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Posted at 9:36 AM ET, 03/11/2011

Small businesses and taxes

By Ezra Klein

Donald Marron offers six observations on taxes and small businesses. I think the first will surprise a lot of people.

By Ezra Klein  | March 11, 2011; 9:36 AM ET
 
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Comments

A lot of so-called "pass through" businesses are sole-proprietors who pay taxes at the same rates they do on other income, like wages. Plus, they have to pay the full Social Security tax of 12.4% on top, making the effective rates quite high. And, they can't take a lot of deductions that are allowed for corporations. I don't think this argument holds water, at least not for sole-proprietors.

Posted by: AuthorEditor | March 11, 2011 9:58 AM | Report abuse

"Pass through" means they avoid double taxation (once at the corporate level and again at the individual level), which can be a major advantage.

Essentially everyone pays social security tax at 12.4% (up to income limits). The issue is not who writes the check to the government, it's who bears the cost. There's lots of literature on tax incidence.

Posted by: fuse | March 11, 2011 10:18 AM | Report abuse

"Low capital gains taxes benefit businesses that are small in terms of investment, income, or assets."

Here is my graph of the empirical effective tax rates of thousands of corporations: http://www-958.ibm.com/software/data/cognos/manyeyes/visualizations/effective-tax-rate-small

Notice how the ones with the least tax burden are not "small in terms of investment, income, or assets." Actually, pretty much the opposite (REITs, investment companies).

I think he ignores the fact that large corporations can take advantage of low international tax laws (allowed by US tax code) - an option not available to most small businesses. For instance Google rate of 2.4% on foreign profits: http://www.bloomberg.com/news/2010-10-21/google-2-4-rate-shows-how-60-billion-u-s-revenue-lost-to-tax-loopholes.html

@chris_Gaun
chrisgaun@gmail.com

Posted by: chrisgaun | March 11, 2011 11:32 AM | Report abuse

Both income and deductions pass through. And its the latter that provides the tax breaks for small business.

William Vickrey had the right idea, eliminate the corporate income tax but start taxing unrealized capital gains (at regular income tax rates). Tsy would make far more from taxing accrued gains than it'd lose by taxing corporations even with setting a generous annual exemption for retirement and small business investments.
http://books.google.com/books?id=QzGAPcjf6ksC&pg=PA182&lpg=PA182

Many people erroneously think its impractical if not unconstitutional to tax unrealized capital gains, but the IRS already does so for liquid assets annually (futures contracts) and illiquid assets retrospectively with interest paid for each year of deferred taxes upon sale (passive foreign investment company stock).

Posted by: beowulf_ | March 11, 2011 11:51 AM | Report abuse

Chris Gaun, good point about REITS and investment company. They're tax exempt so long as at least 90% of their earnings are passed through to shareholders as dividends. Making that the rule for all corporations would take care of the problem of corporations sitting on $2 trillion in cash.

They'd either have to pay out a dividend (taxed like regular income, ideally)) to shareholders or pay a stiff undistributed profits tax to the IRS.

Posted by: beowulf_ | March 11, 2011 12:02 PM | Report abuse

Taxing unrealized capital gains may not be unconstitutional, but it seems very impractical to me, given all the various kinds of capital out there and the means of accounting for all factors governing it, never mind the expense involved in tracking basis, the effects of depreciation or improvements to certain kinds of capital, and readjusting basis for taxes paid quarterly for all capital assets owned. Realization is simply the most practical point for any party to assess the taxable value of capital.

Posted by: arm3 | March 11, 2011 12:35 PM | Report abuse

Samll business have been nailed with taxes.Many small business have been pushed out by big corporations.The Government needs to take it easy for the small businesses

Thanks National Juris Solutions

Posted by: national-juris-solutions | March 11, 2011 4:22 PM | Report abuse

Small businesses need a serious break in today society

Thanks National Juris solutions

Posted by: national-juris-solutions | March 11, 2011 4:24 PM | Report abuse

It's a shame small business gets little attention from Congress because it has a relatively small lobby. Big business has unfettered access to law makers and it pays off. Why else would we conceivably give disproportionately large tax breaks to corporations who hire offshore? And not give equally large tax breaks to small businesses who hire at home? That alone proves the unfairness of the American tax code.

The tax code is driven by monied special interests, not by what is best. How should we handle the tax code? Trash it, flatten it and keep the lobbyists away from Captiol Hill.

Posted by: gfoster56 | March 12, 2011 7:27 AM | Report abuse

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