The Pitchforks are out! How can we funnel the anger into something constructive? If you can pass a 90% tax rate, why not a 50% tax rate on all income over $1 million?
The problem with tax rate increases is that they hit small businesses unfairly, and we depend on small business for most of our jobs. Small and family businesses do not export jobs and are the bulwarks of their communities.
Unlike big companies who pay corporate income tax rates, small businesses pay at individual income tax rates, not corporate tax rates, and business owners pay social security and medicare tax on their business income that their corporate competitors do not.
Let's eliminate the unfair competitive advantage that public corporations enjoy, impose a surcharge tax on millionaires without impacting jobs, simplify tax filings for small business and make the tax more efficient and effective.
Partnerships and S corporations are the business vehicle of choice of small business owners and entrepreneurs. Those entities do not pay tax but pass the tax items though to the owners. The owners then include that income in their personal returns and pay personal income tax on the income.
Currently C corporations, which are the type of corporations that trade on the stock exchanges, pay at corporate tax rates. Their owners then pay income tax at a 15% rate on the dividends the corporation pay. While some economists argue this is double-taxation they miss the point that the corporate tax is intended to level the playing field between big and small businesses. The real unfairness comes from the 15% tax rate that investors pay on capital gains and dividends when those dollars spend just as well as salary or small business income. A grocery store owner is faced with the anomaly that reinvesting in the business could generate additional business income taxable at 36% while investing capital in the stock of a competitor, Wal-Mart, could generate dividend and capital gain income taxable at 15%.
Raising the individual income tax rate to 50% will only make small business and Main Street weaker. However, it is possible to restructure the taxation of small businesses to allow for rate increases without impacting these businesses unfairly. Moreover, the restructuring would make the tax system more efficient and effective.
The business (but not the investment) portion of a partnership or S corporation would be taxed as if it is a regular C corporation and the entity would pay that tax to the IRS. Rather than report the income on a K-1 to the owners who would then pay individual income tax on that income, the K-1 would show the same items of income loss or credit and the owner's share of the tax. If as a result of the inclusion the individual income tax would be less, the owner can file for a federal income tax refund. If it would be more, of course, the owner would not elect to include the income in the personal return.
This would shield business owners from the higher individual income tax rates. Moreover, if individual rates go up, it becomes less likely that the owners will file in their individual returns. Owners do not like the individual filings, but do so to avoid double taxation of income distributions. The new structure would avoid taxation of previously taxed income and increase the owner's basis in the entity without the need to file an individual return.
By imposing the tax at the entity level, the IRS is more likely to collect the tax. The fewer the individual filings, the less the complexity, including the state tax filings. Also the IRS will need to deal with only one taxpayer -- the entity -- when it audits.