Tax changes that impact how individuals and businesses invest, borrow, save and allocate resources can have substantial economic ramifications. Tax codes help people take advantage of new opportunities to pursue upward mobility while strengthening their economic security.
Establishing an environment conducive to investment can increase worker opportunities and strengthen our economy. Eliminating double taxation on corporate income, allowing full deductibility for short-lived assets and streamlining the treatment of Research & Development expenses all help foster more investment activity.
Tax Cuts for Individuals and Pass-Through Businesses
The tax cut for individuals and pass-through businesses will have multiple effects on investments. Pass-through income refers to profit from businesses passed on directly to owners for personal taxes at ordinary rates, so this bill provides deductions for some of that income, reducing it from 35% down to 20%; additionally it limits certain industries’ ability to deduct their expenses; this has particular ramifications on those making more than $25,000 such as partners in law firms or hedge funds who pay high income tax rates – such as partners of law firms or hedge fund partners making more money are most impacted.
Economic models predict that individual income tax cuts will raise after-tax wage rates, thus increasing household consumption demand and investment. But the effects will depend on whether borrowing rates decline sufficiently as well as on other model assumptions and parameter values – leading to small estimated initial impacts on investment. Also, increased first year bonus depreciation and amortization schedules of R&D expenses likely stimulated investment but limited interest deductibility prevented full participation.
Increased First-Year Bonus Depreciation
Accelerated depreciation offers businesses a greater after-tax return on their investments, offering enough of an incentive to increase equipment and structure investments. Specifically in the construction industry, such increases may prompt more capital spending on equipment.
The Tax Cuts and Jobs Act (TCJA) increased the amount of qualifying property eligible for immediate deduction through bonus depreciation and Section 179 expensing, but these provisions will expire after 2022. To maximize these incentives, businesses should act quickly – cost segregation studies can identify parts of buildings which qualify as tangible personal property with shorter depreciation recovery periods, thus qualifying them for bonus depreciation deductions.
Reducing the US corporate tax rate will have a profound effect on business investment, decreasing both inbound and outbound foreign direct investment (FDI).
Scheduled Amortization of R&D Expenses
As of 2022, companies must capitalize their R&D expenses and amortize them over five years. Prior to this change in tax policy, taxpayers could elect under IRC Section 174 either to deduct these expenditures in their year of incurrence or defer and amortize them over time.
Research and development (R&D) is an essential driver of innovation, and should be treated accordingly within the tax code. Unfortunately, however, this recent change to R&D deduction represents a step backward.
R&D amortization will reduce investment across the economy, yet particularly hit IP-intensive sectors like manufacturing and tech. According to Tax Foundation modeling, businesses that fail to restore full R&D expensing in future legislation could face significantly higher taxes in 2023 and beyond than anticipated; policymakers must address this issue in order to encourage investment and accelerate economic growth; bipartisan Senators Maggie Hassan and Todd Young recently introduced legislation to bring full R&D expensing back.
Limit on Interest Deductibility
The tax reform has reduced companies’ ability to deduct interest expenses as part of their deductible expenses, making this provision difficult to evaluate as it will have different impacts depending on factors such as debt levels, credit risk exposure and industry or investment behavior.
Corporations looking to finance investments may choose between raising money from investors or taking on debt. Unfortunately, the tax code can skew this decision towards debt over equity.
The limit on interest deductions will significantly lower US firms’ effective tax rates (EATR) relative to those of other countries, making US firms more appealing to foreign investors while simultaneously making low-tax countries like Ireland more appealing. It remains uncertain how the new law will influence foreign investor flows – it might reduce Ireland’s EATR by decreasing inbound FDI, while increasing outbound flows from high tax countries like Germany by decreasing outbound flows – though any such effects would likely be small and its overall effect neutral.
