by Rod D. Martin
September 5, 2004
During the fight for President Bush’s 2001 tax cuts, supporters regularly quoted from another tax cutter, President John F. Kennedy. And as with JFK’s proposals, Bush’s passed the Congress and dramatically expanded our economy.
There was, however, at least one difference between the Bush tax cut plan and JFK’s. Kennedy’s plan allowed businesses to depreciate their assets 32% faster than before; and he also instituted a 7% credit against tax liabilities for new investments in machinery and equipment.
Translation: JFK made it possible for businesses to grow faster, so they were able to hire more people who, in turn, made more money.
In my continuing series on the need to repeal our current tax system and replace it with a flat tax, I’ve identified five key reforms to help us break away from our deeply flawed tax system.
Replacing our system of depreciating assets is clearly one of them.
But just as there was a difference between President Bush’s 2001 tax cuts and JFK’s, there is a key difference in JFK’s plan and ours at Vanguard PAC. Indeed, America needs to go far beyond what JFK did, and allow full business expensing in the very first year. We must let businesses deduct the entire cost of their capital investments at the time they are purchased.
Currently, that’s not allowed. Not even close.
The IRS requires that most purchases of plant and equipment be written off gradually, over a period of years. These depreciation deductions are set by law and vary for different assets in a complicated maze of regulation.
Besides requiring a needless army of accountants to comply with these Byzantine laws, this current system is unjust on its face: essentially, Washington is forcing every business that purchases a capital good to give the government an interest-free loan for the life of the asset. And if that weren’t bad enough, this distorts business’s investment choices by ignoring the time value of money and the inevitable effects of inflation.
The longer the investment term — the longer a business is forced to drag out the deduction — the less the deduction is worth, and the greater the tax cost associated with the purchase. But the rules equally price a dollar of future depreciation and a dollar of depreciation today. And they make no distinction between inflated dollars and real dollars.
These are typical made-in-Washington rules. They put an obvious chill on long-term investment, the last thing we should do if our goals are greater economic growth, higher productivity, lower inflation, higher wages, or increased living standards.
Taxes are also a key component of the cost of capital. When Uncle Sam bars businesses from deducting fully and immediately the cost of a new capital asset, that makes these investments more expensive, making firms less likely to purchase them, less likely to grow, and less able to hire.
What’s more, if our nation’s inflation rate begins rising from its near-historical lows, this will just exacerbate the problem, making long-term investment projects even less attractive than they already would be.
Who gets hurt the most by this system? Rapidly growing mid-size companies, the very sort that creates the largest percentage of the new jobs in America. These are companies that are big enough to consider serious investments in plant and equipment — and to need them if they want to keep growing — but small enough to feel the pinch of dysfunctional depreciation schedules.
The current law forces them to do business with one hand tied behind their backs.
One would think that the barons of the Beltway, who wailed incessantly about the lack of business investment after the NASDAQ crash and the September 11 attacks, would have supported depreciation reform unequivocally.
But of course that’s not what happened.
Rather than dealing with the problem and helping Americans get back to work, they preferred pursuing their favorite pastime: blaming President Bush for the newly-slow economy and hoping that issue would somehow defeat him come Election Day.
Well, maybe it will. But it won’t be because the economy hasn’t rebounded. It won’t be because the President’s tax cuts didn’t make more than the difference he promised. And it won’t be because Democrats had a plan.
But should George Bush win his second term, one of the first reforms he must address, in the spirit of JFK before him, is full business expensing. It’s long past time we consigned our dysfunctional dinosaur of a system to the ash heap of history, where it belongs.
Read the Whole Flat Tax Series, by Rod Martin