Tax reforms must include lower rates and expensing

Raymond Keating
Raymond Keating

From at least 2007 to 2016, businesses, entrepreneurs, investors and workers were beaten down thanks to misguided and costly government actions, including tax hikes and increased regulatory costs. The U.S. desperately needs pro-growth relief and reform on both the tax and regulatory fronts.

Looking at the tax issue, efforts in Congress and by the White House to advance major relief and reform are most welcome. Recall that during the presidency of Ronald Reagan, that’s exactly what was accomplished with a major tax cut passed in 1981 and then tax reform in 1986. Today, the hope is that Congress and the White House will combine these into one effort. That’s a sound policy choice to quickly derive the benefits for our economy,  entrepreneurs and work force.

Unfortunately, some dispute has emerged between reducing tax rates on entrepreneurs and businesses and providing full expensing for capital expenditures by entrepreneurs and businesses. This isn’t a productive debate if policymakers are serious about providing a sound foundation upon which economic, income and employment growth can flourish.

If tax relief and reform is going to be substantive and pro-growth, then a substantial and across-the-board lowering of tax rates on personal income, corporate income and capital gains are required. That’s more or less a given in tax reform circles.

At the same time, providing straightforward expensing as an option stands out as a necessity if we’re serious about making this a pro-growth initiative. After all, investments in equipment, facilities, technology and tools are vital for economic and productivity growth, which in turn drive profitability and increased incomes for workers.

Currently, expensing is limited for small businesses. That is, expensing is limited to $500,000 per year (with that indexed for inflation in future years) in capital spending, with a dollar-for-dollar phase out occurring when investments hit $2 million and climb to $2.5 million. Full expensing would simply allow all capital expenditures to be written off or deducted as a business cost in the year the investments were made.

Further incentivizing private-sector capital investment through expensing is a win-win-win-win for entrepreneurs, small businesses, large firms and workers. Assorted studies drive home this point.

For example, a study published in early 2015 by the National Federation of Independent Business Research Foundation estimated permanent small business expensing at the $500,000 level would, over 10 years, boost jobs by 197,000 and real economic output by $18.6 billion. Permanent small business expensing was signed into law in December 2015.

In a July 2016 Tax Foundation study of the House Republican tax reform plan, allowing for full expensing of capital investments was estimated to boost gross domestic product growth over a 10-year period by 5.4 percent, which in this model accounted for more than half the growth of the overall tax reform package.

Much has been made of the Tax Foundation study estimating a revenue “loss” to the federal government of $2.2 trillion over the first decade with full expensing. However, that’s according to unrealistic static analysis. Under more realistic dynamic scoring, the “loss” falls to $883 billion and shrinks further into the future.

Another Tax Foundation report noted: “By removing nearly all barriers to investment from the business tax code, full expensing could grow the long-run size of the U.S. economy by 4.2 percent, which would lead to 3.6 percent higher wages and 808,000 full-time jobs.” These analyses also find that moving to full expensing would have a larger economic growth impact than would a reduction in the corporate tax rate. Of course, it must be made clear reducing the tax rate also has a significant positive impact on GDP growth. Again, pro-growth tax reform requires both.

Finally, it must be noted that when we’re talking about expensing and tax rate cuts, this is overwhelmingly a small business story. Overall and industry by industry, it’s small businesses doing the investing. For example, just looking at C corporations, consider the following Census Bureau data:

Among all C corporations, 86 percent have less than 20 employees and 96.9 percent less than 100 workers.

In mining, quarrying and oil and gas extraction, 75.2 percent of C corporations have less than 20 workers and 89.2 percent less than 100 employees.

In construction, 88.4 percent of C corporations have less than 20 workers and 98.2 percent fewer than 100.

In manufacturing, 67.7 percent of C corporations have fewer than 20 employees and 89.2 less than 100 workers.

In the end, whether we’re talking about lower tax rates or full expensing, pro-growth tax reform very much is a small business issue. It’s essential a tax package making its way to President  Donald Trump’s desk includes both.