This week, Senator Marco Rubio (R-FL) announced his new economic growth agenda. As part of his agenda to grow the economy, he wants to reform the United States’ 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. code.
According to his speech, his proposal will focus on both the individual and the business side of the tax code. While there are many problems with the current tax code on both the individual side and the business side, Rubio only outlined two reforms on the business side of the tax code in his speech. Nonetheless, these two reforms are vital pieces to any fair, neutral, pro-growth tax system.
Moves to 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.
Typically, when a business is calculating its taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. for the IRS, it takes its revenue and subtracts its costs (such as wages, raw materials, and state and local taxes). However, with capital investments (buildings, machines, and other equipment) the calculation is much more complicated. Businesses in the U.S. and throughout the world are generally not allowed to immediately deduct the cost of their capital investments. Instead, they are required to write them off over several years or even decades.
Having to deduct the cost of capital investments over a long period of time erodes to value of these deductions, boosting businesses’ taxable income and their taxes paid, create a disincentive to invest.
Rubio’s plan would get rid of this complicated capital 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 and move to full immediate expensing for businesses. From his speech:
“The reforms we are considering would allow businesses to take a full and immediate deduction for all investments. This fair and equal treatment would end the crony capitalist loopholes that benefit politically connected corporations.”
Allowing businesses to immediately write-off the full cost of capital investments, as they do with wages and raw materials, would reduce the cost of capital, create an incentive to invest, and lead to higher wages for workers and greater economic growth.
Territorial Corporate Tax System
The United States has a complicated “worldwide” system of taxation. This system requires businesses to pay the 35 percent federal corporate tax rate on their income no matter where it is earned—domestically or abroad. Once a corporation earns profits overseas and brings it back to the United States, those profits are subject to the 35 percent U.S. corporate tax rate minus any taxes they paid overseas. This puts American corporations at a competitive disadvantage and creates a “lock-out” effect that traps corporate profits overseas.
Rubio’s tax plan would fix this by moving to a territorial corporate tax system:
“We can fix that by implementing what 28 of the 34 OECD countries already have: a territorial system of taxation. The fact that the vast majority of developed economies in the world already have a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. – including all other G8 nations – has put American companies at a major competitive disadvantage.”
Moving to territorial would put U.S. corporations on an even footing with their foreign competition, rid the tax code of some of its most complicated features, and remove the incentive businesses face to keep profits overseas.
These reforms are not the only changes that the United States needs to make in order to have a fair, neutral, and pro-growth tax system, but moving to full expensing and a territorial system are necessary steps the U.S. has to take to get there.
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