Reform the Individual Tax Code for Small Business Success

September 5, 2013

This week our economist Kyle Pomerleau has a new study on how individual tax rates have a big impact on U.S. businesses and economic growth. As Kyle points out, the number of small firms that are not subject to the corporate income tax has been growing significantly in the last 30 years, so much so that the majority of business income in the U.S. is now taken in by these so-called "pass-through" business entities.

The income from these firms is passed through to their individual owners, where it is then subject to the individual income tax, which currently has a top rate of 39.6%. Most pass-through income is taken in by individuals who are subject to this top rate, thus giving smaller businesses an even higher tax rate than U.S. corporations – which already are taxed at the highest rate in the developed world.

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A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

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.

A corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.