America's Richest Are Hiding in Small Business
Half of the rise in US income inequality comes from pass-through business income, and the owners of these businesses aren't tech giants — they're car dealers, beer distributors, dentists and hot dog vendors, protected as "small business" for forty years.
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The argument · tap a timestamp to hear it
Tax-return data assembles a different picture of the rich
More than a decade ago the two authors were commissioned by the Treasury to link corporate tax returns with the returns of owners and employees, because the IRS itself couldn't match the different forms belonging to the same business. They found that the picture of the rich painted by the media and by Capital in the Twenty-First Century is very different from the actual picture in US tax returns: not passive rent-collecting Gilded Age monopolists, but millions of actively operating middle-market regional business owners. This data project later became the basis of the book.
— Owen ZidarSeventy percent of pass-through income flows to the top 1%
Of pass-through business income, 70 cents of every dollar flows to the top 1% of earners. From the 1980s to 2021, more than half of the rise in the top 1% income share came from pass-through business income. So anyone trying to understand income inequality and wealth inequality can't get around this sector. The authors had assumed monopolistic giants were passively collecting the money, but found instead middle-market regional businesses spread across the whole country, numbering in the millions.
— Owen ZidarCar dealers are the single biggest bucket of pass-through income
The book opens with a "wedding of the century": a third-generation Mercedes dealer in Florida threw his daughter's wedding in Paris, renting out Versailles for the dinner and spending $60 million, just after selling the dealership for several hundred million dollars. When the authors looked at top 0.1% pass-through income by industry, car dealers ranked first. They then went to yacht and private jet registration data and found these people by name, because tax returns themselves can't identify individuals.
— Owen ZidarCar dealer wealth is half skill, half licence
The authors tell two stories. Larry Miller started in Toyota's parts division, took the parts business from 961st to first, and went on to own more than 40 dealerships and buy the Utah Jazz — a good case of "move slow and make things." But the other side is regulatory protection: franchise laws were meant to protect small dealers from being force-fed inventory by Ford and GM, yet in 2008 Chrysler had three times as many dealerships as Toyota while selling the same number of cars, and closing a store meant paying three years' rent. Dealers also enjoy geographic monopolies and high margins on add-on services like warranties and financing.
— Owen ZidarBeer distributors are a rent-collecting layer left by Prohibition
The truck you see on the road with Budweiser on it actually belongs to a distributor, such as Reyes. These distributors sit between brewers and bars, restaurants and grocery stores; state laws require beer to pass through this layer, originally to stop big brewers from controlling production and distribution at once. The result is that these "little guys" became big guys, showing up en masse in the private jet data. The authors mention a beer wholesalers' convention in San Antonio where the mayor said he'd never seen so many private jets at the airport.
— Owen ZidarSame anaesthesiologist, far higher tax burden for the employee
The book compares two anaesthesiologists: one runs a private practice through an S-Corp, the other draws a salary from a hospital system. The former treats most of his income as business profit, paying no payroll tax and no uncapped Medicare surtax, even though he bills Medicare heavily. The IRS only requires payroll tax on the "reasonable compensation" portion of wages; anything above that counts as profit. The 2017 reform cut the top pass-through rate from 37% to below 30%, and although it put guardrails on professional services like doctors, by spinning out surgery, ancillary services or real estate, more income can still be shifted into the lower-rate bucket.
— Owen ZidarA quarter of federal elected officials are pass-through owners too
The authors say the reason the tax loophole survives so long is that roughly a quarter of federal elected officials are themselves pass-through business owners. Ohio Senator Bernie Moreno is a car dealer, and the Social Security plan he co-proposed with Elizabeth Warren is funded by payroll taxes on working-class wages, with no mention at all of these wealthy business owners. The authors argue the most realistic reform isn't abolishing the loophole but capping it by income: for instance, once business income exceeds $1 million or $400,000, you can no longer take the deduction that cuts the rate from 37% to 30%.
— Owen ZidarThe owners' share of the pie rose from four-tenths to five-tenths
Over the past 25 years, 60% of growth in the corporate sector came from the pass-through form, so the pie is getting bigger; at the same time, the share owners take out of the pie rose from a third to 40% to about 50%. Using data from 2001 to 2021, the authors calculate: value added per worker rose from $34,000 to $52,000, a gain of $18,000, of which owners took $15,000. They attribute this to skill scarcity (the US has 30% fewer doctors per capita than the OECD average, with the AMA restricting supply), policy-created scarcity, and the rising value of professional services such as M&A.
— Owen ZidarIn their own words · checked verbatim
So this income is among the most concentrated. So pass-through business income, 70% of every dollar pass-through business income goes to the top 1%.
Owen Zidar12:16
And they had just sold the dealership. Uh, for several hundred million dollars to actually a consortium that Nick Saban was a co-owner of, um, but they dropped $ 60 million on this wedding.
Owen Zidar15:22
That's one, you know, broader lesson of the book is that it takes a long time, you know, in contrast to the Silicon Valley, move fast and break things. It's often move slow and make things.
Owen Zidar19:23
I like to think of the tax code like a house that sort of depreciates over time and you kind of need to like invest in it, like repair windows, replace the floor, this kind of thing. These loopholes are like the depreciation that's applied to this house over time.
Owen Zidar36:33
The reason they've been so persistent, we haven't fixed them, is because it turns out that like a quarter of federal elected officials are also pass-through business owners.
Owen Zidar38:35
if you take all pass-through income, only 20% of it is actually small business, according to an old Treasury study. The vast majority are big businesses that happen to be private.
Owen Zidar39:36
So I think if memory serves, in 2001, the value add per worker, so that's like add up profits and pay for people, was. 34K a worker. And then that went up 18K to 52K in 2021. So there's 18K per worker of growth. Owners got 15 of that and workers got the rest.
Owen Zidar52:58
Figures
| Share of pass-through income flowing to the top 1% | 70% | 12:16 |
| Share of the rise in top 1% income going to pass-through | More than half | 12:16 |
| Cost of the wedding of the century | $60 million | 15:22 |
| Number of dealerships Larry Miller eventually owned | More than 40 | 19:23 |
| Chrysler vs. Toyota dealership count in 2008 | Chrysler had three times as many as Toyota, with the same sales volume | 20:24 |
| Top pass-through rate after the 2017 reform | Cut from 37% to below 30% | 35:33 |
| Share of federal elected officials who are pass-through business owners | About a quarter | 38:35 |
| Share of pass-through income that actually belongs to small business | 20% | 39:36 |
| Share of corporate-sector growth over the past 25 years coming from pass-through | 60% | 48:52 |
Glossary
- pass-through
- An entity whose business profits are not taxed at the corporate level but pass straight through to the owner's individual tax return, such as an S-Corp or a partnership.
- S-Corp
- A US corporate form for small businesses whose profits pass through to shareholders' personal returns and are not subject to corporate tax.
- search fund
- A vehicle in which a student or entrepreneur first raises money for two years to search for a small business to acquire, then raises a second pool to do a mini LBO once one is found.
- LBO
- An acquisition using a large amount of debt, repaid out of the target company's cash flow.
How to listen
Investors and founders who care about US tax policy, wealth distribution, PE and search funds, and regional middle-market businesses; anyone who wants to understand the pass-through tax loophole.
The opening chit-chat about how hard government data is to use can be fast-forwarded; the core content starts at 11:16 with the explanation of pass-through.