Not a Grand Bargain for Everyone

August 01, 2013

From far and wide there have been a lot of responses to Obama’s “grand bargain” on corporate tax reform, many of them critical.

The most obvious point of contention to the president’s plan is from small businesses. It is not that they feel left out. On the contrary, they feel like they are going to take a hit in this deal.

Obama is proposing to lower the corporate income tax rate from 35 percent to 28 percent. He wants to pay for this by what he calls “broadening the base” or “getting rid of those loopholes.”

On its face, this seems like a worthy goal. Not only does it offend peoples’ sense of fairness to give one business a tax preference over another, but it is bad tax policy. You don’t want a tax system that dictates what and where investment in the economy should go.

However, there are many loopholes in the past he has stated he wants to get rid of that are not really loopholes. One of the major ones in his budget is what is called accelerated depreciation. This allows businesses to write-off capital expenses (houses, equipment, etc.) faster over time. In the IRS’s perspective, this has allowed corporations to lower their taxable income.

From an economic perspective this more closely reflects a firm’s real income any given year. (Of course the ideal policy would be expensing, which allows businesses to write off the entire cost of new capital expenses in the year it is purchased.)

For a corporation, getting rid of accelerated depreciation may not be such a bad deal if the tax rate is lowered from 35 percent to 28 percent, which this bargain likely does. If your taxable income goes up, but the rate at which it is taxed goes down, many companies will likely still see a lower tax bill.

However, small businesses do not get the same deal. Most small businesses are what are called pass-throughs and are taxed through the individual tax code. That means many are taxed at rates that exceed 40 percent in the individual code.

So this deal would similarly raise the taxable income of pass-throughs, but would not give them the benefit of a lower tax rate.

This is on way this proposal would further skew the tax difference between corporations and pass-throughs. One does not to need to think hard about why this grand bargain isn’t grand for everyone.

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