One Cheer for Obama Tax Plan, with Plenty of Caveats

President Obama’s new economic recovery plan, coming more than a year-and-a-half after an infusion of $1 trillion in big-government spending failed to “stimulate” the moribund economy, deserves one qualified cheer.

The president’s plan, unveiled in a partisan speech Wednesday in Cleveland that mostly consisted blaming economic woes on his predecessors, did contain at least one specific break from the administration’s previous policies. His call for 100 percent first-year expensing for plants and equipment and making permanent the research and development tax credits, with some important tweaks, would positively affect incentives for growth. Would that he had proposed these across-the-board tax cuts in early 2009 rather than the government-directed stimulus spending.

Unfortunately, the other elements in the recovery plan are more of the same big-government spending and meddling. The $50 billion “infrastructure bank,” as initially described, appears to contain few mechanisms to control wasteful spending, and  the body”s members would be shielded from accountability to Congress or the next administration. A White House fact sheet also lists nannyist “smart-growth” priorities for the infrastructure spending such as “environmental sustainability” and “livability,” which are code words for controlling where people live and work.

The small business lending bill before that the president touted in his speech also is a boondoggle with destructive effects. Called the “Son of TARP” by National Review writer Stephen Spruiell,  the bill would subsidize community banks to make loans to businesses the government approves. This reeks of the kind of “industrial policy” of picking if winners and losers that brought Japan down.

By contrast, the virtue of the President’s proposals for expensing and the R&D tax credit is that they apply across the board, not just to politically-favored businesses. Expensing, or accelerated depreciation, allows firm to write off the cost of purchasing equipment in the first year of purchase, not according to an arbitrary  depreciation schedule created by the IRS. Supply side economists such as Gary Robbins, Stephen Entin, and Ernest Christian have proposed expensing for years as a supply-side tax reform that would boost productivity.

As FedEx CEO Frederick Smith (whom we at CEI, in reference to our esteemed founder and president Fred L. Smith Jr., call “the other Fred Smith”) has put it: “If we buy a 777 airplane from Boeing, under the current tax code, we generally write that asset off over seven years for tax purposes. But buying a $150 million airplane is a big risk because you don’t know what the market’s going to be like when that plane is delivered some four years after the initial order. So the best way to mitigate the risk of making that capital purchase, which provides jobs for pilots, mechanics, ground support, hub workers, and couriers, is to allow the company to get that money back quicker. It reduces risk and encourages investment more quickly in new equipment, facilities and jobs.”

The R&D tax credit is actually redundant to this tax proposal, because expensing could apply to equipment for research and development.  But the expensing proposal in the Obama plan, as currently proposed, would unfortunately have limited effect because it only lasts one year.

Temporary tax cuts, including the ones offered in past Bush and Obama stimulus packages, have been shown not to work because individuals and businesses don’t change their spending habits without permanent changes in income expectations. Nobel laureate Milton Friedman described this as the “permanent income hypothesis.” Beyond that, however, there is the practical problem that a factory, for instance, can’t be built in one year. So a company like won’t start making a large multi-year  investment now, if it know it can’t expense the costs in the second and third years.

And then there are the tax hikes the president proposes to “pay for” the taxes and spending. The White House hasn’t specified what so-called loopholes it would eliminate, but it had earlier proposed closing off foreign tax credits for multinational firms. But those tax credits exist because the U.S. is one of the few countries that taxes worldwide income at all, and U.S. firms would be put at a huge disadvantage to their foreign competitors if they had to pay both U.S. and foreign taxes on the income they earned.

In truth, the expensing provision don’t need to be “paid for” with any offsets. As the White House fact sheet points out, “most of this relief would be recouped by the Treasury as businesses regain their strength. Specifically, businesses would get the upfront deduction for their investment—now when they most need it—but would give up their future annual depreciation allowances in future years when the economy is stronger.” And the dynamic effect that supply siders identify could actually increase tax revenues.

So while rejecting the infrastructure spending and small business lending subsidies, Republicans should meet the president halfway on the business expensing provisions. On this section alone, the GOP should offer to waive the pay-go rules that require offsets if Obama forgoes his proposed tax hikes (putting aside for the moment the tax hike of letting the Bush tax cuts expire) and extends the expensing provisions for a few more years.