Reform Tax Treatment of Business Income

This option combination reforms the tax treatment of business income by repealing the Section 199A passthrough deduction, lowering the top marginal tax rate on ordinary income from 37 percent to 35 percent, providing full expensing for all capital investment, and flipping the tax treatment of interest to disallow deductions for interest expenses and not tax interest income received.

Repealing the Section 199A passthrough deduction, which generally allows passthrough businesses to deduct 20 percent of qualified business income, would increase marginal tax rates on business income. Similarly, flipping the treatment of interest would also increase the cost of capital for businesses by raising marginal tax rates on debt-financed investment. However, lowering the top marginal tax rate on individual income would reduce marginal tax rates and providing full expensing for all capital investment would lower the cost of capital. On net, the effect would be lower marginal tax rates on labor and capital.

On a conventional basis, this option would increase the primary deficit by $298.6 billion over the budget window, with some of the cost front-loaded due to the change in timing of business deductions. Long-run GDP would rise by 1.3 percent, and long-run GNP by 1.7 percent. On a dynamic basis, this option would decrease the primary deficit by $608.5 billion from 2027 through 2036, $907.1 billion more than the conventional estimate. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be 14.8 percentage points lower than baseline, reaching 161.1 percent by 2056.

On average, taxpayers would see a 1 percent increase in after-tax incomes on a conventional basis in 2027. By 2036, after-tax incomes fall on average by 0.3 percent as the disallowance of new interest deductions becomes more binding and the timing effect of full expensing fades; only the top 1 percent of filers would see an increase.

On a long run dynamic basis, all income groups would see an increase in after-tax income, averaging 0.6 percent. After-tax incomes are buoyed by the long-term increase in incomes from higher economic growth.