In the debate over the 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. extenders, the 55 or so tax provisions that need to be extended year after year, it’s easy to just throw up your hands and say: “let’s just get rid of them all- they are just a bunch of wasteful loopholes that benefit the few at the expense of the many.” This is likely something you hear from proponents of a flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. : a tax system with few loopholes and deductions.
It is easy to understand where proponents of a flat tax are coming from. A lot of our tax code is wasteful, unfair, and harms the economy. The extenders must be like that and we should get rid of them and move to a simpler, flatter tax.
If you share the above sentiment, you are right for the most part. However, the issue of tax extenders is slightly more complicated. While most tax extenders are wasteful, there are a few that are worth keeping and would actually be part of a flat tax.
Specifically, a couple of the current tax extenders would exist in a flat tax as a way to properly define business income.
One of the necessary features of a flat tax is full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. of business investment. This is the ability for a business to deduct the full cost of a capital investment (machinery, equipment, and buildings) in the year the purchase was made.
Our current tax code does not allow this. Instead, businesses have to depreciate their capital investments, or deduct them in stages, over a long period of time. The result is that businesses do not get to deduct the full present discounted value of the cost of the investment. This understates business costs, overstates business income, and thus leads to higher tax bills.
Some tax extenders mitigate this unattractive feature of our tax code. For example, bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. , which allows a business to deduct 50 percent of the upfront cost of a capital investment (except for buildings), is a tax extender that mitigates the poor treatment of capital investments in our tax code.
Bonus 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. moves the tax code halfway to how capital investment would be treated under a flat tax.
I agree with the sentiments of supporters of a flat tax: our tax system is broken, unfair, and harms economic growth. A lot of tax extenders are part of this problem. However, getting to a better tax code isn’t always as easy as just scrapping it all.
More on Tax Extenders here.Share