What about Small Business Tax Reform?

June 10, 2013

Corporate tax reform gets most of the attention in Washington these days, and rightfully so (the corporate tax code is a giant mess and the studies show that it is the most harmful tax to economic growth). But what about small businesses?

In the United States, small businesses, or pass-throughs, earn 61 percent of all business income and make up 30 million businesses across the country. Small businesses – companies organized as s-corps, partnerships, and sole proprietorships – pass their business income through the company to the owner’s individual income tax return. Because they pay income tax on the individual returns, they often face the high tax rate of 39.6 percent. Such a high rate, like with the corporate tax, damages economic growth.

But Rep. Devin Nunes (R-CA) has a pretty good idea on how to fix that: something he calls the American Business Competitiveness tax reform.

The plan, which he rolled out last fall in an op-ed, would treat all businesses the same, and at an equal and lower rate of 25 percent. Perhaps the most important aspect of the congressman’s plan, though, is how it treats income.

His plan is a cash flow business tax that allows companies to fully expense all costs immediately. Rep. Nunes says this will spur investment and economic growth, and there’s reason he’s right to believe so. Tax Foundation analysis shows that under the current tax code, 100 percent expensing option would boost GDP by 2.28 percent over the long run – and this is under the current tax code. If you rewrite the code as the plan suggests and cut the tax rate for all businesses as well, you could expect to see a couple additional points added to long term GDP.

A big reason for the economic growth from Rep. Nunes’s cash flow tax is because the plan properly defines the income tax base. Current law requires depreciation schedules that understate costs and overstate income, treating cost recovery as tax expenditures. This plan would completely rewrite those rules.

The correct treatment of income is crucial to investment and growth for so many small businesses, and gives them the freedom to invest when it makes business sense, instead of investing for tax reasons.

But with the discussion so fixated on revenue neutrality, people might be wary of the revenue a new system would bring in on a static bases. Fortunately, Rep. Nunes says he’s flexible on the 25 percent rate, because he says he’s confident the reform would bring in more revenue through economic growth, whether the rate needs to be 20 percent or 30 percent.

“You’re going to bring so much money off the sidelines and plow it into the economy,” he’s quoted saying in a Post article. “You’ll have really strong economic growth.”

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