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.
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.