At an uncompetitive 39.1 percent, the U.S. corporate income tax rate is about 14 percentage points higher than the international average of around 25 percent. Lawmakers on both sides of the aisle have recognized that the corporate rate should be lowered, and policymakers have been focused on revenue neutral corporate tax reform options to bring the rate down. Many are seeking to pair a rate cut with the elimination of widely used business expenditures in order maintain revenue neutrality.

This kind of revenue neutral corporate-only reform seems like an attractive option because it gets around the difficult issues of reforming the individual tax code. However, a new analysis by the nonpartisan Tax Foundation shows that this approach could lead to reduced economic growth and increased taxes on 95 percent of American businesses.

“There are several flaws with revenue neutral corporate-only reform,” explains Tax Foundation Economist Kyle Pomerleau. “First, corporate-only tax reform leaves a significant amount of businesses out of tax reform. 95 percent of all businesses in the U.S. are ‘pass-through’ businesses, which file taxes through the individual income tax code instead of the corporate income tax code. As a result, they would not see any benefit from a corporate rate reduction.”

“Secondly, the focus on revenue neutral reform could lead to increased taxes on these pass-through businesses. Paying for a revenue neutral corporate rate cut may require eliminating business tax expenditures widely used by all businesses, while maintaining current tax rates on pass-through businesses. As a result, the tax burden on pass-through businesses would increase.”

Although this type of reform could increase taxes on pass-throughs, how would it impact overall economic growth? According to the Tax Foundation’s TAG model, corporate tax reform which relies on the elimination of business tax expenditures to maintain revenue neutrality would reduce the size of the economy by 0.2 percent, GDP by $36 billion, wages by 0.2 percent, and employment by approximately 32,000 jobs. 

“Reducing the corporate rate is crucial to improving our competitiveness, but it shouldn’t be at the expense of pass-through businesses,” adds Pomerleau. “Policymakers would be wise to seek alternatives that improve our competitiveness at both the corporate and individual income tax levels.”

Full report: Potential Economic Impact of Revenue Neutral Corporate Tax Reform on Pass-Through Businesses