Pethokoukis, Economics, Taxes and Spending, U.S. Economy

Why the Baucus corporate tax reform plan is anti-innovation, anti-growth, and anti-startup

America needs to lower its sky-high corporate tax rate. But there is a right way and a wrong way to do it. Senate Finance Chairman Max Baucus looks to haved just proposed the wrong way.

According to Bloomberg, the Baucus corporate tax reform plan would require “companies to take deductions for many capital asset purchases over a longer period … showing for the first time the tradeoffs in his plan to lower the corporate tax rate. … The changes proposed today would generate about as much money during the next decade as repealing accelerated depreciation, according to Finance Committee staff. A 2011 estimate from the Joint Committee on Taxation said that such a change would generate $724 billion over a decade. That’s enough to finance a corporate rate cut of several percentage points, though final estimates aren’t available. Baucus has said he wants to see the U.S. corporate tax rate, now at 35 percent, reduced to less than 30 percent.”

Ok, here’s your trouble:  Corporate tax reform should reduce the tax penalty on business investment. Cutting the corporate tax rate does this. But this gain is offset in part or in full if the rate cut is accompanied by a slow-down in depreciation deductions.

But it’s worse than that. This sort of tax swap can actually make the tax penalty on new investments bigger, which favors established businesses over entrepreneurial start-ups. As AEI’s Alan Viard has written:

For old capital, a rate cut paid for with slower depreciation is a big win. All of its future payoffs get taxed at the lower rate. Yet, it’s spared from the depreciation slow-down – the longstanding rule is that depreciation changes apply only to new investments.

If the overall reform package is revenue-neutral and old capital comes out ahead, then new investments have to pick up the slack. For new investments, the loss from the depreciation slow-down must outweigh the benefits of the rate cut, amplifying the tax penalty.

That means we end up with the worst of both worlds. First, we shower windfalls on investments that have already been made by giving companies tax savings that they were never promised. This reward for past investment is senseless – we can’t change the past. Then, we turn around and raise the tax penalty on new investments, which can still be changed. And they will be changed – the stiffer penalty will discourage investment and slow economic growth.

Although the details of corporate tax reform may sound technical, the stakes are high. We can’t afford to give windfalls for investments made in the past. Instead, we should reward the new investments that will help move us towards a prosperous future.

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