New district and regional taxes introduced have resulted in marginal state and local tax rates in excess of 26 percent for many Portland small businesses. If all of President Biden’s tax proposals were adopted, these owners could expect marginal tax rates of more than 80 percent, by far the highest in the country in decades.
Most of Portland is in Multnomah County, where voters approved a new high-income income tax with a maximum rate of 3 percent on incomes over $ 250,000 to fund preschool programs. The tax took effect on January 1st. A new 1 percent income tax was also introduced across the metropolitan area to fund supportive housing services that would be added to individual incomes greater than $ 125,000 (including small business owners’ wages) and those businesses net business income of owners at higher Thresholds.
This 4 percentage point increase in local tax is on a long list of existing state and local small business taxes: the individual state income tax, a gross income tax on business activities (including small businesses), both state and regional taxes, and taxes on Corporate and county levels on corporate income, including partnerships and sole proprietorships. They add up – quickly.
Gross income tax, known as Corporate Activity Tax (CAT), is levied on almost all of the company’s gross income at a rate of 0.57 percent, but includes limited deductions for certain business expenses. To compare this tax to the tax that is levied on net income (e.g. wages and profits), we need to make certain assumptions about a company’s profit margins and how much it can deduct.
Nationwide, the average profit margin for a small business is around 7 percent, and the taxpayer is granted a deduction equal to 35 percent of the higher of their labor costs or the cost of goods sold. Assuming these costs are evenly distributed, we get an effective rate of 6.82 percent for a “typical” small business. We’ll use this in our analysis, but it’s important to note that tax rates will vary widely for different industries and companies – one of the criticisms of gross income taxes.
Our typical small business would therefore face a marginal rate of 26.19 percent (including the calculated CAT rate) for its operations in Multnomah County, broken down as follows.
| VAT | Tax base | level | rating |
|---|---|---|---|
| Individual income tax | Individual income | Status | 9.90% |
| Corporation tax | Business Gross Income * | Status | 6.82% |
| Oregon Transit Tax | wage | Status | 0.10% |
| Supportive tax on housing services | Business and Individual Income | Regional | 1.00% |
| TriMet Transit Tax | wage | Regional | 0.7737% |
| Preschool for all taxes | Individual income | district | 3.00% |
| Business tax | Net business income | district | 2.00% |
| Business license tax | Net business income | city | 2.60% |
| Total state and local taxes | 26.19% | ||
|
Note: * Applies to gross receipts with deductions at a rate of 0.57 percent. The 6.82 percent effective interest rate is calculated as described above and is intended to reflect the stresses and strains of a typical small business. Source: state and local tax offices; Research of the tax foundation. |
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This is an amazingly high local tax rate, but it gets worse when combined with federal taxes. Pass-through entrepreneurs pay an individual federal income tax on all net income from their businesses. They are also legally responsible for paying employer Social Security and Medicare taxes for their employees. However, it is important to note that (1) significant portions of these taxes are limited and therefore not related to the border dollar, and (2) economically, employees bear the burden of these taxes. However, the business owner bears both the employer’s and the employee’s costs for her own wage taxes. Thus, the top marginal rate for that portion of their income could total nearly 70 percent, adding the following federal taxes to their government obligations.
| VAT | Tax base | level | rating |
|---|---|---|---|
| Individual income tax | Individual income | Federal | 37.00% |
| Medicare payroll tax | wage | Federal | 2.90% |
| Additional Medicare Tax | wage | Federal | 0.90% |
| Portland State & Local Taxes | Multiple sources | State / Local | 26.19% |
| Current all-in tax burden in Portland | 66.99% | ||
|
Sources: Internal Revenue Service; state and local finance departments; Research of the tax foundation. |
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Finally, President Biden has proposed several changes to the federal income tax law for individuals and transit businesses that are expected to be included in the upcoming American Families Plan Act. (Changes to corporate tax are included in the American Jobs Plan Act, which is currently being released.) These proposals include:
- Increase the highest marginal individual income tax rate to 39.6 percent, a restoration of the TCJA (Pre-Tax Cuts and Jobs Act) rate;
- Creation of a “donut hole” for wage tax, where the social security tax (6.2 percent each for employers and employees), which is currently only levied on the first $ 137,700 wage income and is therefore not part of a marginal tax rate, over $ 400,000 in income is restored;
- Restoration of the so-called pease restriction, which reduces the value of itemized deductions by 3 percent of each dollar of taxable income above a certain threshold (which can be expressed as a marginal rate of 1.118 percent below a maximum tax of 39.6 percent); and
- All individual deductions are limited to 28 percent.
If these provisions were to become law, federal taxes on the marginal rate of a small business in Portland of 26.19 percent would be as follows.
| VAT | Tax base | level | rating |
|---|---|---|---|
| Individual income tax | Individual income | Federal | 39.60% |
| Social Security via Donut Hole | wage | Federal | 12.40% |
| Medicare payroll tax | wage | Federal | 2.90% |
| Additional Medicare Tax | wage | Federal | 0.90% |
| Pease limitation | Individual income | Federal | 1.188% |
| Portland State & Local Taxes | Multiple sources | State / Local | 26.19% |
| Biden Plan All-In Portland Tax Load | 83.18% | ||
|
Sources: Internal Revenue Service; state and local finance departments; Research of the tax foundation. |
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And as if that weren’t enough, next year comes a new state-level tax on paid family vacation of 1 percent on wages up to $ 132,900. That’s a lot of taxes at all levels, but the high state tax rates combined with unusually high taxes at the regional, county, and city levels create a uniquely competitive landscape in Portland.
Portland has always been proudly weird – but does it really want to be that weird?
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