Today’s House Ways and Means Select Revenue Measures hearing focused on the special burdens that the tax code imposes on small businesses and pass-through entities and the need for comprehensive tax reform to address these problems.

  • The witnesses were:
    • Dr. Robert Carroll, Principal, Qualitative Economics and Statistics, Ernst & Young LLP, Washington, DC;
    • Ms. Patricia A. Thompson, Chair, Tax Executive Committee, American Institute of Certified Public Accountants, Piccerelli, Gilstein & Co. LLP, Providence, Rhode Island;
    • Mr. Dennis Tarnay, Chief Financial Officer, Lake Erie Electric, Inc., Cleveland, Ohio; and
    • Dr. Donald B. Marron, Director, Tax Policy Center, The Urban Institute, Washington, DC.
  • In his opening remarks, Subcommittee Chairman Pat Tiberi said, "Our current system of taxation was written for an economy that was very different from the competitive, global economy of today." Tiberi added, "It’s time to enact a tax code that is competitive with the rest of the world, that is fair, and that is simple. Small businesses must also be included in comprehensive tax reform. Reforming corporate taxes means only reforming roughly ten percent of federal revenues. That’s not comprehensive tax reform. Many small businesses pay taxes under the individual income tax rates, as pass-through entities. The last thing we want to do as a part of tax reform is create a situation where we are putting small businesses at a competitive disadvantage. I fear leaving them out of tax reform will do just that."
  • Carroll said, "The vast majority of businesses in the United States have chosen to organize as flow-through businesses. Today, flow-through businesses comprise more than 90 percent of all business entities, employ more than 50 percent of the work force and report more than one-third of all business receipts. Forty percent of business net income is reported by individual owners of flow-through businesses. These taxpayers pay 43 percent of business taxes when filing their individual tax returns. With the increasing prominence of flow-through businesses, it is important to carefully consider how the flow-through form fits into the US tax system and how any particular tax reform might affect flow-through businesses…[E]limination of business tax expenditures to finance a lower corporate rate can raise substantial issues for flow-through businesses. Flow-through businesses could potentially lose the benefit of widely used business tax provisions without the benefit of the lower corporate tax rate."
    • Carroll added, "The flow-through form helps mitigate the economically harmful effects of the double tax on corporate profits, in which the higher cost of capital from double-taxation discourages investment and thus economic growth and job creation. Moreover, double taxation of the return to saving and investment embodied in the income tax system leads to a bias in firms’ financing decisions between the use of debt and equity and distorts the allocation of capital within the economy." Carroll concluded, "Some have suggested that tax reform focus first on reform of the corporate income tax before focusing on reform of the individual income tax. With the flow-through sector representing more than half of all business activity, as measured by employment, and paying 43 percent of total business taxes, it is difficult to see how significant reform of the corporate income tax system can be achieved without also addressing the taxation of the flow-through sector."
  • Thompson said, "Simplification is needed in areas such as depreciation, Alternative Minimum Tax ("AMT"), partnerships, and retirement plans. Minimizing overall uncertainty throughout the Code and expanding provisions intended to help small business to include non-corporate entities should also be considered."
  • Tarnay said, "Predictability and stability within the tax code provide businesses, particularly small businesses which typically have tighter profit margins, the necessary lens with which to make decisions regarding growth, investment, or reinvestment of capital and expanding new employee job opportunities. Lower tax rates on small businesses mean that the money we do not have to pay in additional taxes instead can be reinvested in our businesses and workforce, spurring and economic recovery that in Ohio is slow at best. Further, a simpler tax code means small business owners can spend less time on costly and burdensome compliance activity and invest more of their time on innovation and growing their businesses. Simplicity also helps to minimize taxpayer confusion over exactly what liability is owed, and help with financial planning for the future. That simplicity could also prove beneficial to government as they seek to close the tax gap. Tax reform for small businesses is about one thing in America: JOBS for all business sectors."
  • Marron testified, "America’s tax system is needlessly complex, economically harmful, and often unfair. Because of a plethora of temporary tax cuts, it’s increasingly unpredictable. And it fails at its most basic task, raising enough money to pay our government’s bills. For these reasons, the time has come for fundamental tax reform. Such reform could have far-reaching effects on every participant in the economy, including small businesses. To provide a foundation for thinking about these effects, my testimony discusses basic facts about the relationship between tax policy and small business. I make six main points:
  1. Today’s tax code generally favors small businesses over larger ones. Provisions such as Section 179 expensing, graduated corporate tax rates, and special, low capital gains taxes benefit businesses that are small in terms of investment, income, or assets.
  2. Many small businesses also benefit from the opportunity to organize as pass-through entities. S corporations, limited liability companies, partnerships, and sole proprietorships all avoid the double taxation that applies to income earned by C corporations.
  3. However, the benefits of organizing as a pass through are not limited to small businesses. Some large businesses adopt these forms as well. Although these large firms account for a tiny share of pass-through entities, they represent a substantial fraction of pass-through economic activity. For example, only 0.2 percent of partnerships had revenues above $50 million in 2005, but they accounted for 57 percent of partnership income. For that reason, lawmakers should take care not to assume that all pass throughs are small businesses.
  4. Small businesses face disproportionately high costs in complying with the tax code. They are also more likely to understate their income and underpay their taxes. High compliance costs thus disadvantage responsible small businesses, while the greater opportunity to evade taxes can advantage less responsible ones.
  5. An ideal tax system would collect enough revenue to pay for government services while minimizing distortions to economic activity. To the extent possible, economic fundamentals, not tax considerations, should drive business decisions about organizational structure. By treating pass throughs and C corporations differently, our current tax system deviates from that ideal.
  6. Many tax reform proposals would reduce business tax preferences and use the resulting revenue to cut corporate income tax rates. Such revenue-neutral reforms could lessen the disparity in tax treatment between pass throughs and C corporations. Pass throughs would see their tax burden increase (since they would lose tax preferences but not benefit from the rate reduction), while C corporations would, on average, see their taxes decline."
  7. Today, Rep. Paul Ryan, Chairman of the House Budget Committee, said that House Republicans are considering including some form of corporate or individual tax reform in their FY 2012 budget blueprint expected to be released in April. Ryan said, "That's what we're looking at. Yes, we want to look at corporate reform, we want to look at tax reform for economic growth." Ryan added, "Whether our resolution will include that or not, you'll find out in April. We clearly want to go down the path of making our tax code more efficient, making our tax code more pro-growth, more competitive."
  8. The testimony can be accessed here.