Corporate Tax Reform Is Too Important For the U.S. Economy to Be Held Up For Small Business Interests, New ITIF Analysis Finds

WASHINGTON—Reforming the U.S. corporate tax system could provide a major boost to U.S. economic growth and competitiveness, but according to the Information Technology and Innovation Foundation (ITIF), progress continues to stall due in large part to small business advocates who falsely claim that corporate-only reform is unfair and economically harmful. ITIF, a leading innovation policy think tank, rebuts advocates’ claims in a new report out today and urges policymakers to ignore the rhetoric and forge ahead on much-needed corporate tax reform.

“Corporate tax reform is one of the most important things Congress can do to boost productivity, create more high-paying jobs, and increase economic growth,” said Joe Kennedy, ITIF senior fellow and the report’s author. “Unfortunately, support for reform is being held hostage by small business advocates who want special treatment. But when you look beyond their emotional rhetoric and focus on the facts, it is clear that one special interest should not hold up broader reform, especially when its claims are largely without merit.”

Kennedy explains that the vast majority of small businesses are not subject to the corporate income tax. Instead, these businesses are structured as sole proprietorships, partnerships, or S corporations, and their income automatically passes through the business and appears on the owners’ individual tax returns. Because of this, small businesses are seeking reform of the individual tax system simultaneously with the corporate system—a much more politically difficult endeavor.

While Kennedy agrees the individual tax system also needs to be reformed, his report argues that corporate-only reform isn’t inherently unfair to small businesses. Specifically:

• Pass-throughs would still pay a lower overall effective tax rate. While it is accurate that corporate tax cuts will reduce the difference between what C corporations pay and what pass-throughs pay, pass-throughs will still have an advantage because they only pay taxes once (at the individual level), whereas corporate shareholders pay twice (at the corporate and individual level).
• Reducing corporate tax expenditures will have a small effect on small businesses. While eliminating some business deductions, exclusions, and tax credits to pay for lower rates will result in higher total taxes for pass-throughs, the total effect is likely to be small because most tax expenditures are for individuals. Furthermore, the investment-spurring tax expenditures—which account for nearly 70 percent of tax benefits to pass-throughs—would not be changed.
• Most pass-through income is earned by large businesses. While the emotional support for small businesses tends to get conflated with the tax treatment of pass-through entities, pass-through income is largely skewed toward big businesses anyway.
• Tax law should not favor small business. Unlike most large multinational corporations, most small companies do not directly compete with foreign companies, either domestically or in overseas markets. Therefore, the effect of higher rates on small companies is limited, since they don’t compete with firms overseas facing lower rates.
• Small businesses will benefit from corporate tax reduction. Many small businesses are part of multinational supply chains and rise or fall on the health of their globally traded corporate customers. As corporate-tax reduction enables corporations to invest more at home and sell more abroad, small businesses will benefit from the extra business.
• Congress has other ways of helping small business. These include tax simplification and regulatory reform.

“Reducing effective tax rates, especially on investment, research, and innovation, is crucial for American competitiveness. Done right, corporate tax reform means greater investment by both domestic and foreign firms, enhanced competitiveness, and faster productivity growth, all of which will help firms of all sizes and corporate forms. Tax reform will be a difficult political job under any circumstances, so let’s not make it tougher than it needs to be.”

Read summary.

Read report.