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Preferential Pass-Through Business Tax Rates and Tax Avoidance

April 29, 2017

Preferential Pass-Through Business Tax Rates and Tax Avoidance

Leonard Burman and Joseph Rosenberg, Tax Policy Center (April 2017). The large (and growing) share of businesses organized as pass-through entities—those that do not pay the corporate income tax but rather pass profits through to owners, who report the income and pay tax on their individual tax returns—has been a sticking point in recent efforts to reform the individual and corporate income taxes. Reforms focused on lowering the 35 percent statutory corporate tax rate have raised concerns about “small businesses” that would not benefit from the lower rate. Some reform plans, such as President Trump’s tax plan and the House GOP’s tax reform blueprint, have proposed a new lower individual tax rate for pass-through income. Kansas has gone so far as to exempt pass-through businesses from income tax entirely.

Advocates of such proposals argue that they would stimulate employment and the economy. For example, here’s President Trump during the 2016 election:

“I’ll be reducing taxes tremendously, from 35 percent to 15 percent for companies, small and big businesses. That’s going to be a job creator like we haven’t seen since Ronald Reagan. It’s going to be a beautiful thing to watch. Companies will come. They will build. They will expand. New companies will start.”

However, the proposals would also create new avenues for tax avoidance, and they would continue to tax corporate investment more heavily than other forms of investment.