This Key Reform Must Be Central to Any New Tax Plan
By Salim Furth, Heritage Foundation Research Fellow in Macroeconomics & Adam Michel, Heritage Foundation Policy Analyst
As Congress and the president move toward consensus on tax reform, one key reform should remain the centerpiece of any plan that moves forward: making investment expenses tax-deductible.
When conservatives discuss corporate tax reform, we have two primary goals:
1) Lower the corporate tax rate as low as possible, if not eliminate it entirely.
2) Allow businesses to deduct all investment expenses from their taxable income.
Both goals would lower the cost of capital, leading to increases in investment, jobs, and wages.
Established businesses prefer lower rates, since those benefit existing operations. But the economy, and workers, benefit much more from expensing.
A dollar’s worth of expensing gives a much bigger bang than a buck’s worth of lower corporate rates. Expensing will raise wages and increase the number of jobs significantly faster than rate cuts.
There are three reasons for expensing’s big advantage.
1. Expensing favors the future over the past.
Expensing would only apply to new investments, so it only benefits companies that are investing and creating jobs. Companies that are coasting on past investment would benefit much less. In an economy suffering from a historically low rate of startups and dynamism, expensing is just what the doctor ordered.
2. Expensing cuts way down on the compliance cost of the corporate tax.
According to the IRS, business tax compliance costs are over $100 billion per year, representing a massive waste of money and effort. Complete expensing would greatly simplify tax-paying.
3. Expensing equalizes the treatment of all types of investment.
Under current rules, some investments face much tougher tax treatment than others. In particular, low-tech structural investments—like warehouses and retail shops—are disadvantaged. Those are the kinds of investments that are needed to create low- and middle-income jobs.
Straightforward economic models show that expensing would lower the cost of capital in the U.S. relative to the rest of the world, and investment would increase to the point that investors earn the same rate of return as they did before the reform.
But expensing would also permanently increase the demand for labor, leading to a boost in job creation and wage growth.
Reducing corporate tax rates is also important. Expensing certainly helps make the U.S. corporate tax structure globally competitive, but lower rates would enhance that benefit.
In particular, a lower rate discourages companies from shifting profits overseas. Without a globally competitive, low U.S. corporate tax rate, U.S. businesses will continue to be disadvantaged compared to their foreign counterparts.
Expensing of investment and a reduction in corporate tax rates would both lower the cost of capital. Expensing is more effective at encouraging job creation and wage growth, while a low corporate rate helps put American businesses on a level global playing field.
In the context of deficit-neutral tax reform, Congress should make expensing its first priority and then lower the corporate tax rate as much as possible, given the savings from base-broadening measures and spending cuts.
*Originally published in The Daily Signal, click here.