The Economic Consequences of State Pass-Through Entity Tax Legislation

In response to the imposition of a cap on individuals claiming a federal itemized deduction for state and local income taxes paid, many U.S. states have enacted pass-through entity tax (PTET) legislation permitting pass-through entities to pay and deduct state income taxes at the entity level rather than the owner level. We estimate that the enactment of PTET legislation is associated with a $21,889 on-average annual decrease in high-income taxpayers’ reported pass-through income, resulting in $13.3 billion less in aggregate annual federal income taxes paid assuming a marginal rate of 24 percent. However, despite this increase in business owners’ after-tax cash flows, we fail to find evidence that PTET legislation spurs GDP growth. Our findings contribute to the literatures examining pass-through entity taxation and the consequences of state income tax policy. We also provide policymakers important and timely evidence on the economic costs and benefits of PTET legislation. Data Availability: All data are publicly available from sources identified in the text. JEL Classifications: H24; H25; H71.