Three Good Ideas in Clinton’s Small Business Tax Plan
August 23, 2016
Earlier today, Hillary Clinton’s presidential campaign released a small business policy plan, which includes several proposals aimed at simplifying tax filing for small businesses.
So far, during the campaign, Clinton’s tax proposals have largely focused on raising taxes on high-income individuals and multi-national companies, rather than reforming the structure of the U.S. tax code. The policy plan released today is a welcome departure from this approach, as it includes several proposals that would make the federal tax code less burdensome and distortionary:
1. Allowing small businesses to immediately deduct up to $1 million in capital investments
When calculating their taxes, businesses are generally not allowed to immediately deduct the full cost of their investments. Instead, they are required to spread out the deduction over time, according to a set of depreciation schedules. For many small businesses, calculating depreciation deductions can be exceedingly complicated. In fact, the IRS estimates that U.S. businesses spend 448 million hours a year complying with federal tax depreciation rules.
Under Clinton’s proposal, small businesses would be able to “expense,” or immediately deduct, up to $1 million in capital investments every year. Currently, Section 179 of the tax code allows certain small businesses to expense up to $500,000 in capital investments, so it looks like Clinton’s plan would effectively double the Section 179 threshold.
Allowing small businesses to expense up to $1 million of investments would mean that many businesses would no longer have to go through the complex process of figuring out their depreciation deductions. It would also be good economic policy: lengthy depreciation schedules can discourage business investment, and there is strong evidence that allowing businesses to expense their capital expenditures leads to higher investment.
2. Quadrupling the start-up deduction
One category of business expenses that the Clinton plan addresses specifically is start-up expenses, the costs of setting up a new business. Under the current federal tax code, small businesses are only able to deduct up to $10,000 in start-up and organizational costs. Any start-up costs above that threshold must be deducted over a longer period of time.
As a result, new businesses are disadvantaged by the federal tax code: they face significant up-front costs, but are unable to deduct those costs until sometime in the future. By quadrupling the maximum deduction for start-up costs, Clinton’s plan would make it easier and less expensive to start a new business.
3. Allowing businesses with less than $25 million in gross receipts to use cash-flow accounting
When a business files its taxes, it is required to use a standard accounting method to calculate how much income it has earned. The two primary accounting methods used in the United States are accrual accounting and cash accounting. The major difference between these methods has to do with timing. To take an example: a business that purchased a building in 2015 and paid for it in 2016 would report the expense in 2015 under accrual accounting and in 2016 under cash accounting.
Generally, cash accounting is much simpler and easier than accrual accounting. However, the U.S. tax code does not allow corporations or partnerships with more than $5 million of gross receipts (or sales) to use the cash accounting method. Clinton’s proposal would raise this threshold to $25 million, allowing more businesses to use a simpler accounting method.
Allowing businesses to use cash-flow accounting for tax purposes is also economically sound policy. Because cash accounting allows businesses to deduct their expenses in the year that they occur, it is functionally very similar to full expensing, with comparable economic benefits.
All in all, Clinton’s proposed tax changes for small businesses would improve the federal business tax code and make tax filing simpler for many companies.
It’s worth asking, though: why just small businesses? Why not try to reform the tax code for businesses of all sizes? If expensing and cash-flow taxation are good policies, then the Clinton campaign should push to extend them to all U.S. businesses, not just the smallest ones.
It's also worth noting that several of Clinton's other tax proposals would raise taxes on some small businesses, including the Buffett Rule and her proposed "millionaire surcharge." As much as the three policies listed above would simplify small businesses' tax compliance burdens, Clinton's overall tax plan would increase some companies' total tax bill.
Note: In addition to these three proposals, Clinton’s small business plan would create a new standard deduction for small businesses, which would give businesses the option to stop keeping track of their business expenses for tax purposes. It’s unclear exactly how this proposal would work, and the campaign hasn’t specified how large the standard deduction would be, so it’s hard to tell whether this would be a good policy change.