Celebrate 'Small Business Saturday,' but pass corporate tax reform
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Nov. 26 is Small Business Saturday, which the federal government describes as "a day to celebrate and support small businesses and all they do for their communities."

But our celebration of small business should not blind us to economic realities.

One of the most important initiatives to boost economic growth is corporate tax reform that lowers effective rates, especially on companies that invest in research and development or compete in overseas markets.

Unfortunately, opposition from the small-business lobby, including the National Federation of Independent Businesses, threatens to scuttle this effort.

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With the election of Donald TrumpDonald TrumpChaffetz: Threats against lawmakers should be taken seriously Warren cautions Dems against infighting CIA director: Leaks 'seem to be on the increase' MORE as president, there is now a real opportunity to pass legislation to lower effective corporate tax rates, but if the small-business lobby insists on also lowering the top marginal rates on individuals, Senate Democrats will in all likelihood oppose any efforts at reform, given their legitimate concern over rising income inequality.

America should be proud of its small business men and women. They take risks to bring the kinds of products and services to market that consumers value. Just as important, because every Fortune 500 company started as a small company, the continued ability to start firms is vital to the creation of new national champions.

However, America should also be proud of its large corporations.

Companies like Caterpillar, General Motors, IBM and Apple have revolutionized economic management, brought new products to market, created jobs for hundreds of thousands of workers and have also been bedrocks of the communities they operate in.

Because most small businesses are organized as sole proprietors, partnerships or Subchapter S corporations, they do not pay corporate income tax. Instead, their income "passes through" the firm and appears directly on their owners' individual tax returns, where it is taxed as normal income.

As a result, they pay less tax than would the owner of a Subchapter C corporation where income is taxed twice — once at the corporate level and again at the individual level when owners pay taxes on dividends and capital gains.

The small-firm lobby is resisting corporate tax reform because it would lower income tax rates for corporations, not for individuals, thereby reducing their existing tax advantage.

Americans should be wary when government gives preferential treatment to some industries because of political considerations. All things being equal, tax policy should not try to influence decisions such as what business form a firm chooses or whether it borrows or issues stock.

But current tax policy already favors small business with many provisions, such as bonus depreciation on new investment, targeted specifically to small firms.

Moreover, things are not always equal. We know that research and capital investment benefit society as a whole, not just the company that does it. Therefore, we subsidize it.

We also know that many of our corporations face strong competition both from imports here at home and when they try to sell into overseas markets. Much of this is because corporations doing business in America face the highest tax rates among developed countries. Furthermore, these high tax rates apply to foreign income when it is repatriated. This also strongly discourages foreign companies from locating in the United States.

A central goal of corporate tax reform is to reverse this tax disadvantage, making firms doing business in America more globally competitive while also making America a more attractive place for foreign firms to locate production.

In contrast, the majority of small businesses compete domestically against other small firms. As a result, they do not face a competitive disadvantage from tax policy compared to firms from other countries.

In fact, to the extent that they participate in the supply chains of companies that do face a tax disadvantage, lower corporate tax rates should benefit them as a group.

And all firms, large and small, will benefit from the stronger economic growth that greater investment and competitiveness delivers.

Finally, it is very possible that Congress will increase the tax incentives available to small businesses that invest in research and capital equipment. For example, the House Republicans' current tax proposal calls for immediate expensing of all capital investment, a provision that would benefit small and large businesses.

Despite its importance, the need to boost the international competitiveness of larger companies often gets overshadowed by our emotional attachment to small businesses.

Yet the former are the main drivers of the economy. From 1993 to 2010, companies with less than 20 employees accounted for only 15 percent of net job gains.

In contrast, firms with over 500 employees accounted for 38 percent of net job gains.

Moreover, compared with larger businesses, small companies are less productive, pay lower wages, export less, do less research and development, and provide less job security.

Although the small-business lobby is at the forefront of opposition to corporate tax reform, most pass-through businesses are large companies. Therefore, most of the benefit of reducing taxes on pass-through income will go to them.

Although firms making $100,000 or less filed 56.1 percent of the Subchapter S corporation and partnership tax returns in 2012, they accounted for only 12.3 percent of net business income from those groups. In contrast, companies with at least $10 million in assets earned 55 percent of business income.

If Congress truly wants to target small business for help it should focus on issues that have a disproportionate effect on them, like tax simplification and regulatory reform.

But what it shouldn't do is hold up needed reform for the sake of one special interest group.

Kennedy is a senior fellow at the Information Technology and Innovation Foundation (ITIF). He previously served as the chief economist for the U.S. Department of Commerce.


The views expressed by contributors are their own and not the views of The Hill.