Why Not Just Get Rid of Them All?

November 26, 2014

In the debate over the tax 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 tax: 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 expensing 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 depreciation, 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 depreciation 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.

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