W2018-2 Tax Based Switching of Business Income

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Authors: Richard Prisinzano and James Pearce

Abstract: Discussions of genuine tax reform often focus upon broadening the individual and corporate tax bases and lowering tax rates. These discussions also tend to assume that reform will be “revenue neutral”, meaning that the new tax structure would generate the same receipts for the government as the old structure. Because firms can currently either incorporate or operate as a pass-through entity, one question that results from these discussions is how firms will react to the relative change in the corporate and non-corporate tax rates. Our results suggest that a 10 percent reduction in the tax wedge between the net corporate and individual tax rate will result in a 0.5 to 0.9 percent increase in the share of positive business income accruing to corporations.

Key Words: Tax Policy, Corporate Tax, Tax Wedge, Income Shifting, Entity Choice, Pass-Through Business