Combination 8:

Reform Tax Treatment of Business Income

Topline Estimates

Gross Domestic Product (GDP)
+1.3%
Gross National Product (GNP)
+1.7%
Full-Time Equivalent Jobs
+427K
Wage Rate
+1.0%
Capital Stock
+1.9%
Conventional Primary Deficit Change (10‑Yr)
+$298.6B
Dynamic Primary Deficit Change (10‑Yr)
-$608.5B
Dynamic Total Deficit Change (10‑Yr)
-$593.5B

Source: Tax Foundation General Equilibrium Model.

This option combination reforms the tax treatment of business income by repealing the Section 199A passthrough deduction, lowering the top marginal tax rate on ordinary income from 37 percent to 35 percent, providing full expensing for all capital investment, and flipping the tax treatment of interest to disallow deductions for interest expenses and not tax interest income received.

Repealing the Section 199A passthrough deduction, which generally allows passthrough businesses to deduct 20 percent of qualified business income, would increase marginal tax rates on business income. Similarly, flipping the treatment of interest would also increase the cost of capital for businesses by raising marginal tax rates on debt-financed investment. However, lowering the top marginal tax rate on individual income would reduce marginal tax rates and providing full expensing for all capital investment would lower the cost of capital. On net, the effect would be lower marginal tax rates on labor and capital.

On a conventional basis, this option would increase the primary deficit by $298.6 billion over the budget window, with some of the cost front-loaded due to the change in timing of business deductions. Long-run GDP would rise by 1.3 percent, and long-run GNP by 1.7 percent. On a dynamic basis, this option would decrease the primary deficit by $608.5 billion from 2027 through 2036, $907.1 billion more than the conventional estimate. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be 14.8 percentage points lower than baseline, reaching 161.1 percent by 2056.

On average, taxpayers would see a 1 percent increase in after-tax incomes on a conventional basis in 2027. By 2036, after-tax incomes fall on average by 0.3 percent as the disallowance of new interest deductions becomes more binding and the timing effect of full expensing fades; only the top 1 percent of filers would see an increase.

On a long run dynamic basis, all income groups would see an increase in after-tax income, averaging 0.6 percent. After-tax incomes are buoyed by the long-term increase in incomes from higher economic growth.

Modeled Results

Explore All Reform Options

Browse, search, and sort every reform option in the guide.

About the Authors

Erica York Tax Foundation
Expert

Erica York

Vice President of Federal Tax Policy

Erica York is Vice President of Federal Tax Policy with Tax Foundation’s Center for Federal Tax Policy. Her analysis has been featured in The Wall Street Journal, The Washington Post, Politico, and other national and international media outlets.

Garrett Watson Tax Foundation
Expert

Garrett Watson

Director of Policy Analysis

Garrett Watson is Director of Policy Analysis at the Tax Foundation, where he conducts research on federal and state tax policy. His work has been featured in The Washington Post, The Atlantic, Politico, the Associated Press and other major outlets.

Huaqun Li Tax Foundation
Expert

Huaqun Li

Senior Economist, Director of Modeling Projects

Dr. Huaqun Li is Senior Economist, Director of Modeling Projects at the Tax Foundation. She focuses on developing and maintaining the Foundation’s Taxes and Growth Model, which models the budgetary and economic effects of changes to federal tax policy.

William McBride or Will McBride Tax Foundation
Expert

William McBride

Chief Economist & Stephen J. Entin Fellow in Economics

Dr. William McBride is the Chief Economist & Stephen J. Entin Fellow in Economics at the Tax Foundation, where he oversees major research projects primarily related to reforming the federal tax code, advancing sound tax policy, and improving the federal government’s fiscal outlook.

Alex Durante Tax Foundation
Expert

Alex Durante

Senior Economist

Alex Durante is a Senior Economist at the Tax Foundation, working on federal tax policy and model development. Alex worked as a research assistant at the Federal Reserve Board and served as a staff economist on the Council of Economic Advisers.

Alex Muresianu Tax Foundation
Expert

Alex Muresianu

Senior Policy Analyst

Alex Muresianu is a Senior Policy Analyst at the Tax Foundation, focused on federal tax policy. Previously working on the federal team as an intern in the summer of 2018 and as a research assistant in summer 2020. He attended Tufts University, graduating with a degree in economics and minors in finance and political science.

Peter Van Ness Tax Foundation

Peter Van Ness

Research Software Developer

Peter Van Ness is a Research Software Developer at the Tax Foundation working on federal tax policy and model development. Peter previously worked as a research assistant at another think tank and as a data analyst at a consulting firm.

Aleksei Shilov Tax Foundation Research Software Developer

Aleksei Shilov

Research Software Developer

Aleksei Shilov is a Research Software developer at the Tax Foundation working on economic model development and federal tax policy. Aleksei joined the Tax Foundation as an intern in January 2025. He holds a B.S. in computer science and a minor in economics from Northeastern University and is currently based in Boston, MA.

Daniel Bunn Tax Foundation President & CEO
Expert

Daniel Bunn

President and CEO

Daniel Bunn is President and CEO of the Tax Foundation. Daniel has been with the organization since 2018 and, prior to becoming President, successfully built its Center for Global Tax Policy, expanding the Tax Foundation’s reach and impact around the world. Prior to joining the Tax Foundation, Daniel worked in the United States Senate at the Joint Economic Committee.