Macroeconomic Perspective on the Rise of Pass-through Businesses

From 1980 to 2012 the share of U.S. business receipts from businesses organized as pass-through entities (for example LLCs and S-corporations) rather than traditional C-corporations nearly triples. This paper investigates the origins of the secular rise of pass-throughs and evaluates it's macroeconomic consequences. We exploit the panel dimension of the administrative data from the Longitudinal Business Dynamics dataset to document a number of facts characterizing the pass-throughs and C-corporations and to estimate the transition matrices between the legal forms. We show that the entry margin and switching margin account for the most of the rise of pass-throughs. Further, using the Statistics of the U.S. Businesses we argue that the shift in the distribution of organizational forms is related to the structural transformation of the U.S. economy and to some other economic forces, such as rise in the dispersion of productivities, which account for within-sector increase of pass-throughs role. We quantify the impact of different economic forces using the structural macroeconomic model, in which entrepreneurs in both sectors choose endogenously the legal form of organization. We proceed to evaluate the macroeconomic consequences of growing importance of pass-through businesses for the U.S. economy with particular focus on the role of microeconomic heterogeneity for macroeconomic outcomes, propagation of aggregate shocks, misallocation and finally welfare.