Both Democrats and Republicans have expressed interest in reducing the corporate tax rate—now the highest among developed countries—in order to improve the competitiveness of American businesses. According to a new study by the nonpartisan Tax Foundation, however, the implications of lowering individual tax rates are also considerable because of the tremendous growth in non-corporate, or “pass-through,” business forms.
Non-corporate businesses are often referred to as “pass-throughs” because the firm’s profits are passed directly through to the owners and taxed on the owner’s individual tax return. Over the past three decades, the number of pass-through business has tripled to over 30 million while the number of corporations has declined to 1.6 million. Along with this growth, the income of pass-through businesses has increased five-fold, while the income of traditional corporations doubled.
“Many people don’t realize just how much business income is taxed at the highest individual rate,” said Tax Foundation economistKyle Pomerleau. “The majority of businesses today are pass-throughs, and most pass-through income is earned by taxpayers with income greater than $200,000 a year.”
Although the top federal tax rate on pass-through income is 39.6 percent, this is not the only tax for which a pass-through business is liable. Additional city and state income and self-employment taxes typically add up to a relatively high top marginal tax rate. The average top marginal rate for the 23 million sole proprietorships in the U.S. is 47.5 percent, and the average top rate for the 7.3 million S-corporations is 44.5 percent.
“As lawmakers consider ways to improve the competitiveness of American businesses, they should remember that individual income tax rates are just as important to business activity as the corporate rate,” added Pomerleau. “Pass-through businesses account for a large percentage of business income and employment in the United States. Raising taxes on them could curtail their hiring and other investment plans, putting more strain on an already struggling economy.”
Tax Foundation Fiscal Fact No. 394 “Individual Tax Rates Impact Business Activity Due to High Number of Pass-Throughs,” by Kyle Pomerleau is available online. To schedule an interview, please contact communications associate Richard Borean at 202-464-5120 or borean@taxfoundation.org.
The Tax Foundation is a nonpartisan research organization that has monitored fiscal policy at the federal, state, and local levels since 1937.
