Thursday, March 10, 2011

Big Firms Should Not Be Taxed as Passthroughs, Experts Tell Senators

By Brett Ferguson

Large partnerships that have more in common with the way corporations operate than small businesses should not be allowed to be taxed as passthrough entities, a panel of tax experts told the Senate Finance Committee March 8.

About 60 percent of the revenues attributed to small businesses because they come from taxes paid by passthrough entities actually come from a small number of very large partnerships that are essentially being allowed to treat the corporate tax as an “elective.”

“It doesn't make sense to have large businesses that operate very much in the same way as corporations to have an option of which tax they want to pay,” said Alan Auerbach, a professor of economics and law at the University of California at Berkeley.

Likewise, Columbia Law School professor Michael Graetz told the committee that the tax system gives so many advantages to passthrough entities that “it is foolish not to organize a business entity to be taxed as a partnership rather than a corporation” unless the business is one that needs access to the market for public capital.

“Given the flexibility in choosing whether and where to incorporate a business and the growing role of private equity in the world economy, creating greater parity between large corporate and passthrough businesses would be a valuable step to take. This would also allow much simpler, more favorable rules to be applied to small businesses,” Graetz said.

Senate Finance Committee Chairman Max Baucus (D-Mont.) told reporters the issue is worth further discussion and said his primary concern is that large passthrough entities and their principals lack the same sort of accountability that corporations and their directors face.

“There is a lot less accountability for passthroughs and it is concerning,” Baucus said.

Consumption Taxes Get Bipartisan Interest

Senators of both parties also took an interest in the possibility of instituting a consumption tax as an alternative to the existing income tax system.

Although the Senate voted 85-13 in April 2010 on a resolution rejecting implementation of a value-added tax, Sens. Tom Coburn (R-Okla.), Ben Cardin (D-Md.), and Tom Carper (D-Del.) took the basic concept of adopting a consumption-based system seriously.

“What would be wrong with just a flat consumption tax at every level in this country with a rebate back for the necessities of life to every citizen in the country? You'd keep progressivity, you'd eliminate regressiveness in terms of the payroll tax, and you would also markedly advantage our exports. We are at a distinct disadvantage … because of embedded income taxes that our European counterparts don't have,” Coburn asked the witnesses.

His assertion was generally met with positive responses from the panelists, including Glenn Hubbard, President George W. Bush's top tax adviser who helped push for the 2001 and 2003 tax cuts.

Graetz said he also strongly supports the idea of consumption-based taxes, but would not have them solely replace the income tax.

Both Hubbard and Auerbach suggested that there is a way to implement a VAT-type tax without the political blowback, saying moving toward taxing cash flow and using wage taxes would have the same effect as a VAT.

Graetz, however, warned that it would be difficult to implement a cash flow tax that would allow for taxes on imports and not exports because it would violate World Trade Organization rules and would require all of the United States' existing trade treaties to be renegotiated.

“It's not a service to the American people, not to let them know what is being taxed. It is the reason our corporate tax is so bad today, because they think someone else is paying it,” Graetz said.

The complete text of this article can be found in the BNA Daily Tax Report, March 9, 2011.

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