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Tax reform won't help most businesses

Non-corporate businesses may end up subsidizing tax breaks for corporations.

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Donald walks through the basic math in his testimony: Corporations pay at a maximum rate of 35 cents on the dollar. Then, their shareholders pay up to 15 percent on the remaining 65 cents for a total rate of about 45 percent. Non-corporate business owners pay only a top individual rate of 35 percent. This is why nearly all businesses choose the non-corporate form.

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But Obama’s concept of tax reform would change this equation. Corporations would lose the benefit of some tax breaks but in return may pay at a top rate of as low as 25 percent (Obama has yet to propose a plan so I am guessing here). Non-corporate businesses would lose those same deductions and credits, but get no benefit from the corporate rate cut. In fact, Obama would have very successful pass-throughs, whose owners pay the top individual tax rate, pay even more.

He’d raise the statutory rate to 39.6 percent and restore the phase-outs of itemized deductions and personal exemptions (worth about another 2 percentage points). Thus, he’d cut the top corporate rate to, say, 25 percent, while raising the top rate for non-corporate businesses to 42 percent. If Congress wanted to use some tax revenues to help reduce the deficit, it could raise those individual rates even more.

To make things more complicated, Obama would also raise the capital gains rate to 20 percent (with another add-on in the law to help pay for health reform). This would further disadvantage double-taxed corporations.

For real people, a decision that was once a no-brainer would suddenly become awfully complex. Do I organize as a corporation and pay a relatively low corporate rate but a rising rate on gains and dividends, or do I organize as a pass-through and pay a much higher individual rate but no second-level tax?

For politicians, the decision would be just as agonizing: Do I equalize the tax treatment of corporate and non-corporate businesses by raising taxes on the pass-throughs and lowering taxes on some corporations? Obama seems convinced that reforming corporate and individual taxes together is too heavy a lift, and focusing on corporate first will be easier. I keep thinking about that about that small business and multinationals headline and am not so sure.

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