Individual Tax Rates Impact Business Activity Due to High Number of Pass-Throughs

September 11, 2013

Support for lowering the corporate tax rate has been expressed by both Democrats and Republicans in order to improve the competitiveness of American businesses. However, they differ in their plans for the individual tax code. While Republicans have proposed lowering the top individual rate from 39.6 percent to 25 percent, in parity with the proposed corporate tax rate, Democrats are less willing to consider lowering the individual tax rate, says Kyle Pomerleau of the Tax Foundation.

The implications of these policy differences are considerable because of the tremendous growth in non-corporate business forms over the past 30 years. Today, there are vastly more non-corporate businesses than traditional corporations and they now earn more net income than traditional corporations. These businesses face top marginal tax rates higher than 50 percent in some states. Thus, ignoring the top individual tax rate -- even while lowering the corporate rate -- means the United States will continue to expose a broad swath of businesses to high tax burdens.

Non-corporate firm types are often referred to as "pass-through" entities because the firm's profits are passed directly through to the owners and taxed on the owner's individual tax return. By contrast, the profits of traditional C corporations are taxed at the corporate level first before being distributed to the owners (shareholders) who are then taxed again at the individual level.

  • Between 1980 and 2010, the total number of pass-through businesses nearly tripled, from roughly 10.9 million to 30.3 million.
  • Meanwhile, the number of traditional C corporations declined steadily from 2.2 million to 1.6 million between 1980 and 2008.

As lawmakers consider policies to improve the competitiveness of American businesses, they should not forget that individual income tax rates are just as important to business activity as the corporate rate.  The various proposals to raise income taxes on high-income earners would fall heavily on America's non-corporate businesses. Pass-through businesses are currently facing top marginal rates on average between 44.5 percent and 47.5 percent and as high as 51.8 percent in California. These pass-through businesses account for a large percentage of business income and employment in the United States. Raising taxes on them could curtail their hiring and other investment plans, putting more strain on an already struggling economy.

Source: Kyle Pomerleau, "Individual Tax Rates Impact Business Activity Due to High Number of Pass-Throughs," Tax Foundation, September 3, 2013.

 

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