A senator who proposes to cut the corporate tax rate probably expects
praise from corporate leaders. When, instead, he finds them among his
most vocal critics, the senator should consider the possibility that his
plan needs more work.
So it is with Sen. Max Baucus, D-Mont., whose corporate tax proposal has few fans among the businesses it would affect.
One
reason is that, as business lobbyists have pointed out, Baucus' plan
would add complexity and vagueness to the existing tax code, which is
more than amply complex and vague to begin with. The bigger reason,
however, is that in order to make the plan revenue-neutral, the proposal
would slow business' ability to write off investment costs.
That
is exactly the opposite of what a sensible tax policy - one that seeks
to encourage and expand economic activity - ought to be doing. Yet tax
writers like Baucus (chairman of the Senate Finance Committee) who are
looking for revenue often seek to defer the ability of businesses to
deduct expenses. In the short term, this makes the budget numbers work
out, even though in the long term it does not actually produce any net
revenue. In fact, by reducing business investment and the future
economic return on that investment, such policies actually reduce
government revenues in the long run.
To repeat, this is the opposite of sensible tax policy.
Baucus'
proposal would benefit old business investments and hurt new ones.
Thanks to lower rates, a business that continues to see benefits from an
investment it wrote off years ago will face lower taxes on its returns
going forward. However, a business that makes an investment under the
new rules will only get the lower rate at the cost of slower write-offs.
Old and established companies would, for years after Baucus' plan was
implemented, enjoy benefits that startups could not touch.
Companies
need cash to invest in plants and equipment, to conduct research, to
build their brands and to pay their workers. Uncle Sam demands that
taxes be paid in cash too. If the corporate tax rate is 35 percent and a
company that has made $200 turns around and spends $100 on capital
investments, then that company only has $100 left to use for other
purposes, including paying taxes. But if the government, instead of
allowing the company to deduct the full $100 spent that year, only
allows it to deduct $50 right away and demands it deduct the other $50
later, it effectively taxes $150 of "profit," even when the company only
has $100 in ready cash to pay those taxes. This means a larger slice of
that $100 pie has to go to the Treasury, leaving less for other needs.
If
the government really wants to encourage corporate investment, it
should allow companies to write off their investments as quickly as
possible, rather than forcing them to stretch out the deductions over a
long period. In fact, this was the approach that President Ronald Reagan
and Congress took in 1981 with the Economic Recovery Tax Act, which
sparked the major investment boom that lasted through that decade.
American productivity gains increased sharply through the remainder of
the 20th century, partly as a result.
Baucus also wants to slash
the business expense deduction for advertising, which has not won the
plan many friends on Madison Avenue. Currently, all of a business'
advertising costs can be treated as a deductible expense immediately.
Baucus would halve that, with the half not immediately expensed
amortized over the following five years. This move seems especially
reactionary when one considers the pace at which modern advertising
moves.
"This stuff used to happen over months and years. It now
happens over minutes and hours," Jim Davidson, the executive director of
the Advertising Coalition, said in response to the proposed change. (1)
In
the case of advertising, there's an old saw that says half of
advertising dollars are wasted; the problem is that you can't know which
half. The IRS has always felt that advertising creates a long-term
benefit by building brand equity and, as a result, that it should not be
deducted up front. But companies that spend dollars to build brand
equity can't pay those same dollars to the government in the form of
taxes. The government, like the companies, ultimately benefits if and
when advertising results in greater profits. This means the government,
like companies, will lose when punitive tax policy pretends that
companies can spend dollars on advertising and still use those dollars
to pay the government simultaneously.
Baucus' bill would be
harmful, but I am not terribly worried about it. The prospect of a major
tax bill passing during this Congress is virtually nonexistent. With
any luck, a more business-friendly Congress - and possibly a more
business-friendly administration - will take up the issue after the
2014, or more likely after the 2016, elections.
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