Two of the Republican senators who have stepped forward to block the party’s dash toward a tax overhaul say they are withholding their support to stick up for Main Street. Big corporations, they argue, are being given preferential treatment compared with smaller businesses that are organized differently and known as pass-throughs.
The David-and-Goliath story that the senators, Ron Johnson of Wisconsin and Steve Daines of Montana, are spinning would be compelling — except that it is wrong.
Pass-throughs have a lower total tax burden than corporations do. That advantage exists now and remains in both the House and Senate versions of the tax bill.
If corporations are “the haves,” then pass-throughs are the “have-mores.”
“I honestly don’t know what he’s talking about,” Alan J. Auerbach, a tax expert at the University of California, Berkeley, said of Mr. Johnson’s complaints. “Tax rates are going down a lot. It’s businesses versus everybody else.”
Businesses are taxed in different ways. Corporations and their investors are subject to two layers of taxation. First, a corporate rate on profits is paid directly by the company. Under current law, the top rate is 35 percent. Then, when the business pays returns to its investors, they pay tax on the money they’ve earned when they file in April. That income — dividends and capital gains — is taxed at a top rate of 23.8 percent. (Generally, if your income is less than $200,000, the rate is 20 percent.)
By contrast, pass-through businesses pay tax just once. These are small and mammoth partnerships, proprietorships and companies with fewer than 100 shareholders known as S corporations, and they include the corner grocer and deli owner, the National Football League and Fiat-Chrysler. They aren’t subjected to any separate business tax, but pay on their individual income tax when the money thrown off by the business is passed through to its owners. The rate depends on what bracket someone is in, but the highest is 39.6 percent.
So while the corporate rate by itself may be lower than the top pass-through rate, the total tax burden on corporations is higher. That is one reason so many businesses organize themselves as pass-throughs.
In the Republican rewrite of the tax code, both corporations and pass-throughs would see a huge cut in taxes. For corporations, the rate would drop to 20 percent. Rates would vary for pass-throughs, depending on how much income they earned, but the top rate in the Senate bill is 31.8 percent.
So which kind of business would you prefer to be if the Senate bill were law? Let’s assume that two businesses are the same in every way, except one is organized as a corporation and the other as a pass-through.
Hundred Corporation earns $100 in profits. A 20 percent tax rate would give $20 to the I.R.S., leaving $80 left to return to investors. That $80, when paid out, would be taxed at a flat 20 percent rate, giving the I.R.S. an additional $16, and leaving investors with $64.
The total tax rate turns out to be 36 percent. (Big earners pay an additional 3.8 percent on their dividend income, and they would owe even more.)
Now look at Hundred Partners, a pass-through that also earns $100. Even the wealthiest owners would pay no more than 31.8 percent in taxes.
“As long as there is any tax at the corporate level, it’s going to be better to be a pass-through” in terms of lower rates, said Richard Prisinzano, senior economist with the Penn Wharton Budget Model at the University of Pennsylvania, President Trump’s alma mater.
Pass-throughs are often mistakenly thought of as small, middle-income businesses. Many are. But the overwhelming share of the money they generate goes to a tiny sliver of rich Americans. Nearly 70 percent of the total income earned by such partnerships goes to the top 1 percent, according to a Treasury Department analysis.
The National Federation of Independent Businesses has endorsed the bill. But several trade groups have joined Mr. Johnson and Mr. Daines in arguing that the bill does not do enough to help some pass-throughs compete with traditional corporations. Some, like the American Institute of Architects, complain that service providers — including themselves, dentists, accountants, lawyers and doctors — are not sharing in the windfall like other businesses. Others note that not every single pass-through would benefit.
“The bill could provide only very limited benefits to investors in partnerships that have few direct employees, e.g., real estate partnerships,” analysts from PwC wrote this month. “In some cases, investors might face a lower overall tax burden operating such activities as a C corporation rather than as a partnership or S corporation.”
Mr. Prisinzano at Penn said such results would be possible — and would probably involve wealth individuals deferring corporate returns — but that they would be the exceptions.
Besides, if business owners think being organized as a pass-through is a worse deal, they could simply convert to a corporation. “If pass-throughs really thought corporations were better,” Mr. Prisinzano said, “they could always check the box and be taxed liked a corporation.”