President Trump has proposed a maximum 25% tax rate on income that individuals receive from “pass through entities”. Pass through entities are businesses that don’t pay corporate income taxes, but rather pass their net income each year through to the owners to be taxed as part of the owners’ individual tax return. These pass through entities include S-Corporations, partnerships, limited liability companies (LLCs), and sole proprietorships. Currently, income from pass through entities is taxed at the same rate as any other ordinary income – up to a maximum rate of 39.5%. (President Trump’s proposal for ordinary income for most taxpayers is a maximum tax rate of 35%.) He justifies the lower tax rate for pass through entities because, he says, these pass through businesses are the job creators.
This begs at least two questions: Do pass through entities really create more jobs than non-pass through entities? Even if so, why should the income of an employer be taxed at a lower rate than an employee if they earn the same amount? Tax fairness would dictate that two people with the same income would pay the same amount of tax, regardless of source.
Regarding job creation, it is important to know that pass through entities are not just manufacturers, wholesalers or retailers, who may or may not be job creators. They are also professionals such as doctors, lawyers, accountants. Most hedge funds and private equity funds are pass through entities. About 95% of all businesses are pass through entities. Of those, about 99% have revenues of less than $10 million. The 1% of pass through entities with revenues of more than $10 million earn about 83% of all profits! So, some pass through entities are very large, and many owners of pass through entities have very high incomes. Is it fair for business owners to pay at a 25% rate while regular workers with the same income pay at a 35% rate? I don’t think so.
I expect to write several blog posts on President Trump’s tax proposal. The idea of reducing tax rates is a good one – especially if the total plan is revenue neutral and doesn’t increase our $20 Trillion debt. This means that tax reform that reduces rates must also reduce special tax breaks for politically favored groups and/or reduce spending. I hope that Congress, which controls all tax legislation, will not “bet on the come” – that is assume future tax revenue will increase due to future growth in the economy. Our government uses a 10 year look forward to determine the deficit/surplus effect of any change in taxing or spending. In recent decades, it seems that all tax and spending changes have significant costs up front with the promise of savings toward the end the the 10 year period. Let’s not keep doing that.
“Iowa has enjoyed tremendous economic benefits by being a leader in both wind power development and wind manufacturing.” So wrote Mike Prior, Milford, interim executive director, Iowa Wind Energy Association, in a letter to the editor on 2/4/2012, (“Wind energy is important jobs provider”) He went on to extol the many benefits that Iowans have enjoyed as a result of the funding that taxpayers have provided to those in the industry. He urged that we, “… continue to invest in Iowa’s future.”
Good economic analysis must consider both what is seen and what is not seen. We see the jobs. We see the payments to farmers. What we don’t see are the other jobs that would have been created if people had been left to spend or invest their own money. Other jobs would have been created that would not be dependent on government handouts. Instead, we hear a never-ending story about how we must continue to provide taxpayer support or the investment and jobs will be lost. This is very typical when government creates new “incentives” and makes “investments” in what should be left to the private sector.
Welfare for wind energy producers is like all other special interest giveaways: the benefits are large and concentrated among the few who who are politically connected, and and costs are relatively small and disbursed among many taxpayers. This is a classic case in public choice theory. Those who directly benefit have a great incentive to lobby government to continue the subsidies, and those who pay the taxes don’t have a strong incentive to oppose any specific program.
We need legislators who will stand against political favors for special interest factions who press their political power for their own self interest.
Link to Register article: http://www.desmoinesregister.com/apps/pbcs.dll/article?AID=2014302040081