What's Missing From the GOP Tax Plan
Now that the Republican tax plan has been released, taxpayers are finally getting an idea of where the GOP is headed on tax reform. Many of the proposed reforms are encouraging. A substantial reduction to the corporate tax rate; reducing burdens on pass-through entities; and boosting the standard deduction — these are all positive reforms for taxpayers. But one provision should be improved upon: the proposal to institute “full expensing” on a temporary basis.
Full expensing is a policy that would allow businesses to completely and immediately recover costs for investments in assets. Rather than making such a policy permanent, the GOP plan lays out a framework to implement it “for at least five years.” While this recognizes the importance of encouraging capital investment, it does not go far enough to stimulate economic growth.
That businesses should receive a tax deduction for investments is not a controversial proposition. Investment deductions are effective generators of economic growth, as businesses are only able to deduct the costs of activities that grow the economy. This is why full expensing is the best way to encourage business investment.
Under the current system, business owners are forced to recoup the cost of an investment over its “useful life.” Depreciation regimes use a complicated system that makes it hard for businesses without the means to pay for armies of tax lawyers to keep up. Allowing businesses simply to deduct the value of an investment up front makes tax filing far simpler for businesses. Full expensing would ensure that businesses are not taxed on investments at all, allowing them to recover all of their costs immediately and plow more into growing their businesses.
By contrast, the GOP’s proposed framework permits full expensing for new investments over the next five years only. After five years, the system would apparently revert to a more complicated depreciation regime that drags cost recovery out over the course of many years. This is an inefficient method of encouraging economic growth for several reasons.
First and foremost, temporary expensing would not provide the same economic benefit as full expensing. Temporary expensing is a temporary solution to a much bigger problem, which is that our depreciation system is too complex and inefficient. The GOP solves this problem for five years, but then leaves businesses to deal with it later. Policymakers should craft fixes that work in the long term.
Temporary expensing would also cause significant economic distortion. Businesses would be incentivized to move planned investments forward in time artificially so as to take advantage of expensing during the five-year window. This would result in a flood of investments, followed by a sudden investment slowdown in year six. Businesses might also decide to delay investments in the hope of a new expensing policy. Either way, temporary expensing would not provide the consistency in tax law that businesses value.
Finally, a temporary period of full expensing would incur “costs” in the form of foregone revenue without netting all of the benefits of a permanent fix. Moving to expensing involves sharp drops in revenue in early years. But data from the Tax Foundation shows that revenue picks up substantially after a transition period — eventually becoming “revenue positive” over the long term. A temporary policy would capture only the early revenue dip, not the later uptick.
If Republicans go with a temporary period of full expensing, they will miss an important opportunity in an otherwise excellent tax-reform framework. While a temporary solution would catalyze economic growth in the five years it is in place, the gains would be short-lived, eventually reverting to a depreciation regime that exacts more of a tax penalty for investment. This would result in a “clawback” of government revenue starting in year six in the form of higher taxes. That might improve a 10-year CBO “score” of the GOP tax policy — but only at the cost of penalizing businesses after five years.
The push for temporary expensing is most likely driven by political constraints, rather than sound policy ideas. Of course, budget realities are a valid concern in crafting tax reform. But the amount of growth one stands to gain from making full expensing permanent greatly outweighs any budgetary or political costs. Congress should do everything in its power to make full expensing a part of tax reform legislation.
Andrew Wilford is an Associate Policy Analyst with National Taxpayers Union Foundation. Follow him on Twitter @PolicyWilford.