March Madness Exposes a Tax Code Flaw

Last night’s NCAA men’s basketball championship capped off a March Madness season full of busted brackets, missed bets, and office pools gone wrong. For most people who put money on the tournament, the final result meant a loss. But under the tax code, even people who break even over time can still owe tax on money they never actually earned.

That is because the One Big Beautiful Bill Act limits gambling loss deductions to 90% of losses starting in 2025. A gambler who wins and loses the same amount over a year can still owe tax as if real income were left over. Adam Michel of the Cato Institute recently highlighted that problem, and it points to something much bigger than sports betting. Across the tax code, Washington often delays, caps, or denies the full use of losses. The result is the same: taxpayers are forced to pay tax on phantom income, and the biggest penalty falls on risk-taking, investment, and entrepreneurship.

The Tax Code Should Measure Real Income

A neutral tax system should tax real income, meaning income after accounting for the costs of earning it, including the risk of loss.

The gambling example makes the problem easy to see. If someone wins $10,000 and loses $10,000 over the same year, there is no net income. Taxing that person anyway is not a tax on profit. It is a tax on a distorted number that ignores economic reality.

That same principle applies far beyond gambling. Businesses often spend years taking losses before becoming profitable. Investors absorb losses in one project before seeing gains in another. Startups can spend years in the red before ever turning a true profit. If the tax code does not fully recognize those losses, it overstates taxable income and raises the effective tax burden on the very activity policymakers claim to support.

Loss Limits Create Phantom Profits

This is where the code goes wrong.

Net operating loss rules already limit how businesses can use losses from prior years. Following the 2017 changes, many businesses can no longer carry losses back to prior profitable years and instead must carry them forward. C corporations can generally offset only 80% of taxable income with prior losses. Pass-through firms face other restrictions, including the excess business loss rule. Passive activity loss limits add another layer.

The result is simple. A firm can still be recovering from earlier losses and yet owe tax as if it has already become fully profitable.

Individual investors face a similar problem. Capital losses can offset capital gains, but if losses exceed gains, only $3,000 can be used each year against other income. The rest must be carried forward.

That matters because delayed deductions lose value over time. Inflation erodes them. Time erodes them. Meanwhile, taxes on gains are imposed immediately and in full. The code recognizes success right away but makes taxpayers wait to recognize failure. That is not neutral treatment. It is a built-in bias against risk.

Why This Matters for Growth

A pro-growth tax code should not treat risk-taking as a vice.

New businesses rarely follow a straight line. Many lose money early. Some fail outright. Others survive only after years of trial, error, and reinvestment. The same is true for many investments. Several bad bets may come before one good one. That is how innovation works.

When lawmakers limit the recovery of losses, they raise the effective tax rate on uncertain, long-term, and entrepreneurial activity. That pushes the code in exactly the wrong direction. It favors safer, more established income and penalizes the kind of experimentation that often leads to growth.

Congress Should Fix the Gambling Loss Rule and Go Further

The new limit on gambling losses should be reversed. Taxpayers should be able to deduct 100% of their losses against winnings.

But the broader reform should not stop there. Congress should move toward full and fair loss treatment across the tax code. That means allowing losses to offset income more fully, removing arbitrary restrictions on business net operating losses, and indexing carried-forward losses so inflation does not quietly reduce their value. Tax policy should reflect economic reality, not punish taxpayers for the timing of success and failure.

CFE Takeaway

The lesson from the gambling loss change is bigger than March Madness. When the tax code limits losses, it taxes phantom income and discourages risk-taking. That is bad policy for workers, investors, startups, and growth. Washington should stop pretending gross receipts are the same as real profit and start treating losses the way a sound tax system should.