Study: Pass-through businesses encourage income inequality

Businesses that pay taxes through the individual system — so-called pass-throughs — are fueling the rise in income inequality, according to a new study authored in part by Treasury economists.

That’s because pass-throughs, which include both small businesses and large law firms, don’t pay as much in taxes as corporations. In fact, the top 1 percent saw their share of income double between 1980 and 2013, with more than half of that jump driven by pass-through income.

{mosads}Pass-throughs, which include S-corporations and partnerships, paid an average rate of 19 percent in 2011. The tax rates for partnerships was even lower on average, at 15.9 percent. Corporations, on the other hand, paid close to 32 percent on average.

The top tax rate for both individuals and corporations in 2011 was 35 percent. For the highest-earning individuals, the top rate is at 39.6 percent.

The five Treasury economists, joined by three academics, found that pass-through income and participation was highly concentrated within the top 1 percent, with the wealthiest earning roughly seven of every 10 dollars from pass-throughs. 

That’s far higher than the 45 percent of corporate income that flows to the top 1 percent.

The paper added that the average effective rate on businesses would be 4 percentage points higher — 28 percent rather than 24 percent — without the increase in pass-through activity. That’d be worth about $100 billion more in revenue for the Treasury.