Paul L. Caron

Wednesday, May 8, 2024

The Rise Of Pass-Throughs: An Empirical Investigation

Sebastian Dyrda (Toronto; Google Scholar) & Benjamin W. Pugsley (Notre Dame; Google Scholar), The Rise of Pass-Throughs: An Empirical Investigation:

Pass-through entities have emerged as the leading U.S. business organization form in recent decades. Using comprehensive confidential administrative data, this paper highlights five core findings: (1) the rise in pass-throughs is pervasive across industries and states; (2) the pass-through share converges unconditionally across both; (3) 60% of the rise is driven by entrants' organizational choices; (4) shifts in firm and organizational dynamics following the 1986 Tax Reform Act show continued effects through the 2000s; (5) organizational forms exhibit high persistence with little lifecycle variation. Our study implies that tax or regulatory policy changes might take decades to fully manifest.

We develop the LBD-TLFO data set with taxable legal form information for nearly all U.S. businesses. Examining these data over the 1982–2015 period, we identify new insights into the rise of pass-throughs. Despite initial differences across industry and geography, passthrough adoption converges unconditionally, leaving little scope for compositional effects to explain the rising pass-through share. Instead, applying a dynamic decomposition framework, we determine that shifting organizational choices of entrants explain 60% of the 1982–2015 rise and almost all since the mid-1990s. Most of the shift in reorganization and entrant organization patterns coincide with the TRA86, meaning almost two decades of continued rise in the pass through share was pre-determined. We also see little lifecycle pattern to the choice of legal form, making the initial choice highly persistent. We document a number of legal and accounting requirements that constitute a significant source of real reorganization frictions. Our findings indicate that policy changes in the presence of these frictions take many years to fully diffuse through the entry margin. Incorporating the differing short- and long-run elasticities is important when studying public finance and macroeconomic responses to tax and entrepreneurial policy shifts.

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