Obama’s Business Tax Cuts

By :: September 7th, 2010

With the economy stalled and his party’s November electoral chances sagging, President Obama is rolling out a new plan to boost growth—a mix of infrastructure spending and business tax cuts. The tax changes make some sense on their own merits, although I’m not sure how much they’d do to jumpstart an economy that can’t seem to get untracked.

The White House has leaked two major proposals that it will formally announce later this week: Through 2011, it would allow all businesses to write-off the full cost of capital equipment in the year they buy it, and it would permanently extend the research and experimentation tax credit.

Immediate tax write-offs for business investment—called expensing in tax jargon—has some real benefits. The current system, where firms gradually deduct the cost of new equipment over time, is complicated and often unfair. Some gear qualifies for very generous tax treatment while other investments get the short end of the stick.

But true reform requires another step: Eliminating the deduction businesses get for borrowing to buy this equipment. Combined, taking these two steps would be big steps twoard a business consumption tax. But permitting firms to both deduct interest costs and expense equipment would create troubling opportunities for tax shelters. 

Moreover, it is not clear whether a temporary shift to expensing will do much to boost today's weak economy. After bottoming out at the beginning of 2009, orders for U.S. made durable goods had been rising smartly until they lost steam again over the last couple of months. Will temporary expensing get capital spending back on track? Perhaps, but keep in mind that today’s economic malaise is caused largely by a lack of consumer demand. And if a company sees no pickup in orders for widgets, it isn’t likely to go out and buy a new widget stamper—even with a new tax break. On the other hand, firms that are running at full capacity will happily take advantage of the new expensing rule, though it isn’t clear why they need government help. 

A word about the life expectancy of this proposal. Don’t count on expensing to go away in 15 months, as Obama proposed. Once companies make this tax accounting change, they won’t willingly go back. Just look at what’s happened to the allegedly temporary expensing rules for small business. 

The story of the research credit is a bit different. This subsidy has been on the books for decades, but as only a temporary measure. This is a good thing for those lobbyists who are paid big money to advocate for extending it, and for politicians who find the debate a steady source of campaign contributions.

But it is stupid tax policy. R&D benefits the overall economy, and if policymakers believe the tax credit encourages research, they should make it permanent so companies can develop long-term research budgets. If, on the other hand, the credit is little more than a windfall to those firms that would be doing research anyway, Congress should just kill it. My own sense is that the temporary credit has been less useful than many inside the Beltway believe. Perhaps Congress could improve the credit by making it permanent.                  

Keep in mind that while Obama’s initiatives seem expansive, their real budget cost is relatively low. Because companies would have deducted this newly-expensed investment over time anyway, they will effectively pay back any short-term tax savings and Treasury will eventually recover most of its revenue loss. The White House claims business would get an immediate tax cut of $200 billion but figures the 10-year cost of this 15-month proposal would be only about $30 billion.

Similarly, while permanently extending the R&D credit will seem expensive under budget rules, its real cost will be relatively small. After all, there isn’t much difference between extending a tax subsidy one year at a time forever or putting it in the law once and for all.

But let’s face it, while the economics is interesting, this proposal is all about politics. And it will be fun to see how business executives respond to the implicit tradeoff Obama is offering: We’ll cut some taxes for your companies, raise others, and make you give up the low personal tax rates you’ve enjoyed for the past decade. Stay tuned.    

8Comments

  1. Anonymous  ::  9:28 pm on September 9th, 2010:

    I like the fact that it moves closer to VAT. I also like the fact that the debate over this pretty much demolishes the assumption that supply side capital availability is more important than consumption in deciding when to invest.
    Of course, this does nothing for consumption. In order to free that up, families need a shot in the arm through a refundable tax rebate – hopefully in time for December spending. If possible, this should be done without Treasury sending checks, but should instead be incorporated into normal payroll where possible.
    The other necessary item, which no one talks about much, is either chaning bankruptcy rules to allow Mortgage cramdowns in reorganization and/or using the leverage of the Federal Reserve's ownership of Mortgage Backed Securities to reduce principal balances when the loan is under water. The GSEs should do this too. This will impact families who need it the most and free up a lot of pent up spending. Failure to do this will only ratchett up uncertainty, since this population may yet walk away from their homes.

  2. Anonymous  ::  3:23 am on September 13th, 2010:

    All of the measures that the ORahma admin dream up seem like sops to the Republics & businesses big and small, but really make no sense if no one’s buying anything.
    Per usual, Rahmbama tosses out some kind of bone, but who can figure out why or what the bone is for. Just makes ‘em look durn boneheaded in the end.
    Nothing for the small peeps, and nothing that really matters for anyone. Same old, different day. Nothing to see here folks, move along now.eurrency exchange

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