After-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.
What Is the Significance of Corporate After-Tax Income?
Companies can judge whether to pursue a project by determining whether it meets a required after-tax rate of return, or hurdle rate. Projects that yield greater after-tax income are more economically attractive for a business to pursue. When a jurisdiction imposes a corporate income tax, the tax raises the pretax return required to yield an acceptable after-tax return, as the investment return is reduced by the tax paid on the investment return. As a result, the corporate income tax reduces the number of projects that meet a required rate of after-tax return, thus impeding capital formation and discouraging growth. While virtually all major taxes have varying degrees of negative impact on economic growth, the corporate income tax is considered the most harmful.
What is the Significance of State Individual After-Tax Income?
A state individual income tax reduces the after-tax income of people living in a state and the after-tax return of investments made by pass-through businesses in a state. State individual income taxes vary across the country, with some states like Florida imposing no individual income tax, while California taxes income at a top rate of 13.3 percent. Thus, a worker earning an income of $100,000 might have a different after-tax income depending on what state he or she lives in. Certain individuals and pass-through businesses relocate to low-income tax states in order to maximize their after-tax income.
How Does Expensing Factor into It?
The tax code’s treatment of expensing also has implications for after-tax income and business investment decisions.
Business income is the difference between revenues and costs. When businesses can fully expense the cost of an investment in machinery, equipment, and buildings in the first year the investment is made, the business is able to maximize the after-tax return of the investment. Failure to allow full and immediate expensing for business investments effectively shifts the tax burden forward in time as businesses face a higher tax burden today because they cannot fully deduct their costs. This decreases the after-tax return on an investment.
When costs for things like equipment, machinery, and buildings can only be deducted over several years instead of immediately, the business is not able to recover the full cost of its investment. That is because the value of a dollar immediately deducted under a policy of full expensing is worth more to a business than the value of a dollar deducted for depreciation in a later year. The result is a higher cost of capital, which reduces capital formation, productivity, and wages.
The Tax Cut and Jobs Act’s full expensing provision, allowing the immediate write-off of full business investment costs for certain investments, was in effect until 2022 before phasing out.
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