Why We Need Tax Reform: High Business Taxes
This is part three of a monthlong blog post series on tax reform.
Comprehensive tax reform must lower tax rates for all businesses – C corporations and pass-through entities. Why?
At 35%, the United States has the world’s highest marginal corporate tax rate. Unfortunately, last week, it wasn’t an April Fool’s Day joke when we celebrated a year with this dubious distinction. As I noted a few weeks back, our effective tax rate, the actual rate of tax paid, is one of the highest in the world, an average 7.6 percentage points above our global competitors. And unlike other countries, we have made no moves to lower this rate. While our major trading partners, including Canada and the United Kingdom, are dropping rates, we are falling behind by simply standing still.
There are a plethora of reasons why a high corporate tax rate is bad. Taxes are a cost of doing business. Whether you are a company that operates domestically, or you are an American worldwide company growing your brand globally while supporting jobs here at home, lower costs are good. So lower tax rates are good. They help companies compete, grow, and create jobs. Further, lower marginal corporate tax rates help attract foreign investment to the United States, which drives economic and job growth. Finally, studies suggest that higher corporate tax rates mean lower wages.
But reforming only the corporate tax code is “like putting sunscreen on half of your face and letting the other side burn.” Comprehensive tax reform also must lower rates for pass-through entities, like S corporations and partnerships. Under the individual code, pass-through entities face a top marginal rate of 39.6%, with combined marginal rates close to 45%.
Since 1980, the number of pass-through entities has tripled to nearly 32 million; more business income is taxed under the individual code than the corporate code. According to an Ernst & Young study, more than 90% of businesses in the United States are organized as pass-throughs. From 2004 through 2008, they paid 44% of all federal business income taxes and employed 54% of the private sector.
Further, choosing to operate as a C corporation versus as a pass-through entity isn’t always a tax driven decision. While there are tax factors, businesses often make entity choices based on ease of formation, ease of profit sharing, and succession planning.
In sum, higher business taxes, for corporations or pass-through entities, are bad for everyone. As Congress embarks on comprehensive tax reform, it must lower tax rates for all businesses.