Senate Republicans last week agreed on a budget resolution allowing a $1.5 trillion increase in the federal deficit over the next 10 years from tax legislation. This resolution paves the way for 51 Republican Senators to enact mammoth tax cuts by September 30, 2018.
As the centerpiece of these tax cuts, President Donald Trump has proposed to lower the corporate tax rate to 15% from 35%. However, despite the deficit cushion of $1.5 trillion allowed by last week’s budget resolution, a 15% rate is totally unrealistic.
Cutting the corporate tax rate to 15% would cost the U.S. Treasury $3.7 trillion over 10 years. But that cost cannot come close to being offset by repealing existing tax preferences, which all will be fiercely defended by special interests. A realistic legislative target would be a corporate tax rate of 25%. And under Senate rules this rate would have to expire after 10 years because it creates future budget deficits.
Let’s do the math on corporate and individual rates, together with optimistic assumptions about limiting existing tax preferences. The numbers are based on dynamic estimates from the nonpartisan Tax Policy Center, unless noted otherwise.
I recently testified at a Ways and Means Committee hearing about tax reform. While there is broad agreement about the need to reduce the U.S. corporate tax rate, which is now highest among the world’s advanced economies, Committee members asked how they could explain this to constituents. Would this be perceived as fair?
When businesses choose their legal form for tax purposes in the United States they have several options. The simplest option is that the owner can operate the business without a separate legal entity in which case the income is taxed directly to the individual on their tax return. This is known as a sole proprietorship. An alternative is a pass-through entity, which is not taxed at the entity level (generally) but instead “flows through” income to the owner(s) who are taxed on their individual income tax returns. These entities include partnerships, LLCs, and S-corporations.
The other common type of organizational form is the C-corporation, which is subject to an entity level tax. In addition, when dividends are paid, the shareholders are taxed on the dividend income. Thus, the C-corporation form of business organization may result in double taxation. Almost all publicly traded businesses are taxed as C-corporations, while many small business are organized as pass-through entities.