Director of Federal Tax Policy
Among the 2017 tax law’s most flawed parts is a large tax break for certain “pass-through” income — which the owners of businesses such as partnerships, S corporations, and sole proprietorships report on their individual tax returns rather than pay the corporate tax. Its proponents misguidedly argued that it was needed to maintain “parity” (i.e., a level playing field) between these businesses and corporations, since the latter would benefit from the law’s deep cut in the corporate tax from 35 percent to 21 percent. Although there was no parity between these two types of business taxes before the 2017 tax law to begin with, proponents continue to argue for parity in order to justify this tax break, as a recent Senate Finance Committee hearing shows.
The parity argument has always been misguided. Pass-through businesses enjoyed a significant tax advantage over corporations before the 2017 law, researchers found, and the owners of pass-through entities who think they’ll pay less in tax if their businesses are organized as corporations can always convert their businesses to corporate status. With a faulty rationale to address a problem that didn’t really exist, those who wrote the new tax law gave pass-through businesses a new tax break that created real problems: it mainly benefits the wealthy, loses large amounts of revenue, and greatly expands an existing tax loophole that invites many wealthy individuals to game the system.
To reverse the damage of this and other flawed provisions of the 2017 tax law, policymakers need a clear-eyed view of the tax challenges the nation confronts.
In short, the pass-through provision is deeply flawed. From a Joint Committee on Taxation analysis, we estimate that 61 percent of its benefit will flow to the top 1 percent. This windfall will cost $415 billion over ten years, and roughly $50 billion a year after 2021. And because of its incentive for rampant gaming, it poses a risk to the integrity of the income tax. That’s why policymakers should repeal the pass-through tax break.