Small Businesses Are An Afterthought In Senate Tax Fight

WASHINGTON Republican senators say tax reform would benefit small businesses but their true goal is to help the biggest firms, a fact dramatically illustrated by a Republican-on-Republican policy fight this week.

The legislation would reduce the top corporate tax rate, the one paid by the largest publicly-traded companies, from 35 to 20 percent. Most companies, however, don’t pay the corporate tax, and the IRS taxes their income at the individual level when it passes through to their owners’ personal tax returns.

Two Republican senators complained that the legislation’s changes for these “pass-through” firms weren’t generous enough relative to the corporate cut. But they were only mad because the legislation disadvantaged rich firms compared to the very richest firms, not because it disadvantaged truly small sole proprietorships with storefronts on Main Street.

“I’m concerned about all businesses being able to compete, but when you’re a small guy your tax rate’s already pretty low, so from that standpoint you’re able to compete,” Sen. Ron Johnson (R-Wis.), the former CEO of a pass-through business, told reporters this week.

Since pass-through business income gets taxed at the individual level, those firms would benefit from the reduced tax rates for individuals in the Republican plan. The Senate version would also give those companies a special deduction for a portion of their qualified business income. The House version would instead set a special rate of 25 percent for that income, which would be much lower than the top individual rate of nearly 40 percent.

Johnson said he thought the House version was better, since the 25 percent rate is closer to the 20 percent corporate rate. The 25 percent pass-through rate had been part of a “framework” for the legislation Republicans unveiled in the fall, and Johnson was annoyed the Senate plan went a different way.

“It’s obviously the more successful people like manufacturers, the larger pass throughs, that are literally at the top marginal tax rate that compete globally and those are the ones that the framework in announcing a 25 percent tax rate recognized you can’t leave those businesses behind,” Johnson said.

“The very small ones, they have their own rate reductions,” he said, referring to the individual income tax reductions.

The Senate plan’s pass-through deduction, which would allow most firms to exclude 17.4 percent of their qualified business income from taxes, would leave the highest-earning businesses owners still paying effective tax rates above 30 percent.

Most companies aren’t that rich, though. Eighty-six percent of households with pass-through income already pay a top marginal income tax rate of 25 percent or less, according to the liberal Economic Policy Institute . (House Republicans eventually amended their plan with a complex scheme for a lower effective rate for companies with lower incomes.)

“The Senate approach is more elegant,” Steven Rosenthal, a tax lawyer and expert with the Tax Policy Center, said in an interview. “What Ron Johnson objects to is not the elegance of the Senate’s approach but the size of the exclusion.”

Johnson and Sen. Steve Daines (R-Mont.) nearly derailed the Senate bill which the National Federation of Independent Businesses had already endorsed   with their objections this week, though they came aboard after Republican leaders increased the size of the pass-through deduction from 17.4 to 23 percent.

“I was able to secure more than $60 billion in tax cuts for Main Street businesses,” Daines said in a statement . “These Main Street businesses will be able to provide more jobs and higher wages in Montana and across the country. I’ve seen enough progress to vote yes to move the debate forward.” 

Though pass-throughs are often used in political rhetoric as a proxy for small businesses, they can be just as large as the “C corporations” that pay the corporate tax (though they’re not allowed to have more than 100 shareholders). Households with adjusted gross incomes above $250,000 earned nearly two-thirds of pass-through income in 2011, according to the Congressional Research Service , though they represented just 6 percent of returns with pass-through income. Filers earning more than $1 million accounted for a third of pass-through income and 1 percent of returns.

The Senate’s tax bill could pass as soon as Friday, though its fate is uncertain. The Johnson-Daines change is just one of several significant adjustments Republicans are making while the bill is on the floor. Ultimately, the House and Senate need to agree on the same bill before it can become law.

Arthur Delaney co-hosts the HuffPost Politics podcast: