The deduction was also designed to support the domestic manufacturing sector and reduce effective corporate tax rates. This incentive distorts the allocation of capital. A number of policy options related to the Section 199 deduction conclude this report. Legislative History and Background

The Section 199 domestic production activities deduction was added to the Internal Revenue Code (IRC) as part of the American Jobs Creation Act of 2004 (AJCA; P.L. The Deduction: Applying the Deduction to Qualified Activities

The production activities deduction allows taxpayers a deduction based on the lesser of taxable income derived from qualified production activities (qualified production activity income; QPAI) or taxable income. Eligible income includes that derived from production property that was manufactured, produced, grown, or extracted within the United States. Electricity, natural gas, and potable water production is also eligible. Construction performed within the United States may also qualify for the deduction, as can engineering and architectural services associated with domestic construction projects. In 2012, more than one-third of corporate taxable income was eligible for the Section 199 deduction. These revenues could be used to offset the cost of a tax rate reduction. Eliminating the deduction for all businesses would generate enough additional revenue to offset the cost of approximately a 1.4 percentage point reduction in the corporate tax rate. Alternatively, tax policy can also reduce economic efficiency. Figure 1 illustrates the distribution of Section 199 claims made by corporations across industrial sectors, relative to the distribution of total corporate assets, total corporate business receipts, and total corporate profits (net income less deficit) for 2013. , As noted above, in 2013, 66% of corporate claims of the Section 199 deduction were made by firms in the manufacturing sector. Corporate claims of the Section 199 deduction were also small for the education services, health care, and social assistance sectors. In 2016, an estimated 73% of the revenue loss associated with the production activities deduction was attributable to the corporate sector, with the remainder claimed by pass-through businesses on individual income tax returns ( Table 1 above). For example, if the Section 199 deduction is repealed in exchange for a revenue-neutral lower corporate tax rate, the construction sector stands to potentially lose relative to other sectors. Broadening the tax base by repealing the Section 199 deduction, using the revenue generated to reduce tax rates, would remove an existing distortion in the tax system and could enhance economic efficiency. The Tax Reform Act of 2014 ( H.R. The House Republican 2016 "Better Way" Tax Reform Blueprint also proposed to repeal Section 199 as part of a comprehensive tax reform that would repeal tax expenditures and lower tax rates. In isolation, repealing the Section 199 deduction and providing a revenue-neutral reduction in tax rates could increase the effective tax rates of taxpayers previously qualifying for the deduction. In addition, if the deduction is repealed for all businesses, but the revenues are used only to reduce corporate tax rates, the effective tax rate on pass-through entities could increase. 6 ) did not include a repeal of the Section 199 deduction for oil and gas.
In 2004, Congress added the Section 199 domestic production activities deduction to the Internal Revenue Code (IRC). The deduction was intended to achieve a number of policy goals, including compensating for repeal of the extraterritorial income (ETI) export-subsidy provisions, supporting the domestic manufacturing sector, and reducing effective corporate tax rates.
Under current law, qualified activities are eligible for a deduction equal to 9% of the lesser of taxable income derived from qualified production activities, or taxable income. Eligible income includes that derived from the production of property that was manufactured, produced, grown, or extracted within the United States. Electricity, natural gas, and potable water production is also eligible, as is film production. Domestic construction projects, as well as engineering and architectural services associated with such projects, also qualify. Certain oil- and gas-related activities also qualify for the deduction, but at a reduced rate of 6%. Overall, more than one-third of corporate taxable income qualifies for the deduction.
In 2013, 66% of corporate claims of the Section 199 deduction were attributable to the manufacturing sector. Another 16% of the value of corporate claims came from the information sector, while 3% were attributable to the mining sector. Other large sectors of the economy, such as finance and insurance, as well as wholesale and retail trade, had few Section 199 claims, relative to their contributions toward economic activity.
In practice, the Section 199 deduction reduces corporate tax rates for certain selected industries. Providing a tax break for certain industries can distort the allocation of capital in the economy, reducing economic efficiency and total economic output. Economic efficiency may be enhanced by repealing the Section 199 deduction and using the additional revenues to offset the cost of reducing corporate tax rates. Repealing the Section 199 deduction could allow for a revenue-neutral corporate tax rate reduction of an estimated 1.4 percentage points.
For companies currently claiming the Section 199 deduction, repeal of the deduction in exchange for a reduced corporate tax rate could lead to increased effective tax rates. Under current law, activities eligible for the deduction receive a tax break equal to 3.15 percentage points. Further, the deduction can currently be claimed by pass-through entities, including S corporations and partnerships. If the Section 199 deduction were repealed for all businesses, but rate cuts were confined to the corporate sector, the result could be higher effective tax rates on pass-through entities. Repealing the Section 199 deduction only for the corporate tax could allow for a revenue-neutral corporate tax rate reduction of an estimated 1.0 percentage points.
Recent tax reform proposals include repeal of the Section 199 deduction as part of base broadening, providing additional revenue to offset the revenue loss associated with rate reduction. Specifically, both the Tax Reform Act of 2014 (H.R. 1) in the 113th Congress and the House Republican "Better Way" tax reform blueprint from 2016 include repeal of the Section 199 deduction.