No time for a tax increase on small businesses

OPINION:

It was almost as President Trump says: Too much winning.

A big ancillary plus of the American Tax Cuts and Jobs Act, the centerpiece of Mr. Trump’s first-term economic program and perhaps the most apparent legislative success of his term, was that it contained provisions encouraging residents to urge their state and local governments to cut taxes.

That meant Mr. Trump passed the most pro-growth legislation in a generation through a hostile Congress and sent a signal to even high-tax states that tax cuts were the path to economic revitalization.

The American Tax Cuts and Jobs Act, enacted in 2017, doubled the standard deduction and thus significantly reduced the number of taxpayers who itemized on their returns. The legislation capped deductions for state and local taxes at $10,000 for individuals, which meant the deduction didn’t necessarily cover the tax bill in places such as New York, Oregon and California.

Large businesses and even C Corps have always been exempt from these taxes. They are deducted as business expenses. S Corps and individual proprietorships, generally the smallest of small businesses, were charged as individuals. However, 36 states worked out pass-through provisions after the American Tax Cuts and Jobs Act was enacted, so even those small businesses could deduct state and local taxes through various entities.

However, the dream of inspiring blue states to copy their red state brethren and lower taxes did not materialize. Blue state lawmakers directed their anger over the $10,000 deduction at their Republican counterparts. Now, they are back trying to get Congress to “fix” the situation by raising the individual deduction to $100,000 for married couples, meaning a loss of nearly $1 trillion in revenue over 10 years.

In addition, Congress could target those business pass-throughs at S Corps, individual proprietorships and even C Corps. The House Ways and Means Committee writes tax legislation and seeks ways to save. Last week, the full House passed a measure allowing for $4.5 trillion in tax cuts. The package Mr. Trump proposed to extend the 2017 cuts and make other cuts to spur economic growth would consume $4 trillion, but his plan to end taxes on tips and overtime work would consume more.

Now, some members of Ways and Means have discussed a plan to cap the amount that small businesses could deduct to increase the deduction for individuals. That would amount to an effective 6% increase in business tax rates and a blow to companies that produce the most American jobs and are most vulnerable to economic ups and downs.

This is true even though the pass-throughs generate as much as $80 billion annually, or $50 billion if you limit the deduction to state and local income taxes only. A Bipartisan Policy Center and Tax Foundation analysis found that repealing corporation deductions for state income taxes could raise $192 billion over 10 years. However, the Tax Foundation also found that disallowing the deduction would cost American businesses nearly $40 billion a year next year and almost $50 billion annually by 2034, which would seem to mean this is not a terrific deal.

The truth is that there’s nothing wrong with continuing to incentivize high-tax states to lower their rates. Perhaps the continued population losses by these states will prompt a rethinking of tax policy. The principle is worth defending in any case.

Perhaps those who seek reform could be more reasonable. Instead of a $100,000 deductible to address the marriage penalty, how about a $20,000 deduction and perhaps a state and local tax adjustment for seniors? This would provide an adjustment without increasing the deficit and provide a way to do so without creating a huge deduction for wealthy households in blue states at the expense of small businesses across the country.

There are several ways to do this, and Congress should investigate some of them. Small businesses are just beginning to recover from the multiple Biden recessions and even the dramatic steps Mr. Trump has taken to jump-start the economy. This is a time to promote growth and avoid further shocks to the system. This is no time to hit them with another tax increase.

• Brian McNicoll is a freelance writer based in Alexandria, Virginia, a former senior writer for The Heritage Foundation and former director of communications for the House Committee on Oversight and Government Reform.