Please excuse me while I jump up and down on this keyboard trying to flag attention to one of the most egregious GOP give-aways to the top 1% of American income earners. It isn’t as though the Pass Through Loophole hasn’t garnered attention, it just doesn’t seem to have broken through the dismal cloud of information and misinformation about the GOP tax plan and into enough sunlight.
“The big one in the tax plan issued last week by the GOP and President Trump involves what’s known opaquely as “pass-through” business income. Even that term might have been too revealing, so the document the Republicans issued described it even more obscurely as a “tax rate structure for small businesses.” That’s also dishonest, however, because the businesses it affects are often nothing like “small.” [LAT]
There’s nothing new about legislative obfuscation of legislative intent — but this one is a major way to ease the burden on the 1% and put more pressure on the working and middle class Americans to make up the difference. Here’s how it works:
“Pass-through” income is business income that’s reported to the IRS only by individual owners of, or partners in, the business. These businesses can be organized as partnerships, S-corporations, or sole proprietorships. They’re distinguished from C-corporations, which are almost always big businesses with public stockholders; C-corporations pay the corporate income tax, and the shareholders pay personal income tax on their dividends and capital gains.
In other words, if a business is a partnership, S-corporation, or a sole proprietorship it doesn’t pay corporate tax rates. The income earned is reported by individuals. Now, here’s how the Republican plan would specifically benefit the top 1%:
Currently, the top marginal individual rate is 39.6%; the new tax proposal would reduce the top rate on pass-through income to 25%. Pass-through income from an S-corporation, by the way, already is exempted from the Affordable Care Act surcharges that raised the top income tax rate on some high-income earners by as much as 4.7 percentage points.
So, if the business is an S-corporation, sole proprietorship, or partnership the tax rate is 25%. Thus, if Desert Beacon were to become Desert Beacon LLC the income tax reduction would be from a maximum of 39.6% to 25%. Now, who are those who tend to form the businesses which qualify for the LLC Loophole?
“Pass-through business income is substantially more concentrated among high-earners” than traditional business income, Treasury Department economist Michael Cooper and several colleagues observed in a 2015 paper. They also found that about one-fifth of it went to partners that were hard to identify, and 15% got sucked up into circles of partnership-owning partnerships, complicating IRS analyses.”
I sincerely hope the reader isn’t too surprised that these tax avoidance strategies are practiced mostly by high-earners. Let’s take a closer look at the summary of that 2015 NBER paper:
Pass-through” businesses like partnerships and S-corporations now generate over half of U.S. business income and account for much of the post-1980 rise in the top- 1% income share. We use administrative tax data from 2011 to identify pass-through business owners and estimate how much tax they pay. We present three findings. (1) Relative to traditional business income, pass-through business income is substantially more concentrated among high-earners. (2) Partnership ownership is opaque: 20% of the income goes to unclassifiable partners, and 15% of the income is earned in circularly owned partnerships. (3) The average federal income tax rate on U.S. pass- through business income is 19%|much lower than the average rate on traditional corporations. If pass-through activity had remained at 1980’s low level, strong but straightforward assumptions imply that the 2011 average U.S. tax rate on total U.S. business income would have been 28% rather than 24%, and tax revenue would have been approximately $100 billion higher. (emphasis added)
Therefore, if someone is trying to pass this off as a “middle class” tax cut, or a “small business” tax cut, the appropriate (and perhaps most polite) response is BALDERDASH.
It should come as no surprise that Kansas, under the spell of Brownback-ism, tried opening the LLC loophole as a way to “create jobs.” It failed, and failed miserably. Not only did the state find itself in a terrible revenue position, losing money for schools, transportation, and other government services, but it allowed high-income earners to stash more cash. Case in point: KU basketball coach Bill Self was avoiding most Kansas income taxes on his $3 million salary by parking most of his earnings in an LLC. Even some of the tax freeloaders were beginning to feel like tax freeloaders by late Summer 2016. [see also NYT]
And, no one should suggest the amount of money lost because of the ‘reformed’ Kansas tax structure was negligible:
For fiscal year 2014, which ended on June 30, the state collected $330 million less in taxes than it had forecast, and $700 million less than it had collected in the prior year. Those are big numbers in a state that spends about $6 billion annually from its general fund, and the revenue weakness led both Moody’s and Standard & Poor’s to cut Kansas’ credit rating this year. [NYT]
The situation hasn’t gotten any better. There were promises made:
In 2012, Kansas Gov. Sam Brownback signed a bill that, among other things, substantially cut the state’s top tax rate and exempted “pass-through” business income from taxation (President Trump’s tax plan includes a similar loophole). The architects of Brownback’s plan predicted that it would provide an “immediate and lasting boost” to the state’s economy.
And promises not kept. The 2017 numbers are truly remarkable, and not in a good way:
Real GDP growth in Kansas since the fourth quarter of 2012 (Brownback’s cuts took effect in January 2013) has been relatively slow, at 6.1 percent through the third quarter of 2016. That’s about three-fourths of U.S. GDP growth over that same period (8.3 percent). A similar story holds for private employment growth: 5.0 percent in Kansas between December 2012 and March 2017, 9.1 percent in the U.S. overall. [WaPo]
The Kansas Legislature was so disappointed in the Great Brownback Experiment it voted to change the tax law — and the governor vetoed their bill.
“Unfortunately, that part of the plan — what Brownback called an economic “shot of adrenaline ” — hasn’t materialized. The state’s budget deficit ballooned to $350 million. And the small-business provision also created new ways for residents to avoid taxes, meaning more lost tax revenue and compliance headaches for the state.” [Time]
Just what we don’t need — lost tax revenue and compliance headaches. The bottom line of this easy route to the bottom is that:
(1) Claims that pass through exemptions and tax cuts will create new revenue have already prove erroneous. Witness what happened to Kansas.
(2) The loss of revenue from the pass through exemptions was serious and exacerbated an already tight budget situation.
(3) Claims that the tax ‘reform’ would help small middle class business owners proved elusive — the overwhelming numbers of those who benefited, and will benefit, were high income earners.
This would be a good time to contact Senator Dean Heller (R-NV) to let him know that no one is fooled by changing the name from “pass through” to “tax rate structure for small business;” it’s still a way to shift the burden of maintaining government services from high income earners to middle and working class Americans. The Senator can be reached at 202-224-6244; 775-686-5770; or 702-388-6605.