Monday, October 31, 2022
Michael Love (Berkeley) presents Who Benefits from Partnership Flexibility? at UC-Irvine today as part of its Tax Policy Colloquium:
artnerships, unlike corporations, offer business owners and investors great flexibility to divide up income and losses. Although this flexibility can reduce agency and transaction costs, it also presents opportunities to avoid taxes. Regulations limit such behavior, but the question remains: how much tax reduction occurs in practice on account of this flexibility, and who benefits? Using US federal tax records from 2019, I estimate that taxes on partnership income are substantially lower (by 13%, roughly $14 billion) compared to a counterfactual where the same income is allocated according to a less flexible set of rules, similar to S-corporations. I also reconstruct partnership ownership networks to understand who benefits from flexibility. I find that both the use of flexible allocations and the tax benefits therefrom are highly concentrated in a small number of larger, more complex partnership networks, with the largest benefits accruing to very high-income earners and to networks involving tax havens, trusts, foreign entities, and circular structures.
I estimate that traditional “small businesses” only receive about 5% of the tax benefit, while larger and more complex firms, substantially in the investment industry, receive 95%.