The next president stands to inherit a confused and inefficient tax system but also an opportunity for reform, when the 2017 Tax Cuts and Jobs Act (TCJA) expires in 2025. The next administration can address unfinished business by stripping away subsidies that benefit a select few and by crafting a better tax policy for all domestic companies.
Under the current tax code, depreciation schedules specify how different types of assets can be deducted over time. For some investments, firms must wait long periods—ranging from three to 39 years—to deduct costs fully. According to Internal Revenue Service figures, corporations invested $1.1 trillion in 2020 but deducted only $620 billion of those investments on their 2020 tax returns, leaving the rest to deduct on future tax returns. While firms wait, inflation and the time-value of money erode the real value of the deductions, such that firms will be able to deduct only about 81 cents on the dollar of their total 2020 investment costs in real terms. The tax code thus understates business costs and overstates business profits, artificially increasing tax burdens. Higher after-tax costs deter investment, leaving us with a less productive workforce.
Rather than dragging deductions out for years (or even decades), Washington should allow “full expensing”—deducting the entire cost of investments the year that they are made. Policymakers tend to stop short of enacting full expensing. Then, when economic crises hit or industry pressures worsen, they award new subsidies or other forms of protection for specific companies. From tariffs to procurement policy to investment-tax credits, the government tries to identify critical industries or technologies to spare them the full weight of the tax burden. The result is a contorted tax code, structurally biased against investment and rife with special provisions, old and new.
Letting politics dictate capital-allocation decisions does not boast a winning track record. Nations that pursue industrial policy, using tools such as targeted subsidies, often encourage influence-peddling and corruption, resulting in boondoggles rather than breakthroughs. Seemingly well-intended incentives can hamper innovation, make supply chains less resilient, and stifle competition. We should be skeptical that today’s efforts to give special tax treatment to specific industries, such as the Inflation Reduction Act and the CHIPS and Science Act, will bring different outcomes.
Some of the reforms in the TCJA, by contrast, took a step in the right direction. The TCJA temporarily allowed companies to deduct immediately the full cost of certain investments, such as machinery and equipment. That provision accounted for $545 billion of the $620 billion immediately deducted in 2020, but it has since begun phasing out. Along with most of the individual income-tax reforms, it is set to expire during the next presidential term.
Full expensing is a better option than reinstating such exemptions. Some policymakers might worry that permanence would remove a tool that they might use in the next downturn or interact with interest deductions to subsidize capital investment. Both concerns are misplaced. Businesses make investment decisions over long horizons, so a temporary incentive does not make a lasting difference. And while the tax treatment of interest could use reform, that’s no argument for keeping long depreciation schedules and maintaining a bias against investment. Under full expensing, all businesses could deduct all their capital investments—machinery, equipment, R&D, structures, and buildings—immediately. The Tax Foundation estimates that if all firms could do this, long-run GDP would grow by roughly 2 percent over current expectations.
The coming expiration of the Tax Cuts and Jobs Act presents an opportunity for a fundamental tax-policy shift. Implementing full expensing would encourage investment without the unwanted side effects of industrial policy.
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