Donald Trump’s 2017 tax cuts are set to expire at the end of the year, but thankfully, Congress is taking action. The U.S. House of Representatives recently passed the “One Big Beautiful Bill Act,” which packages an extension of the Tax Cuts and Jobs Act (TCJA) with other domestic priorities and will now head to the Senate. (RELATED: Take the Win on the Big Beautiful Bill)
There are upsides and downsides to the new legislation. The bill continues the 2017 tax cuts, requires most Medicaid recipients to work, and phases out expensive green energy subsidies — all good news if you care about shrinking the burden of government. On the other hand, fiscal hawks argue that it doesn’t go far enough because the federal budget will continue to grow too fast. (RELATED: Five Quick Things: The Rescission Cometh)
Wherever you stand, there’s one thing Republicans should all agree on: a tax cut package shouldn’t include a discriminatory tax increase on selected businesses. Yet that’s exactly what this bill does, at least as it is currently written.
It’s a wonky issue, but all that you need to understand is that the tax code allows some businesses, such as S-corporations and LLCs, to deduct their state and local tax payments. Business owners appreciate this system because it tends to be simpler, and it limits their tax burden.
The TCJA preserves this deduction, which has drawn sighs of relief from small businesses. But it also introduces a nefarious exception that would impose a tax increase on so-called specified services trades or businesses (SSTBs). If the current Republican bill passes, businesses considered SSTBs will no longer qualify for the pass-through entity deduction, meaning they’ll be forced to pay more, an effective tax hike.
Tax Increase for SSTBs?
A wide variety of businesses fall into the SSTB category, from dentists to tax advisors to lawyers to doctors’ offices to actuarial scientists. Initially, even real estate agents were considered SSTBs until the government changed its mind in 2019 and reclassified them.
What this shows us is that the SSTB categorization is ridiculously arbitrary. As with so much the government does, no one really understands why this random grouping of businesses exists. What is clear is that the House tax bill makes that silly line between SSTBs and everyone else really matter, discriminating against them and raising their taxes.
As Ryan Ellis writes at National Review, the results will be farcical. “A physical therapy office on one side of the street cannot deduct its state income tax, but a hardware store across the street can. A community pharmacy on one side of the street cannot deduct its state income tax, but giant multinational competitor CVS across the street can.”
Small businesses that are considered SSTBs — and there are many — will be hit especially hard at a time when they’re already struggling. Inflation has proven devastating to many small companies, driving up the price of doing business across the board. Biden-era government regulations also didn’t help, forcing businesses to spend more on administrative costs to navigate the endless thicket of red tape.
Small businesses are far more affected by even minor economic blips than large corporations, which is one reason starting one is such a risky gamble. More than half of small businesses fail in their first year, while two-thirds report that they’re facing financial challenges. The rate of new business creation in the United States has plummeted by 50 percent over the last 30 years, and even tech start-ups are on the decline.
Given this precarious state, why would we want to slap millions of small businesses with a big tax increase? Isn’t this exactly what President Trump is trying to avoid?
There might be an argument for doing so if Congress and the White House were planning to rip up the entire tax code as part of a fundamental tax overhaul. If lawmakers were adopting a better system like a Hall-Rabushka style flat tax, there would be lots of changes that help business, combined with a few that might not be popular. For instance, there would be no deductions for state and local tax payments.
But fundamental tax reform is not on the table. As such, given the tax code that we have, it makes no sense to exclude the deduction for an arbitrary set of businesses. Nor does it make political sense to poison reform efforts with a stealth tax hike on small businesses.
No doubt there will be a number of changes as the Senate takes up the legislation passed by the House. Ensuring that the tax code offers consistency across the board, and not just for those handpicked by the federal government, should be a top priority.
Daniel J Mitchell is the president of the Center for Freedom & Prosperity and a former Senior Fellow at the Cato Institute. He is a Washington-based economist who specializes in fiscal policy, particularly tax reform, international tax competition, and the economic burden of government spending.
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