Analysis: Missouri business tax break has wide reach

JEFFERSON CITY, Mo. -- Legislation awaiting a likely veto by Missouri Gov. Jay Nixon would create a new tax break for the owners of local diners and downtown antique stores. Accountants and doctors could benefit, too. And farmers and car dealers and architects.

So could lawyers and lobbyists.

Nixon has focused on those latter two professions while denouncing the legislation as "an unaffordable giveaway to special interests" that would provide "especially generous benefits for folks that don't need anything."

But Nixon may be oversimplifying the issue while highlighting his opposition.

He could just as easily describe it as a break for ambitious college students running their own lawn-mowing services over the summer. They would benefit, too.

The legislation would gradually cut Missouri's top individual income tax rate to 5.5 percent from 6 percent. It also would phase in a 25 percent deduction for business income reported on personal tax returns -- a category referred to as "pass-through" income.

It's true that many lawyers and lobbyists would benefit from the new tax deduction because of the way their businesses are structured. But so would most Missouri businesses.

"If the policy decision is made to provide a tax cut to businesses, you have to figure out some way to address pass-through entities, because that's the vast majority of all businesses," said Chuck Pierce, a lobbyist for the Missouri Society of Certified Public Accountants.

The tax break would not apply to "C corporations" -- which generally are publicly traded -- because they pay a separate state corporate income tax. But it generally would apply to businesses structured as sole proprietorships, partnerships and limited liability corporations.

Missouri has more than 500,000 active businesses registered with the secretary of state's office. Nearly four-fifths of those are limited liability corporations. Each of those businesses could have multiple owners, partners or members claiming the tax deduction.

Lawyers and lobbyists comprise a relatively small portion of that total.

About 23,000 attorneys live or work in Missouri, according to The Missouri Bar. About 1,000 lobbyists are registered with the Missouri Ethics Commission, though that includes some who wouldn't qualify for the tax break, such as state employees who serve as liaisons to lawmakers on behalf of Nixon's administration.

The tax break for pass-through business income could affect almost 95 percent of all businesses, said Ray McCarty, president of Associated Industries of Missouri, who cited national data available through the Internal Revenue Service.

McCarty said he came up with the idea for the tax break after meeting in August 2010 with the owners of Bennett Packaging and Displays in Lee's Summit. He said the company is organized as an "S corporation" and thus wouldn't have benefited from the corporate income tax cuts being proposed at the time.

It took a while for the idea of a pass-through business income deduction to gain traction in the Missouri Legislature. In the meantime, Kansas changed its law to fully exempt many of those types of businesses from income taxes. Ohio also passed some form of a business income deduction.

Missouri's Republican lawmakers now have made the business income deduction a key part of their tax-cutting agenda.

"It's for small businesses," said House Majority Leader John Diehl. "The backbone of our economy are small businesses -- it's the mom and pop stores on Main Street, it's the people who run businesses out of their homes."

The tax deduction would go only to the owners or partners of businesses, not the employees to whom they pay wages.

Nixon said the deduction would primarily benefit wealthier individuals.

"What lobbyist needs a tax cut? What lawyer does everybody feel so sorry for in this state that they need a tax cut, rather than funding education?" Nixon asked rhetorically while indicating he likely will veto the bill.

Some economists also question the fairness and effectiveness of the business-income deduction.

Scott Drenkard, an economist at the Washington-based not-for-profit research group the Tax Foundation, described the deduction as a "Pandora's box for tax avoidance." He said it could encourage people to reclassify themselves as sole proprietors instead of wage-earning employees of businesses.

Michael Leachman, director of state fiscal research at the Washington-based not-for-profit Center on Budget and Policy Priorities, said the business income deduction would create "a huge windfall for some very wealthy people" without any assurance they would use the extra money to expand their businesses.

"It's a terrible idea if what you're trying to do is boost economic growth," Leachman said.

Proponents contend it's perhaps the best way of boosting the economy.

"This is a tiny cut, but it's going to make a big difference to small-business owners," said Brad Jones, state director of the National Federation of Independent Business. "It's going to make it just a bit easier for people to expand their businesses, create jobs and strengthen the overall economy."

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David A. Lieb has covered state government and politics for The Associated Press since 1995. Follow him at https://twitter.com/DavidALieb