The tax code of the United States needs a major overhaul. It is complex, inefficient, and unfair, favoring some industries and individuals over others. The 2017 Tax Cuts and Jobs Act (TCJA) made some improvements but also left many problems unresolved. The next administration has a chance to create a better tax policy for all domestic companies and workers by eliminating subsidies, simplifying rules, and allowing full expensing of investments.
The Problem with the Current Tax Code
The current tax code distorts the allocation of capital and discourages investment. Under the current system, depreciation schedules specify how different types of assets can be deducted over time. For some investments, such as buildings and structures, firms must wait long periods—ranging from three to 39 years—to deduct costs fully. This understates business costs and overstates business profits, artificially increasing tax burdens. Higher after-tax costs deter investment, leaving us with a less productive workforce and lower economic growth.
The tax code also creates winners and losers among different industries and technologies, by granting special tax breaks and subsidies to favored sectors. These include tax credits for renewable energy, electric vehicles, and research and development, as well as preferential rates for certain income sources, such as capital gains and dividends. These provisions are often justified as promoting public goods or national interests, but they also distort market signals, create rent-seeking opportunities, and reduce tax revenues.
The Benefits of Full Expensing
One of the most effective ways to reform the tax code is to allow full expensing of investments. This means that firms can deduct the entire cost of their investments in the year that they are made, rather than spreading them over time. Full expensing eliminates the bias against investment and reduces the effective tax rate on new capital. This encourages more investment, which leads to higher productivity, wages, and output.
Full expensing also simplifies the tax code and reduces compliance costs. Firms do not have to keep track of different depreciation schedules for different assets or deal with complex rules for bonus depreciation and Section 179 expensing. Full expensing also eliminates the need for special tax credits and subsidies for certain types of investments, as all investments are treated equally.
The TCJA partially implemented full expensing for certain investments, such as machinery and equipment, but only temporarily. The provision accounted for $545 billion of the $620 billion immediately deducted in 2020, but it has since begun phasing out. The next administration should make full-expensing permanent and extend it to all types of investments, including structures and intangibles.
The Challenges of Implementing Full Expensing
Full-time employment is not without its challenges. One of the main obstacles is the fiscal cost. Full expensing reduces tax revenues in the short term as firms deduct more of their costs upfront. This increases the budget deficit and the national debt, which may have negative consequences for long-term growth and stability. However, full expenditure also boosts economic growth in the long term, which may partially or fully offset the revenue loss. Moreover, full expensing can be paired with other revenue-raising measures, such as eliminating tax preferences, broadening the tax base, or increasing the corporate tax rate.
Another challenge is political feasibility. Full expenditure may face opposition from various interest groups and stakeholders who benefit from the current system of subsidies and tax breaks. These groups may lobby against the elimination of their favored provisions or demand compensation for their losses. Full-expensing may also face resistance from some lawmakers, who may prefer to use the tax code as a tool for social engineering or industrial policy. Full expenditure may require a bipartisan consensus and strong leadership to overcome these hurdles.
The Way Forward for Tax Reform
The next administration has a unique opportunity to reform the tax code for a more competitive and fair economy. By adopting full expensing for all domestic companies, the government can stimulate investment, productivity, and growth while simplifying the tax system and reducing distortions. Full expensing can also pave the way for further reforms, such as lowering the corporate tax rate, harmonizing the tax treatment of debt and equity, and moving to a territorial system of international taxation. These reforms can make the U.S. more attractive for business and innovation and enhance its global leadership.
