Republican leadership has released a tax framework that promises to address the burden small businesses face. But the potential impact has been a source of debate among experts.
Republicans have long been advocates for tax reform as a means of spurring economic growth. The tax framework provided some details into the direction they were taking their latest reform effort when it was released Sept. 27. Republicans hope to significantly reform the tax code in a way that hasn’t been done since 1986.
Republican President Donald Trump and other party leaders have stressed how much the plan will help small businesses. Economists and tax policy experts have carefully reviewed the framework to understand what the likely impact will actually be. Some have found that small businesses will be helped while others see the plan doing much more to help the rich.
“We are going to protect small business owners and their families so they can continue to run their companies with dedication and with love,” Trump said Oct. 11 during a speech in Harrisburg, Pennsylvania. “The more than 30 million Americans who have small businesses will see, listen to this, a 40 percent cut in their marginal tax rate.”
The framework promises to limit the maximum tax rate for small and family-owned businesses to 25 percent. The reduced rate will specifically apply to owners of sole proprietorships, partnerships, and S corporations. Those businesses are known as pass-through entities and are often small and family-owned.
“I think the biggest thing they’re going to get out of this is a major rate reduction,” Brandon Arnold, the executive vice president of the National Taxpayers Union, told InsideSources. “If they’re paying at the top marginal rate, and some are, they’re going to see a 15 percentage point cut. Getting from 40 percent to 25 percent. That’s huge.”
Pass-through businesses are structured in a way that helps them to avoid a higher corporate tax. The owners and investors are directly taxed on their income instead of having the corporate rate applied to their business. Republicans hope the approach will lessen the tax burden many small businesses face.
“Some smaller businesses are further down in lower brackets,” Arnold said. “But those brackets are likely to be cut as well. So I think we’re going to see a quick infusion of resources because their tax liability going forward is going to be significantly lower.”
But the tax framework also faces a debate over who actually benefits from the plan. Not every pass-through business is small and family-owned which has prompted concern among critics. The Institute on Taxation and Economic Policy (ITEP) found that wealthy individuals could use the pass-through structure to avoid paying higher taxes.
“By creating a 25 percent lower rate, they’re really creating what’s going to be a complicated problem,” ITEP senior policy analyst Richard Phillips told InsideSources. “If you’re a millionaire and you’re receiving your income as wage income, and there’s a much lower rate on pass-through income then you’re going to want to become a pass-through business.”
The ITEP analysis also estimates that 87 percent of the benefits of this change would go to the richest one percent of taxpayers by 2018. The framework does promise to include measures designed to prevent abuse, but does not yet reveal exactly what those protections will be.
Republicans are also making simplification a primary policy goal in their tax reform push. They argue that many businesses and individuals face an unnecessary burden in just complying with the tax code. They hope that reducing the income brackets and reforming deductions will help to make the process of actually doing taxes easier.
“Having a simpler, easier-to-comply-with tax code will reduce the stress, the heartburn, associated with filing taxes and all the tax requirements small businesses have to face,” Arnold said. “I think if you were to poll business people, you’d see many of them are frustrated, not just with how much they pay, but also with the time and effort they have to dedicate to tax compliance every year.”
The Government Accountability Office found in a 2014 study that the tax code is so complex that very few professional tax preparers are able to calculate the correct tax refund. The National Taxpayers Union found in a 2015 study that the economy loses $233.8 billion and 6.1 billion hours of lost productivity annually because of the complex tax code.
“I think they are facing an excessive burden right now,” Arnold, who has regularly testified on fiscal policy during congressional hearings, said. “There’s just a lot of frustration there because many of them, the small businesses, don’t have a sophisticated team of lawyers and accountants to help them with that process.”
The business community has been highly supportive of the tax reform push throughout the process. The framework has been applauded by industry associations and business leaders for helping to reduce the burden businesses face. The Job Creator Network led a coalition letter from 60 political and industry leaders arguing the plan would be a huge boost for small businesses.
The International Franchise Association (IFA) was one of the industry associations that signed onto the letter. The IFA has been a major advocate for comprehensiveness tax reform since the start. IFA President Robert Cresanti notes that the plan would leave employers more money to invest back into their employees and business.
“For years, the burdensome and complex tax code has held back small business owners and stifled new investments,” Cresanti said in a statement. “Simply put, the framework laid out by congressional leaders and the administration to lower taxes across the board and to eliminate the estate tax will supercharge our economy.”
Small businesses aren’t the only focus of the plan which promises to lower rates and simplify the tax code. The framework is also looking to lower rates for upper and middle-income earners. It reduces the top individual tax rate from 39.6 percent down to 35 percent. It also lowers the corporate rate to 20 percent.
Congress is also continuing to seek input from the business community as it pursues tax reform. The House Small Business Committee held a panel from the small business community Oct. 4 to discuss what matters most to small business owners.