It seems like almost all the news about Congressional Democrats’ tax negotiations in the last few months has been negative. But last week, we finally got some major positive news about their plans to tax the rich. The Associated Press reported that Senate Democrats are planning to extend a 3.8% surtax that wealthy investors currently pay to wealthy owners of pass-through businesses as part of their new “skinny” Build Back Better Act that would bolster the Medicare trust fund.
For years now, wealthy owners of pass-through businesses have gotten away with paying next to nothing in taxes because of deductions and loopholes in our tax code specially designed for their benefit. By implementing this 3.8% tax on individuals making more than $400,000 and couples making more than $500,000 through these businesses, Senate Democrats’ new tax takes a step in righting this wrong and making wealthy people like us start paying our fair share in taxes.
Conservative anti-tax opponents of this move are sure to attack it as an assault on small businesses. While it’s true that pass-through businesses make up the majority of businesses in America, this change would affect very few actual businesses. According to a report from the Brookings Institution, roughly 95% of all businesses in America are pass-throughs, a category that includes an array of business types – like partnerships, S corporations, limited-liability companies (LLCs), and sole proprietorships. But despite their prevalence, almost half of all pass-through income in America flows to just the top 1% of income earners. (Former President Donald Trump is one of those earners – nearly all of his income comes from pass-throughs.) To make matters worse, most pass-throughs owned by the rich are nothing but legal fictions that they and their armies of tax lawyers create to take advantage of the 20% pass-through deduction. The National Bureau of Economic Research estimates that no less than 75% of all pass-through income is actually just personal income being deceptively passed off as business income.
Normal people don’t have the means to hire a lawyer and accountant to form a fake company in order to pay lower taxes, but rich people do. And thanks to the 2017 GOP Tax Cuts and Jobs Act (TCJA) giving pass-through businesses a 20% tax deduction, it’s been exceptionally profitable for them to do so. Before the TCJA, pass-through business income was taxed under the same rate structure as personal labor income, but now pass-through owners effectively only have to pay tax on 80% of their earnings. The GOP implemented this deduction with the purported aim of helping small businesses and workers. But like with most parts of the TCJA, it merely served as a boon for the ultra-rich. According to one estimate by the Joint Committee on Taxation, 61% of the benefits from the pass-through deduction flowed to the top 1% of income earners, while just 4% of the benefits went to the bottom 67%.
Senate Democrats’ latest proposal to raise taxes on the richest pass-throughs is a step in the right direction in righting this wrong. It sends a strong message to wealthy pass-through business owners that they cannot misclassify their income with impunity and forces them to start paying their fair share in taxes. There’s more work to be done in this regard, but it’s certainly a great step forward.
Democrats desperately need a big legislative win to sell to prospective voters ahead of the 2022 midterm elections. By passing this new tax proposal as part of a revamped Build Back Better Act, Democrats could get their win and improve their odds for electoral success. There is overwhelming support among the public for raising taxes on the rich – not to mention protecting vital social safety net programs like Medicare – and this initiative would absolutely deliver.
The only obstacles that remain for Senate Democrats in getting this done lie with moderate Senators Manchin and Sinema. They are why the original Build Back Better Act, which included several other promising tax reforms, failed to pass last year. We can only hope that these two Senators will finally be able to meet the moment, join their fellow Democrats, and put the financial interests of their constituents ahead of their donors.