NCPA - National Center for Policy Analysis

Student Loan Payroll Tax Increase: Another Attack on Small Business

May 21, 2012

President Obama is campaigning heavily for Congress to prevent the lapsing of a special low-interest rate on student loans.  Specifically, unless deferred, the interest rate will rise from 3.4 percent to 6.8 percent on federal Stafford student loans issued after July 1, says Curtis Dubay, a senior policy analyst at the Heritage Foundation.

Senate Majority Leader Harry Reid (D-Nev.) has proposed to offset the cost of continuing to subsidize these loans by raising taxes on small businesses to the tune of $9 billion over 10 years.  He would accomplish this by applying the 15.3 percent payroll tax on certain income earned by small businesses organized as S-corporations.

This policy advocacy is ill advised and ignores the reasons for which S-corporations were first created.

  • An enduring flaw in the federal income tax is the double taxation of income earned by traditional chapter C corporations.
  • These companies first must pay the corporate income tax rate before they can distribute their earnings to their shareholders either as dividends or as capital gains.
  • The shareholders then must pay the 15 percent dividends or capital gains tax rate.
  • The total effective double taxation rate on the income of C-corporations is therefore almost 45 percent.
  • S-corporations were created as pass-through entities that do not pay taxes at the business level.
  • Their income passes through the business and on to their shareholders, who pay tax on their share of the business's earnings on their individual income tax returns.
  • Reid's plan would reverse this important gain in tax reform by reinstating the practice of double taxation of S-corporations.

This plan would hit small businesses during a still-fragile economic recovery.

Source: Curtis Dubay, "Student Loan Payroll Tax Increase: Another Attack on Small Business," Heritage Foundation, May 8, 2012.

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