World Economy

Critics Comment on Reforming US Business Taxes

Critics Comment on Reforming US Business TaxesCritics Comment on Reforming US Business Taxes

Some critics argue that reforming business taxes in the United States won’t help boost economic growth, but a closer look at what drives investment decisions shows otherwise.

In fact, lowering corporate tax rates and allowing businesses to immediately write-off new capital purchases (sometimes referred to as full expensing) would help encourage new investments, create jobs and boost wages. Instead of judging corporate tax reform based on after-tax profits for existing projects or the size of a potential tax cut, policymakers need to focus on how taxes impact new investment decisions, USNews reported.

Skepticism about the impact of a corporate tax rate reduction and other reforms is understandable. Corporate profits as a share of the economy are high by historic standards. Low interest rates make it cheap to borrow, and corporations have an estimated $2 trillion in cash that they are not investing. So simply giving corporations more money wouldn’t actually help the economy.

But this kind of argument ignores the important ways that taxes interact with business decisions. Indeed, there isn’t much of a link between the money corporations have in the bank and their incentive to increase investments and hiring. Tax reform that simply transfers money to companies (such as a tax holiday for repatriating money stored overseas), without addressing the underlying incentives in the tax code, won’t result in a permanent increase in economic output.

However, well-structured tax reform can alter incentives in a way that encourages businesses to invest in new projects. When businesses determine whether it’s worthwhile to build a new factory, they ultimately care about the “discounted cash-flow” that the factory is expected to produce. A business looks at the cost of the investment, the revenue the factory could bring in over its full lifespan, and the taxes the business would pay on those earnings.

If taxes prevent the factory from creating a satisfactory return-on-investment, the factory won’t get built. However, the return on investment, or ROI, would change if the federal government lowered the statutory tax rate on corporate income or increased the size of deductions available for new investments.

Another mistake people make in determining the economic impact of a business tax change is to look at the size of the tax cut. The amount of revenue foregone by the treasury doesn’t tell us much about how a tax proposal would impact the economy.

 A corporate tax reform plan that loses revenue may or may not encourage investment. What matters is how a corporate tax reform impacts the incentives to invest. Revenue-neutral tax reform can still help grow the economy. There is a big difference between cutting the statutory corporate tax rate or enacting full expensing, and a repatriation holiday on past earnings. Only the first two would permanently encourage investment.

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