Obama Business Deduction Invites Gaming, Experts Say
President Barack Obama’s proposal to provide immediate deductions for the full cost of new equipment will encourage companies to game the system just to get the tax benefits, tax experts said.
In a speech today in Cleveland, Obama will propose a plan to let companies, through the end of 2011, deduct the full cost of capital investments in the year the expenditures are made, instead of writing off the expenditure over periods of as many as 20 years, White House officials said.
That accelerated write-off, combined with existing deductions for loan interest, may prompt companies to borrow money for factories, machinery and equipment just to get the tax benefits, said Ed Kleinbard, a former staff director for Congress’s Joint Committee on Taxation.
“It’s an invitation to arbitrage,” said Kleinbard, who now teaches tax law at the University of Southern California in Los Angeles. “You’re putting businesses in the same economic position as if you were inviting them to borrow money to buy tax-exempt bonds.”
Obama’s proposal, which requires congressional approval, is designed to encourage companies to boost the economy by spending some of the record $1.84 trillion in cash they had on hand at the end of the first quarter, up from $1.43 trillion at the start of 2009.
Companies combining deductions proposed by Obama for equipment with deductions for borrowing costs would get benefits -- including refunds or credits against future taxes - - that exceed the additional income they get from new capital spending, according to a 2005 report by the Congressional Budget Office. For every $1 of additional income from new capital spending, companies may be able to get benefits worth almost $1.88, according to the budget office report.
“The combination of free deductibility of interest to make a marginal investment, combined with accelerated depreciation, would lead to negative tax rates on that new investment,” Kleinbard said.
Obama’s plan would supersede an economic-stimulus proposal that applied in 2008 and 2009 and allowed companies to immediately deduct 50 percent of the cost of qualified capital purchases. The Senate is scheduled to vote next week on retroactively restoring the 50 percent deduction for 2010.
Administration officials yesterday told reporters the proposal contains rules to prevent abusive tax shelters such as denying tax benefits for acquired property that is subsequently resold.
Goldman Sachs Group Inc. analysts yesterday said the proposal would probably produce “modest” near-term results because most companies would wait until the end of 2011 to make purchases, the analysts said. The impact would also be “weakened somewhat” if Congress raises other taxes on companies to keep the plan from adding to long-term budget deficits, the analysis said.
The Obama administration estimates full expensing would accelerate $200 billion in tax savings for companies through 2011 and benefit 1.5 million companies and several million individuals who run businesses.
$30 Billion Cost
Total revenue lost from the new proposal over 10 years would only be $30 billion, because companies taking the immediate deductions wouldn’t be able to write off their expenses through depreciation in years to come.
Business groups such as the National Association of Manufacturers have lobbied Congress to extend the 50 percent accelerated deduction. The Commerce Department last month said investment in equipment and software grew at an annual pace of 24.9 percent in the second quarter compared with 0.2 percent in the same quarter of 2009.
In a 2006 report, the Congressional Budget Office said that past proposals to permit full deductions of capital investments “typically are combined with proposals to repeal the deduction for interest expenses.”
Obama’s Republican opponent during the 2008 presidential campaign, Arizona Senator John McCain, proposed to allow one- year expensing for all equipment that currently must be depreciated over three and five years. McCain’s plan would have repealed the interest deduction for companies claiming the benefit, to prevent arbitrage.
‘Giant Tax Shelter’
Even with the interest deduction repealed, Douglas Holtz- Eakin, who was McCain’s economic adviser, said some Democrats attacked the Republican’s proposal as a “giant tax shelter.”
Under Obama’s proposal, Holtz-Eakin said many companies that take advantage of the accelerated depreciation will borrow for capital spending rather than using cash they may need later if business taxes are raised in other areas.
“This is a real sign that they’re now getting that the business community is sitting on their hands,” Holtz-Eakin said.
Alex Brill, a former tax adviser to the House Ways and Means Committee who is now a research fellow at the American Enterprise Institute in Washington, said companies are more likely to borrow because the administration’s proposal “will create a large tax subsidy for debt-financed investment.”
“To get the economy back on track with a subsidy for debt seems a funny way to do it,” Brill said.