize tax treatment and encourage more corporate investment. He says this approach would not personally benefit him because it would not cut taxes on pass-throughs; Mr. Johnson earned between $215,000 and just over $2 million in pass-through income in 2016, through several limited liability companies.
That could work, but I have questions about what happens and what it means for stockholders of publicly traded corporations. If I own 15 shares of “Corporation X,” what would be taxed: my stock holdings or my personal income? Isn’t that a form of “double taxation,” if it’s both? Would executives, who get paid a salary and stock options, face the same form of taxation? That could encourage more businesses to exit the stock market, which would then create more questions regarding what happens to shareholders who want to hang onto their shares instead of selling to larger shares. It’s a complicated question, which Johnson needs to answer (it also shows how ridiculously complicated the tax code is). I’m also not a fan of the government forcing companies and people to do anything that violates Locke’s Natural Law of life, liberty, and property.
Johnson’s opposition to the tax bills has drawn criticism from conservative commentators. Matt K. Lewis writes at The Daily Beast, Johnson’s desire to “fix” the bill will make things more difficult to assure its passage. He notes it’s “impossible to address every concern of 52 Republican senators, not to mention the fact that any changes made to accommodate one senator (who should already be a “yes” vote) have the very real possibility of alienating another senator.”
Lewis also notes Johnson’s opposition could keep tax reform from happening at all.
But when it comes to passing legislation, this is what is called making the perfect the enemy of the good. To which I say this: Good luck passing tax cuts for anybody if Democrats take the House next year (a distinct possibility). Then, you’ll be stuck at a 39.1 percent corporate tax rate (the current rate, when you count federal, state, and local taxes).
Lewis’ criticism makes sense, but some of Johnson’s concerns make sense too (even with the Tax Foundation’s analysis suggesting corporations would still be taxed more than “pass-through” businesses). It’s possible Johnson is just playing politics with his opposition (Lewis noted Johnson seemed irked at the GOP for not supporting his re-election campaign last year), but the same could be said for Senator Rand Paul’s desire for tweaking (including repealing the individual mandate). It just shows tax reform won’t be finished until it’s finished.
Still wish we could just repeal the 16th, slash the federal government 99.9%, and taxes 100% just like “that.” But that won’t happen because government is complicated.