The One Thing Missing From the Qualified Business Income Deduction Conversation: Racial Equity
briefAuthors
President Biden and Congress are considering paring back a tax subsidy for wealthy business owners created at the end of 2017 by the Tax Cuts and Jobs Act (TCJA). Doing so would raise significant revenue, improve the progressivity of the federal tax code, and importantly, increase racial equity.
Section 199A, also known as the qualified business income deduction (or QBI for short), is a 20 percent deduction for income that individuals receive from “pass-through” business—the businesses whose profits are not subject to the corporate income tax, but instead are included as income on the personal income tax returns of the owner or shareholders. There are many complicated rules for determining who is eligible and what types of business income are eligible, but one thing is clear: most of the benefits go to the rich. According to an analysis of estimates from the Joint Committee on Taxation, more than 60 percent of the QBI deduction’s benefits go to the richest 1 percent and just 4 percent to those in the bottom 67 percent.[1]
When crafting tax policy, lawmakers and bill authors often work backward, using a patchwork of changes to help achieve their stated goal. One important consideration that is routinely left out is what impact the change will have on racial equity. Such is the case with the qualified business income deduction, which is helping to further enrich wealthy business owners, the overwhelming majority of whom are white. At present, white Americans own 88 percent of private business wealth despite making up only 60 percent of the population.[2] Meanwhile, Black and Hispanic families confronting much higher barriers to entrepreneurship each own less than 2 percent, despite making up 13 percent and 19 percent of the population, respectively.
There are a host of good reasons to repeal the QBI deduction,[3] including the fact that the deduction is not adequately reaching people of color and is instead worsening racial disparities.
At What Cost?
Though TCJA was billed as a tax cut for working families, analysis by ITEP found that much of the law’s benefits—many of which were tied to changes in corporate taxes or otherwise aimed toward businesses—have gone to America’s wealthiest taxpayers.[4] Relatedly, an analysis on the impact of TCJA by income group and race found that non-white families gained the least, whereas white families gained the most.[5] More than 40 percent of TCJA’s tax cuts flow to a small slice of white households (representing 3.9 percent of all tax returns) with incomes over $243,000. The QBI deduction is an important contributor to this inequity.
A key feature of TCJA was a decrease in the C corporation tax rate from 35 percent to 21 percent. This reduction, however, closed the gap in marginal rates paid by C corporations and other entities, disrupting the preferential tax treatment received by pass-through businesses. After outside lobbying and last-minute revisions, Congress settled on what we now know as the 20 percent qualified business income deduction as a “fix” for those who felt left out.[6] The result was a highly regressive and costly subsidy that treats a business’s owners more favorably than its workers. Making matters worse, seven states have decided to adopt similar subsidies in their own tax codes (Arizona, Colorado, Idaho, Iowa, Ohio, Oregon, and South Carolina), with some of those specifically based on the new federal law.
In practice, the QBI deduction makes the tax code more complicated, which is the opposite of what TCJA’s proponents claimed the law would do.[7] [8] Thresholds, ill-defined terms, and limitations that determine what qualifies for the deduction combine to create an incredibly complex tax provision to adhere to. While its poorly targeted benefits are reason enough to eliminate the deduction, its complexity adds another hurdle for those unable to correctly take advantage of it. According to the Treasury Inspector General for Tax Administration, a review found 12,980 returns from 2019 claiming the QBI deduction to be questionable.[9] The wealthy, meanwhile, can afford expert legal advice to assist in the filing process and help maximize their claims. In fact, a recent investigation of confidential tax records found that just 82 “ultrawealthy” households collectively saved more than $1 billion from their use of the QBI deduction and offered compelling evidence that the owners of companies like WeatherTech, MidFirst Bank, and Uline engaged in aggressive tax planning to squeeze even more out of the deduction.[10]
Understanding the Gap
The racial wealth gap and chasm between, specifically, white and Black Americans is well-known. A history of systemic racism in employment, housing, and education—to name just a few areas—has played a significant part in affecting a range of outcomes in our broader society, including in income and wealth. In 2019, for example, Black and Hispanic households held $24,100 and $36,100, respectively, in median wealth compared to $188,200 for white households.[11]
The pass-through, business-owning population is predominately made up of owners who are most likely to be white, older, male, and wealthy.[12] These outcomes are not entirely unexpected, as a key barrier for people of color starting entrepreneurial ventures is one that is directly tied to the effects of our nation’s history of discrimination: start-up capital.
Capital formation is one of the most important components of starting a business, but white entrepreneurs outpace Black entrepreneurs in access to practically every source of capital including formal sources (banks, venture capital, angel investors, etc.), informal sources (friends, family, close associates), and owner debt and equity.[13] Difficulties may stem from a number of reasons like a lack of intergenerational wealth to pass on; a loan denied because the bank is unfamiliar with a unique business common among minority populations; or denied financing because of an insufficient credit score—a system that only recently began considering rental payments, which is relevant because white homeownership rates are 30 percentage points higher than Black homeownership rates.[14]
While the Treasury Department has yet to publish a formal analysis of the race and ethnic groups that benefit most, and least, from the QBI deduction, it is abundantly clear from what we know about the distribution of private business wealth in the United States that this deduction is primarily available to a select group of taxpayers who are the beneficiaries of private business wealth and is enriching already wealthy owners of big businesses—a group that is disproportionately white. The deduction isn’t so much about expanding opportunities for success as it is about padding the pockets of people for whom our economic system has already made success possible.
Future of the QBI
Fortunately, there is hope for progress in the current Congress. Senate Finance Committee Chair Ron Wyden, D-Ore., recently introduced the Small Business Tax Fairness Act, with the goal of reforming the QBI deduction to target the benefits more effectively toward smaller businesses.[15] Among other things, the bill would phase out the deduction for those earning over $400,000 and would expand the deduction to those in business sectors not previously covered. The income threshold also allows the bill to remain in line with one of President Joe Biden’s campaign promises to not increase taxes on those earning less than $400,000.[16]
Another potential outcome for the QBI deduction is that it will simply expire. The provision is set to end after 2025, though it is possible that it becomes permanent law should wealthy taxpayers and lobbyists increase pressure on lawmakers as they did during the drafting of TCJA.
Congress is only helping to further exacerbate the racial wealth gap by providing preferential treatment through misguided deductions to businesses that do not need them. The best option would be for Congress and the president to repeal the deduction. Short of that, however, Sen. Wyden’s proposal would be a significant improvement, making our tax code more equitable compared to the law as it currently stands.
[1] Chuck Marr, Center on Budget and Policy Priorities, “JCT Highlights Pass-Through Deduction’s Tilt Toward the Top.” April 2018. https://www.cbpp.org/blog/jct-highlights-pass-through-deductions-tilt-toward-the-top
[2] Board of Governors of the Federal Reserve System, “DFA: Distribution of Household Wealth in the U.S. since 1989.” June 2021. https://www.federalreserve.gov/releases/z1/dataviz/dfa/distribute/table/#frb-rs-dfa-table;quarter:126;series:Private%20businesses;demographic:race;population:1,3,5;units:shares;range:1989.3,2021.1. U.S. Census Bureau, “Annual Estimates of the Resident Population by Sex, Age, Race, and Hispanic Origin for the United States: April 1, 2020 to July 1, 2019.” White and Black populations are defined to include only non-Hispanic individuals in the DFA data and we have used to same definitions of these groups in calculating population shares based on Census data.
[3] Samantha Jacoby, Center on Budget and Policy Priorities, “Repealing Flawed “Pass-Through” Deduction Should Be Part of Recovery Package.” June 2021. https://www.cbpp.org/research/federal-tax/repealing-flawed-pass-through-deduction-should-be-part-of-recovery-legislation
[4] Institute on Taxation and Economic Policy, “TCJA by the Numbers, 2020.” August 2019. https://itep.org/tcja-2020/
[5] Meg Wiehe, Emanuel Nieves, Jeremie Greer, & David Newville, Institute on Taxation and Economic Policy, “Race, Wealth and Taxes: How the Tax Cuts and Jobs Act Supercharges the Racial Wealth Divide.” October 2018. https://itep.org/race-wealth-and-taxes-how-the-tax-cuts-and-jobs-act-supercharges-the-racial-wealth-divide/
[6] Justin Elliot & Robert Faturechi, ProPublica, “Secret IRS Files Reveal How Much the Ultrawealthy Gained by Shaping Trump’s “Big, Beautiful Tax Cut”.” August 2021. https://www.propublica.org/article/secret-irs-files-reveal-how-much-the-ultrawealthy-gained-by-shaping-trumps-big-beautiful-tax-cut
[7] Kevin Brady, “Kevin Brady introduces Tax Cuts and Jobs Act, receives kudos from President Trump.” November 2017. https://kevinbrady.house.gov/news/documentsingle.aspx?DocumentID=400863
[8] Orrin Hatch, United States Senate Committee on Finance, “Hatch Opening Statement at Finance Committee Markup of Tax Cuts and Jobs Act.” November 2017. https://www.finance.senate.gov/chairmans-news/hatch-opening-statement-at-finance-committee-markup-of-tax-cuts-and-jobs-act
[9] Treasury Inspector General for Tax Administration, “Millions of Dollars in Potentially Erroneous Qualified Business Income Deductions Are Not Being Verified.” January 2021. https://www.treasury.gov/tigta/auditreports/2021reports/202140009fr.pdf
[10] Endnote 6 & Robert Faturechi and Justin Elliot, ProPublica, “How the Trump Tax Law Created a Loophole That Lets Top Executives Net Millions by Slashing Their Own Salaries.” August 2021. https://www.propublica.org/article/how-the-trump-tax-law-created-a-loophole-that-lets-top-executives-net-millions-by-slashing-their-own-salaries
[11] Board of Governors of the Federal Reserve System, “Disparities in Wealth by Race and Ethnicity in the 2019 Survey of Consumer Finances.” September 2020. https://www.federalreserve.gov/econres/notes/feds-notes/disparities-in-wealth-by-race-and-ethnicity-in-the-2019-survey-of-consumer-finances-20200928.htm
[12] Nathan Goldschlag, J. Daniel Kim, & Kristin McCue, “Just Passing Through: Characterizing U.S. Pass-Through Business Owners,” November 2017. https://cmepr.gmu.edu/wp-content/uploads/2018/10/CES-WP-17-69.pdf.
Michael Cooper, John McClelland, & James Pearce, et al., “Business in the United States: Who Owns it and How Much Tax Do They Pay?” National Bureau of Economic Research, October 2015. https://www.nber.org/system/files/working_papers/w21651/w21651.pdf
[13] Robert W. Fairlie, Alicia Robb, & David T. Robinson, “Black and White: Access to Capital Among Minority-Owned Startups,” National Bureau of Economic Research, November 2020. https://www.nber.org/system/files/working_papers/w28154/w28154.pdf
[14] Kevin L. Matthews II, “There’s a ’credit gap’ between Black and white Americans, and it’s holding Black Americans back from building wealth,” Business Insider. January 2021. https://www.businessinsider.com/personal-finance/credit-gap-black-americans-building-wealth-2021-1
[15] Ron Wyden, United States Senate Committee on Finance, “Wyden Introduces Small Business Tax Fairness Act to End Republican Giveaways to Top 1 Percent.” July 2021. https://www.finance.senate.gov/chairmans-news/wyden-introduces-small-business-tax-fairness-act-to-end-republican-giveaways-to-top-1-percent
[16] Jen Psaki, The White House, “Press Briefing by Press Secretary Jen Psaki, March 15, 2021.” March 2021. https://www.whitehouse.gov/briefing-room/statements-releases/2021/03/15/press-briefing-by-press-secretary-jen-psaki-march-15-2021/