Problems with delaying a corporate rate increase

By Kyle Pomerleau

According to Law360, the Biden administration is planning to delay some of its proposed corporate tax increases, including a rate hike from 21 to 28 percent, in an effort to minimize harm to the economy as it recovers from the COVID-19 pandemic. Unfortunately, delaying the rate increase is not the best way to address those concerns.

A corporate tax rate increase will inflict immediate
economic harm even if its implementation is delayed. Firms are forward-looking,
basing their investment decisions on projected revenues and costs over the life
of a potential investment project. Those costs include taxes that the firm will
pay on the investment’s payoffs, net of any deductions or credits they will
receive for the investment. If Congress has scheduled a future corporate income
tax rate hike, firms will incorporate the rate hike into their investment
decisions today.

Via Twenty20

A delayed corporate tax rate hike will also encourage firms
to delay investments. Consider an investment project that costs $100 when it is
made and provides a $105 return in the following year. And suppose the
corporate tax rate is 21 percent in year one and is scheduled to permanently
increase to 28 percent, starting in year two. Finally, suppose that the firm
can immediately deduct the full investment cost in the year the investment is made.

If the firm makes the investment in year one, it will get a
deduction valued at $21 ($100 * 21%) and the tax on the return will be $28.40 ($105
* 28%). However, if the firm delays the investment until year two, it will
receive a deduction worth $28 instead of $21, with no change in the tax on the return.
The delay will thereby reduce the net tax burden on the investment by $7.

More generally, the incentive to delay investment will
depend on the asset’s life, the timing of deductions for investment costs, and the
extent of the delay of the rate increase.

The simplest way to avoid the economic harm of raising the corporate tax rate is to not raise the rate. If Congress adopts a rate increase, however, it should consider making the rate increase immediate. Congress could soften the economic impact by providing other forms of tax relief. For example, the tax treatment of research and development costs is scheduled to become less favorable, starting in 2022, and the tax treatment of equipment and software investment is scheduled to become less favorable, starting in 2023. Canceling those scheduled changes would go a long way to offset the economic harm of raising the corporate tax rate, with none of the problems that would arise from delaying the rate increase.