The 2025 Tax Debate: The Corporate Tax Rate and Pass-Through Deduction

Source: Internal Revenue Service, Tax Foundation

Policy Change

TCJA included the most significant corporate tax rate change since 1986, permanently reducing the rate from 35% to 21%. Before TCJA was enacted, the tax rate structure followed a graduated pattern, starting at 15% for taxable income up to $50,000, 25% for income between $50,001 and $75,000, 34% for income between $75,001 and $10 million, and 35% for income above $10 million. Under TCJA, the 21% rate applies to all income.

Context

Republicans justified the reduction in the corporate tax rate by arguing the 35% rate made the U.S. a less competitive place for multinational companies to locate economic activity than peer nations. House Republicans wrote:

“The United States has one of the highest statutory corporate tax rates among developed countries. The Committee believes that lowering the corporate tax rate is necessary to ensure domestic corporations remain globally competitive with their counterparts domiciled in the United States’ largest international competitors.”

Democrats criticized the rate cut by arguing it would primarily benefit large corporations and the wealthy, and some argued the corporate rate reduction would provide a windfall to foreign shareholders of U.S. companies.

Impact

The impact of TCJA’s corporate rate cut has been debated since its passage. One study from 2023 argues that TCJA caused U.S. companies to increase domestic investment around 20%, which also increased wages. Another study, from 2022, found that TCJA’s rate cut increased “sales, profits, investment, and employment,” but that economic gains were concentrated among the top 10% of earners. The nonpartisan JCT found that changes in corporate taxes are borne by a mix of business owners and shareholders (capital) and workers (labor), but that capital bears a larger share than labor—75% to 25% for C corporations, and 95% to 5% for pass-throughs.

From a budgetary perspective, TCJA’s corporate tax cut was the most expensive part of the law, projected to reduce revenues by $1.35 trillion from fiscal years 2018 through 2027. The rate cut was offset by approximately $1 trillion in corporate tax increases (by limiting deductions, for example) and international tax reform that raised revenue, such that these pieces combined (corporate and international reform) reduced revenues by $330 billion over 10 years.

Before TCJA, the Congressional Budget Office projected that corporate tax revenues would average $369 billion per year (1.69% of GDP) from fiscal years 2018 through 2023. Instead, corporate revenues have averaged $310 billion per year (1.32% of GDP) over that period, though some of that lower revenue is due to the economic effects of the COVID-19 pandemic.

Corporate tax revenue as a percent of GDP fell an average of 0.66% short of pre-TCJA projections in the first three years of the post-TCJA window (fiscal years 2018 through 2020) but only fell short an average of 0.07% of pre-TCJA projections in the next three years (fiscal years 2021 through 2023).

At least two developments following the enactment of TCJA have made it more difficult to study its impacts, particularly on American businesses: the Trump administration’s imposition of tariffs on hundreds of billions of dollars of imports from China, Canada, Mexico, and other trading partners, and the worldwide economic disruptions of the COVID-19 pandemic.

TCJA also expanded the scope of foreign-sourced income subject to taxation within the United States and provides an incentive for multinational companies to repatriate income previously held offshore. TCJA often applies reduced tax rates to this income—lowering effective tax rates of large profitable corporations, but also increasing tax liability from income that was previously held offshore for indefinite periods of time.

Deduction for Pass-Through Businesses

Revenue Effects at Enactment, FY2018-2027 (JCT): -$415 billion
Revenue Effects if Made Permanent, FY2025-2034 (CBO): -$684 billion

Policy Change

Pass-through businesses, such as sole proprietorships, partnerships, and S corporations, are treated differently than C corporations under the tax code and are not subject to the corporate income tax. Instead, income from these businesses is “passed through” to their owners, who then include their share of profits as taxable income on their individual income tax return.

Under TCJA, single filers with taxable income below $191,950 in 2024 ($383,900 for joint filers) can deduct 20% of their qualified business income (QBI). By reducing the amount of income subject to taxation, the 20% deduction effectively lowers the top tax rate on pass-through business income from 37% to 29.6%. However, the deduction comes with complicated rules and can vary depending on the type of business the owner is claiming a deduction for, the wages the business pays its employees, and the investment property owned by the business. For certain businesses where owners are typically high-income (including health, law, accounting, athletics, and financial services), the deduction phases out once income surpasses a certain threshold.

A complex formula limits the deduction for pass-through businesses whose taxable income exceeds $383,900 for joint filers ($191,950 for single filers). The deduction is reduced through a formula based on a) 50% of the owner’s share of wages the business paid its employees, or b) 25% of the owner’s share of wages it paid its employees plus 2.5% of the owner’s share of the original value of the business’s qualified property. TCJA’s pass-through business provisions are set to expire on Jan. 1, 2026.

Context

Republicans defended the pass-through deduction as a way to “treat corporate and noncorporate business income more similarly under the income tax,” given C corporations received a rate cut of 14 percentage points (40%). Sen. Ron Johnson (R-WI) was a key supporter of the deduction, and originally opposed the Senate’s version of TCJA in November 2017 because he believed it left too wide a gap between the tax rate for C corporations  and pass-throughs (20% and roughly 32%, respectively, in the Senate GOP proposal).

Critics of the deduction said it was “tilted heavily to the wealthy,” complex, and distortive and prone to abuse.

Impact

Though many of the county’s largest companies are organized as C corporations (and pay the corporate income tax), most of the nation’s small businesses—and many mid-sized businesses and even some large businesses—are organized as pass-throughs. For example, nearly 26 million individual tax returns claimed the pass-through deduction in 2021 while only 1.5 million companies filed C corporation returns. While multiple taxpayers can claim pass-through deductions for the same business (such as, for example, when two or more people co-own a business) the disparity holds up when comparing partnership and S corporation returns (9.6 million returns in 2021) to C corporation returns (1.5 million the same year).

The pass-through deduction is one of the most expensive components of TCJA—JCT estimated in 2023 that the deduction would reduce revenues by $199 billion from FY2023-2027. From FY2018-2027, the pass-through deduction cost $415 billion, and is projected to cost $684 billion more to extend from FY2025-2034. According to IRS data, the majority of the tax benefit went to taxpayers with over $200,000 in income in 2020—69%, even as those taxpayers made up only 20% of total claims.

While some tax policy experts predicted a significant portion of pass-through businesses would switch to C corporation status due to the tax rate differential between pass-throughs and C corps—and to take advantage of the new 21% corporate tax rate—there is little evidence as of 2024 that this has occurred. One 2022 study found “no evidence of a ‘large response’ to the deduction,” at least in 2018. Businesses’ response to the deduction may be different if Congress makes it permanent. Some Republicans, including House Ways and Means Chair Jason Smith (R-MO), want to make the deduction permanent. Others, including Senate Finance Chair Ron Wyden (D-OR), want to comprehensively reform the deduction.

Conclusion

TCJA stands as the most substantial overhaul of the business tax code in decades. Though many business provisions in TCJA are permanent law, several continue to inspire debate and deliberation among lawmakers, experts, and the business community, such as the tax treatment of R&D and bonus depreciation. Understanding the implications of these provisions and their potential long-term effects on the economy and government finances will be critical for shaping future tax policies that balance revenue needs, economic growth, and fairness for all taxpayers.

[1] This deficit estimate does not include the $324.4 billion in projected increased revenue from international tax reform in TCJA. We consider these changes in a separate analysis.

[2] For revenue estimates, we reference the Joint Committee on Taxation’s (JCT) December 2017 report, “Estimated Budget Effects Of The Conference Agreement For H.R.1, The Tax Cuts And Jobs Act.”