Back in April, President Donald Trump expressed his support for expanding the deductibility of business meals and entertainment. The president argued, in a tweet, that restoring the old deduction would help the restaurant and entertainment industry, which has suffered greatly due to the COVID-19 pandemic. However, expanding the deductibility of business meals and entertainment is poor tax policy and would be poorly targeted COVID-19 relief.
It is generally good tax policy to allow taxpayers to deduct
the cost of earning income from their taxable income. For example, a contractor
should be allowed to deduct the cost of the tools he or she uses. Likewise, a
worker should be able to deduct the cost of buying a uniform they need for
their job. In contrast, personal consumption expenditures, such as buying
woodworking tools or clothing for personal use, should not be deductible.
The tax code makes the distinction between business expenses and personal consumption by allowing deductions for what are called “ordinary and necessary” business expenses.
Meals and entertainment can be an ordinary and necessary
business expense. For example, it is typical for business owners to take
prospective clients out to a meal or a baseball game to build relationships.
However, it is hard to distinguish these expenses from the personal consumption
of a business owner or their client. Business owners and their clients also
like to dine out and go to baseball games on their own.
Current law deals with this ambiguity by placing limitations on the deductibility of business expenses. Under current law, only 50 percent of the cost of qualified business meals are deductible against taxable income. And since the passage of the 2017 tax act, entertainment expenses are no longer deductible. The Joint Committee on Taxation estimated that the changes passed as part of the 2017 tax act would raise approximately $2.2 billion per year.
While current law is not perfect, it is an improvement over prior law and better than full deductibility of business meals and entertainment expenses. More permissive treatment of business meals and entertainment would make it easier for business owners and their clients to disguise personal consumption as business expenses. And without the hard rules under current law, there would be a greater strain on tax administrators to determine whether a party is a “promotional expense” or just a party.
Expanding the deductibility of meals and entertainment is also poorly targeted in the context of COVID-19. Proposals to expand the deductibility of business meals and entertainment would reduce the after-tax cost of these activities and may encourage some additional activity at the margin but would have a limited impact on the economy and these industries. Simply put, many Americans continue to be uncomfortable with dining out in the presence of the virus.
Ultimately, the most effective way to help the restaurant and entertainment industries is to get the virus under control.