Lazear on Tax Reform

At the Wall Street Journal Edward Lazear proposes reforming the tax code to allow the immediate expensing of capital spending:

Allowing investment expenses to be fully and immediately deductible turns an income tax into a consumption tax, but the logic is subtle. All of an economy’s output is used to produce either current consumption or investment goods. If all income, which must equal output, is taxed, then both consumption and investment are taxed. But if we tax only the part of output that is not investment by allowing investment expenditures to be deductible, all that remains is consumption so only consumption is taxed.

There is no need for any complicated new tax laws or bureaucracies to make this change. Investments in plants, equipment, R&D and even human capital would be deductible from profits when paying taxes, and the deduction could be used now or against future or past tax liabilities.

The potential benefits of moving away from taxing investment to a consumption tax are well documented. A 2005 Tax Advisory Panel appointed by President George W. Bush estimated from Treasury data that moving to a consumption tax by removing taxes on investment would result in a 5%-7% increase in GDP. (Its scoring included lower and flatter individual and corporate rates, though expensing accounted for most of the gain.) A 2001 study in the American Economic Review by David Altig, Alan J. Auerbach and others estimates that GDP would rise more than 9% by moving to full expensing of investment spending (with a flat tax).

If recollection serves, that’s the rule in business-friendly countries, e.g. Switzerland, Hong Kong, Singapore (which also typically have much lower business income taxes). Business spending on financial instruments or real estate frequently cannot be expensed immediately.

One of the benefits of immediate expensing is that it provides fewer incentives for transferring capital overseas.

While I broadly support abolishing the business income tax completely or, as Dr Lazear proposes, changing how business income is calculated to incentivize capital spending, I think his proposal has almost no traction in Congress. Somehow the notion that taxing business income twice is fair (once when realized by the business, once as income by individuals) has caught on and has become a political shibboleth.

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  • ...

    Somehow the notion that taxing business income twice is fair (once when realized by the business, once as income by individuals) has caught on and has become a political shibboleth.

    I think it’s a little more subtle than that. I think that the biggest companies (with the richest owners) like the current system because it puts barriers in the way of smaller firms that might compete with them one day. So GM pays now corporate taxes? Thanks to their lobbying, accounting and legal efforts they don’t! And it’s probably worth it to them to make certain that smaller firms, who can’t afford the lobbyists, accountants, lawyers and overseas investments to pay nothing, get hammered.

    Given that we evidence is mounting that the views of average Americans don’t mean shit if the mega-rich want something different, we can assume that the current tax structure is largely the tax structure that our lords and masters want. It’s just a question of figuring out why they want it….

  • Guarneri

    “I think it’s a little more subtle than that”

    Well, to coin a phrase it’s a little more subtle – and different – than that. A point of order: One would be hard pressed to demonstrate that on a per share or percentage ownership basis the GM-type owners of the world are the “richest owners.” Small to medium sized business owners are, by and large. Only the Gates, Buffets or the Facebook guys of the world fall into that category, and there are few of them. But I digress.

    In any event, those with large lobbying efforts have kind of obviated the corporate level income tax, although at significant lobbying expense. (Hell, GM doesn’t even bother to honor it’s agreements with capital providers…..but I digress again.). Small to medium sized businesses – so many are pass through entities now – have done the same thing. To timing factor of taking the expense in year one vs, say, 3-7, makes the returns significantly better. But for those paying two levels, wow. That timing difference is magnified ginormously.

    But to Dave’s point, it’s a rare pol who really gives a damn about economic efficiency or motivating capital. It’s about the taxes and buying votes and campaign contributions. This proposal has no chance.

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