House Tax Bill Would Worsen Business Tax Parity

The 2017 Tax Cuts and Jobs Act (TCJA) introduced Section 199A. This provision, scheduled to expire next year, provides owners of “pass-through” businesses a 20 percent deduction for qualified business income. The House TCJA extension bill would increase this deduction to 23 percent and make it permanent. This would be a mistake if lawmakers are truly concerned about “parity” between business forms.

Section 199A is meant to address the concern that pass-through businesses would otherwise be at a competitive disadvantage relative to C corporations. In 2017, lawmakers reduced the corporate income tax rate from 35 percent to 21 percent. However, they only reduced the top individual income tax rate from 40.8 percent (39.6 percent plus the “Pease” limitation on itemized deductions) to 37 percent. The 199A reduces the effective statutory rate on pass-through business income to 29.6 percent.

Rather than ensuring “parity” between business forms, the 20 percent pass-through deduction maintained a pre-existing tax advantage for pass-through businesses. While C corporations face a 21 percent entity-level tax that is well below the top statutory tax rate of 37 percent, their profits also face an additional tax in the hands of their shareholders at rates as high as 23.8 percent. Pass-through businesses, in contrast, only face the individual income tax, reduced by the special 20 percent deduction.

After the TCJA expires next year, pass-through business investment will face a marginal effective tax rate of 19.6 percent on average (Figure 1). C corporations, on the other hand, will face an marginal effective tax rate on new investment of 25 percent, giving pass-through businesses a 5.4 percentage point advantage. This estimate takes into account the fact that many owners of C corporations often do not face the individual income tax because assets are held in tax preferred accounts and benefit from provisions like step-up in basis at death.

The House proposal would increase the tax advantage for pass-through business investment by 50 percent. If the House proposal is enacted, the marginal effective tax rate on corporate investment would be 20.5 percent in 2026. Pass-through business investment, however, would face an even lower marginal effective tax rate: 2.5 percent—an eight percentage point advantage. While both business forms would benefit from the expensing provisions in the bill, pass-through businesses would also benefit from the three-percentage point Section 199A enhancement.

In fact, pass-through business investment would have an advantage under the House proposal even if 199A were allowed to expire. This is because most of the tax advantage for pass-through businesses in the House bill is due to expensing. Expensing eliminates the entire tax pass-through businesses pay on qualifying investments, but only eliminates the entity-level tax for C corporations. C corporate investment still faces the individual income tax. Expensing is also why 199A only marginally reduces the tax burden on pass-through business investments in the House bill.

Figure 1. The House Version of TCJA Extension Would Worsen Business Tax Parity. The Marginal Effective Tax Rate by Legal Form of Organization, House Proposal and Current Law, 2026.

Source: Author’s Calculations based on Kyle Pomerleau, “Section 199A and Tax Parity,” American Enterprise Institute, 2022.

The story is the same if the tax burden is measured as the average effective tax rate instead of the marginal tax rate (Table 1, at the end).

Arguments in favor of Section 199A have always been weak, but they are even weaker now than they were in 2017. Since the passage of the TCJA, lawmakers have enacted new C corporate-only tax increases. The Inflation Reduction Act (IRA) included the corporate alternative minimum tax (CAMT) and a one percent stock buyback excise tax. These taxes further increased the tax advantage of being a pass-through business and, if anything, suggest that lawmakers should reduce Section 199A, not increase it.

Lawmakers’ hearts are in the right place. Tax policy should aim to treat all businesses equally and remove tax-induced distortions. Unfortunately, Section 199A fails to accomplish this. Instead, it makes things worse while increasing the cost of the House bill by more than $800 billion over a decade. Lawmakers should focus on other fiscally responsible, pro-growth tax policies.

Table 1. The House Version of TCJA Extension Would Worsen Business Tax Parity. The Marginal and Average Effective Tax Rates by Legal Form of Organization, House Proposal and Current Law, 2026.

	Current Law	House Proposal	House Proposal, No 199A
Marginal Effective Tax Rate
C-Corporations	25.0%	20.5%	20.5%
Pass-through Businesses	19.6%	12.5%	14.0%
Average Effective Tax Rate
C-Corporations	29.8%	28.7%	28.7%
Pass-through Businesses	28.5%	21.3%	26.4%

Source: Author’s Calculations based on Kyle Pomerleau, “Section 199A and Tax Parity,” American Enterprise Institute, 2022.

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