As policymakers consider taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. options to boost the U.S. economy’s long-run economic growth, they should consider reforms that would increase growth the most while minimizing forgone tax revenue. Using our new book, Options for Reforming America’s Tax Code 2.0, we find that providing a full and immediate deduction for business investments, as well as lowering taxes on businesses, such as the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , are some of the best options for boosting U.S. growth for the revenue forgone.
Take, for example, providing a full and immediate deduction for all capital investment made by businesses. We find that this would boost long-run GDP by 2.3 percent, while raising the after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize after-tax income. for the bottom 20 percent of income earners by 2.1 percent. Federal revenue would be about $1.7 trillion lower over 10 years on a conventional basis, and $1.2 trillion lower after accounting for economic growth. However, this cost is reduced past the budget window as deductions for the existing capital stock begin to phase out.
|Enact Full Expensing for All Capital Investment||Lower the Corporate Tax Rate to 15 Percent||Implement Neutral Cost Recovery for Structures|
|Long-run Gross Domestic Product (GDP)||+2.3%||+0.5%||+1.2%|
|Long-run Gross National Product (GNP)||+1.9%||+0.5%||+1.0%|
|Conventional Revenue (2022-2031)||-$1,700 billion||-$980 billion||-$10 billion|
|Dynamic Revenue (2022-2031)||-$1,200 billion||-$850 billion||+$300 billion|
|Long-run Dynamic Percentage Change in After-tax Income, Bottom Quintile||+2.1%||+1.2%||+1.1%|
|Long-run Dynamic Percentage Change in After-tax Income, Top Quintile||+2.9%||+1.7%||+1.5%|
Source: Tax Foundation General Equilibrium Model, March 2021.
Policymakers could alternatively provide neutral cost recovery for structures. This would adjust depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. deductions by inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and a default rate of return to maintain their real value over time. Doing so would raise long-run GDP by 1.2 percent and only cost about $10 billion in federal revenue over 10 years on a conventional basis. It would actually increase federal revenue by $300 billion over 10 years after accounting for economic growth. The revenue cost of this option would increase outside the 10-year budget window as a larger share of structures benefit from the adjustment, but it would raise long-run after-tax incomes for the bottom 20 percent by 1.1 percent.
Lowering the corporate income tax to 15 percent would boost long-run GDP by about 0.5 percent and raise the after-tax income of the bottom 20 percent of earners by 1.2 percent. However, it would reduce revenue by about $980 billion over 10 years on a conventional basis, or $850 billion dynamically.
On the other hand, certain options raise revenue in an exceptionally harmful way. For example, raising the corporate rate to 28 percent would reduce long-run GDP by 0.7 percent and the after-tax incomes of the bottom 20 percent of earners by 1.5 percent, while raising $690 billion in revenue on a dynamic basis. Compared to other sources of revenue, the corporate income tax is among the most damaging to economic growth, lowering productivity and worker’s wages by lowering after-tax returns to new investment.
|Return to the Alternative Depreciation Schedule (ADS)||Raise the Corporate Income Tax to 28 Percent||Institute a Wealth Tax|
|Gross Domestic Product (GDP)||-0.6%||-0.7%||-0.8%|
|Gross National Product (GNP)||-0.5%||-0.7%||-1.5%|
|Conventional Revenue (2022-2031)||+$600 billion||+$890 billion||+$2.2 trillion|
|Dynamic Revenue (2022-2031)||+$420 billion||+$690 billion||+$1.9 trillion|
|Long-run Dynamic Percentage Change in After-tax Income, Bottom Quintile||-0.6%||-1.5%||-0.6%|
|Long-run Dynamic Percentage Change in After-tax Income, Top Quintile||-0.8%||-2.0%||-3.4%|
Source: Tax Foundation General Equilibrium Model, March 2021
Scaling back the recovery of costs for investment also harms growth disproportionately. Currently, firms may deduct the cost of investment under the Modified Accelerated Cost RecoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. System (MACRS), which provides larger depreciation deductions early on in an asset’s life.
Moving to the Alternative Depreciation Schedule (ADS) would lengthen the amount of time it takes for firms to recover investment costs, reducing long-run GDP by 0.6 percent. The after-tax income of the bottom 20 percent would drop 0.6 percent. This change would raise about $600 billion over 10 years on a conventional basis, or $420 billion dynamically, but at a relatively large economic cost.
Finally, a wealth taxA wealth tax is imposed on an individual’s net wealth, or the market value of their total owned assets minus liabilities. A wealth tax can be narrowly or widely defined, and depending on the definition of wealth, the base for a wealth tax can vary. is exceptionally harmful to the economy because it taxes returns to U.S. saving, reducing U.S. saving as well as U.S. investment that is dependent on it (particularly housing and pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. investment).
A wealth tax of 2 percent on net worth between $50 million and $1 billion and 6 percent on wealth over $1 billion would raise $2.2 trillion over 10 years on a conventional basis, but it would reduce long-run GDP by 0.8 percent, reducing the amount of revenue raised to $1.9 trillion over 10 years. American incomes as measured by Gross National Product (GNP) would drop by 1.5 percent, as the returns to new investment accrue to foreign investors not subject to the wealth tax. The after-tax income of the bottom 20 percent would drop 0.6 percent.
The impact of a tax change on long-run economic growth for each dollar of revenue forgone is important to keep in mind when evaluating the trade-offs of tax policy changes. If economic growth is a priority, lawmakers should prioritize reducing tax on business investment.
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