CBO Releases a Report on the Taxation of Capital and Labor Through the Self-Employment Tax

Posted on
September 27, 2012

Today CBO released a report, The Taxation of Capital and Labor Through the Self-Employment Tax.

The Self-Employment Contributions Act (SECA) tax is paid mainly by certain small business owners. That tax on sole proprietors and owners of partnerships is often characterized as one that parallels the Federal Insurance Contributions Act (FICA) tax that employers and employees pay to fund Social Security and Medicare. The two taxes, CBO concludes, are not really parallel in the way that they tax capital income and labor income. (For people who are not self-employed, interest, dividends, rents, and capital gains are capital income, and wages and benefits are labor income.) The differences in the treatment of capital and labor income may prompt people to make choices that they would not otherwise make about self-employment or the organizational form of a business, thereby reducing the efficient allocation of resources.

CBO finds that:

  • Approximately 40 percent of the SECA tax base derives from capital income and 60 percent from labor income. The FICA tax base, in contrast, derives entirely from labor income.
  • More than half of the labor income of self-employed people is not included in the SECA tax base. In contrast, virtually all of the labor income of employees is taxable under FICA.

CBO analyzed three options that would modify the SECA tax base by either reducing the share of capital income or increasing the share of labor income it includes. No option by itself would accomplish both of those objectives when applied to both sole proprietorships and partnerships, but one option would do so if applied only to partnerships.

This report was prepared by Paul Burnham of CBO’s Tax Analysis Division.