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US Pass-Through Tax Plan 'A Massive Tax Break For High Earners'

by Mike Godfrey,, Washington

17 May 2017

The Urban-Brooking Tax Policy Center (TPC) has calculated that the 15 percent tax rate for pass-through businesses proposed by the Trump Administration could reduce tax revenues by almost USD2 trillion over the next decade.

The TPC modeled the effects of two different tax rates on "pass-throughs" –  sole proprietorships, partnerships, and S corporations. Pass-through business income is taxed on the business owners' tax returns as if it were individual income.

As part of comprehensive tax reform, the Trump Administration is considering how to pass the benefits of lower corporate tax rates on to these pass-through business owners also, while also maintaining the integrity of the individual income tax system, which would also be subject to changes. The study assumes that the 12, 25, and 33 percent individual income tax rates and repeal of the Alternative Minimum Tax will go ahead as proposed.

In addition, the study treated the pass-through rate like a cap; at the 15 percent pass-through rate, people in the 12 percent tax bracket would still pay 12 percent on their business income. Finally, the study assumed there would be only one level of tax on pass-throughs, as there is today, not a second tax on distributions to their owners.

The analysis showed that a 15 percent rate applied to a wide range of pass-through income could add as much as USD2 trillion to the debt over the next 10 years, while distributing nearly all the benefits to the highest income households. A third of this would be as a result of a behavioral shift by taxpayers seeking to recharacterize their wages as pass-through income, the study found.

In broadly applying the 15 percent rate, rather than applying it narrowly, three-quarters of the benefit would go to the top one percent of income-earning households, who make USD700,000 or more, the study said. If the 15 percent rate were applied to a narrow definition of qualifying pass-through income, the loss would be halved, it added.

Meanwhile, if Congress set the pass-through rate at 25 percent on a broad income base instead of 15 percent, it would give no benefit to those in the House GOP's 12 percent or 25 percent brackets, but would cut taxes on those pass-through owners who'd otherwise pay tax at the 33 percent rate. Therefore, the higher rate would shrink the overall size of the tax cut and benefit fewer people, but skew the benefits even more to the highest earners, the TPC said.

The TPC estimates that a 25 percent rate on a broad income base would reduce revenue by between roughly USD570bn and USD665bn over 10 years, depending on the amount of income shifting that occurs. Nearly 90 percent of the benefits would go to those in the top one percent. Alternatively, if the 25 percent rate applied to a narrow income base, the revenue loss would be roughly USD400bn.

TAGS: individuals | tax | business | proprietors | tax rates | United States | tax reform | individual income tax | Tax

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