Portland Small Business Owners Facing Weirdly High New Taxes—and It Could Get Worse

April 8, 2021

Newly implemented county and regional taxes yield state and local top marginal tax rates in excess of 26 percent for many Portland small businesses, and if all of President Biden’s tax proposals were adopted, those owners could face all-in marginal rates of more than 80 percent, far and away the highest in the country going back decades.

Most of Portland is in Multnomah County, where voters approved a new income tax on high earners, with a top rate of 3 percent on income above $250,000, intended to fund preschool programs. The tax went into effect on January 1. The entire metro region also saw the imposition of a new 1 percent income tax to fund supportive housing services, which would fall on individual income above $125,000 (including small business owners’ salary income) and those business owners’ net business income at higher thresholds.

This 4 percentage-point local tax increase comes atop a long list of existing taxes on small businesses at the state and local level: the state’s individual income tax, a gross receipts tax on business activity (including small businesses), both state and regional transit taxes, and county- and city-level taxes on business income, including partnerships and sole proprietorships. They add up—quickly.

The gross receipts tax, called the Corporate Activity Tax (CAT), is imposed at a 0.57 percent rate on almost all gross business income, though it includes limited deductions for certain business expenses. To compare this tax with those imposed on net income (things like wages and profits), we must make certain assumptions about a business’s profit margins and how much it can deduct.

Nationwide, the average profit margin for a small business is around 7 percent, and the taxpayer is allowed a subtraction worth 35 percent of the greater of their labor costs or the cost of goods sold. If we assume that those costs are split evenly, we yield a 6.82 percent effective rate for a “typical” small business. We will use that in our analysis, but it is important to note that the rates faced by different industries and businesses will vary widely—one of the criticisms of gross receipts taxes.

Our typical small business, therefore, would face a marginal rate of 26.19 percent (including the calculated CAT rate) on its activities in Multnomah County, broken down as follows.

Tax Tax Base Level Rate
Individual Income Tax Individual Income State 9.90%
Corporate Activity Tax Business Gross Receipts* State 6.82%
Oregon Transit Tax Wages State 0.10%
Supportive Housing Services Tax Business and Individual Income Regional 1.00%
TriMet Transit Tax Wages Regional 0.7737%
Preschool For All Tax Individual Income County 3.00%
Business Income Tax Business Net Income County 2.00%
Business License Tax Business Net Income City 2.60%
Total State and Local Tax     26.19%

Note: * Applied at a rate of 0.57 percent on gross receipts with deductions. The 6.82 percent effective rate is calculated as detailed above, intended to reflect the burdens of a typical small business.

Source: State and local revenue departments; Tax Foundation research.

This is an astonishingly high rate of local taxation, but it gets even worse when combined with federal taxes. Pass-through business owners pay federal individual income tax on all net income from their businesses. They are also legally responsible for paying employer-side Social Security and Medicare taxes for their employees, but it is important to note that (1) significant portions of these taxes are capped and thus are not on the marginal dollar and (2) economically speaking, employees bear the burdens of these taxes. The business owner does, however, bear the cost of both the employer and employee side of her own payroll taxes. Thus, the all-in top marginal rate on that portion of her income could be nearly 70 percent, adding the following federal taxes to her state obligations.

Tax Tax Base Level Rate
Individual Income Tax Individual Income Federal 37.00%
Medicare Payroll Tax Wages Federal 2.90%
Additional Medicare Tax Wages Federal 0.90%
Portland State & Local Taxes Multiple Sources State/Local 26.19%
Current All-In Portland Tax Burden     66.99%

Sources: Internal Revenue Service; state and local revenue departments; Tax Foundation research.

Finally, President Biden has proposed multiple changes to the federal income tax code pertaining to individuals and pass-through businesses, which are expected to feature in the forthcoming American Families Plan Act. (Corporate tax changes are included in the American Jobs Plan Act, which is in the process of being unveiled.) These proposals include:

  • Raising the top marginal individual income tax rate to 39.6 percent, a restoration of the pre-Tax Cuts and Jobs Act (TCJA) rate;
  • Creating a payroll tax “donut hole” where the Social Security tax (6.2 percent each for employer and employee), currently only imposed on the first $137,700 of wage income and therefore not part of a marginal rate, is restored above $400,000 of income;
  • Restoring the so-called Pease Limitation, which reduces the value of itemized deductions by 3 percent of every dollar of taxable income above a certain threshold (which can be expressed as a 1.118 percent marginal rate under a 39.6 percent top rate tax); and
  • Capping all itemized deductions at 28 percent.

If these provisions became law, the federal taxes atop a Portland small business’s 26.19 percent marginal rate would be as follows.

Tax Tax Base Level Rate
Individual Income Tax Individual Income Federal 39.60%
Social Security Above Donut Hole Wages Federal 12.40%
Medicare Payroll Tax Wages Federal 2.90%
Additional Medicare Tax Wages Federal 0.90%
Pease Limitation Individual Income Federal 1.188%
Portland State & Local Taxes Multiple Sources State/Local 26.19%
Biden Plan All-In Portland Tax Burden     83.18%

Sources: Internal Revenue Service; state and local revenue departments; Tax Foundation research.

And as if that’s not enough, a new state-level Paid Family Medical Leave tax of 1 percent on wages up to $132,900 is coming next year. That’s a lot of taxes at every level, but the state’s high rates combined with anomalously high regional, county, and city-level taxes create a uniquely uncompetitive landscape in Portland.

Portland has always been proudly weird—but does it really want to be this weird?

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A pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates.

The tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

A gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding.

A payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 23.05 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue.

An individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S.

The marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax.