How Do Business Owners Respond to a Tax Cut? Examining the 199A Deduction for Pass-through Firms

We measure the short- and medium-run responses of businesses and their owners to Section 199A, a deduction that reduced the effective tax rate on most U.S. pass-through business income beginning in 2018. Using tax records of individuals and businesses, we compare taxpayers with exogenously differing levels of exposure to the deduction, exploiting limitations within the statute. We find little evidence of an increase in reported business income eligible for the deduction during 2018 or 2019. With appropriate caveats about parallel trends in the disruptive COVID period, we also find no effect in 2020 and at most a modest effect in 2021. We do find some evidence of effects on specific hypothesized margins of adjustment. Partnerships reduced ineligible forms of compensation paid to owners by approximately 10 percent, in line with the incentives created by 199A, while S corporations reduced wage compensation to owners by at most 3 percent. We find no evidence that 199A encouraged movements from employee to contractor status or increased contractor activity in 2018. Finally, we find little evidence of changes in real economic activity as measured by physical investment, wages to non-owners, or employment.