Why Tax Subsidies For Plant & Equipment Are Anti-Growth
Construction magnate Dennis Washington is a billionaire today, but at the age of 29 he quit a good job working for his uncle after a dispute over a missed day of work. Another job offer immediately came his way once he resigned, but rather than be someone else's employee yet again, Washington started his own company.
As he told Forbes Life last June, "I borrowed $30,000," then "got a tractor and motor grader on credit and started Washington Construction." The rest, as they say, is history.
Washington's wonderful and very American story sprung to mind recently when I received an e-mail from a doubtless well-intentioned employee at Americans for Tax Reform (ATR). My view that deduction of equipment purchases against corporate taxes amounts to an economy-sapping tax subsidy was not taken well by the person at ATR. Though he and I would probably agree on most policy matters, he angrily told me that ‘all' economists on the right disagree with my view.
Oh well, to quote the great Nigel Lawson, truth "is not established by counting heads." In this case, while my own nirvana would include no corporate tax at all, favoritism toward equipment purchases in the tax code is without question a tax subsidy notwithstanding the energetic e-mails sent my way by an activist at ATR.
A tax cut is for instance a reduction in the price of work or investment without regard to the kind of work or investment taking place. A tax subsidy is a handout attained through the tax code for certain behavior that politicians like. There are deductions for children, for buying a house or an electric car, and yes, for buying business equipment. Considering a subsidy that would allow 100% depreciation on a corporate tax form for equipment purchases, this is a subsidy both for companies long on equipment, and then for the manufacturers of that which would be deductible.
The ATR worker told me all economists support the above subsidy, and while I'm skeptical about 'all,' it's hard to countenance his aggressive assertion that the subsidization of equipment purchases is pro-growth. That's the case given the historical reality that government subsidized investment doesn't have a great track record.
Beyond that, it doesn't make logical sense. Indeed, Google is by most measures a great success, but in its initial days this world-class company was powered by "thirty cheap servers," to quote my Forbes colleague, Rich Karlgaard. By the early 2000s Google had achieved a multi-billion dollar valuation despite having spent very little on equipment relative to its net worth.
With Google's lack of heavy equipment and machinery in mind, why should a General Motors or a FedEx be handed substantial deductions for operations requiring much more than 30 cheap servers? Google was upon its IPO, and still is worth more than GM and FedEx combined, but if 100% depreciation of equipment purchases were implemented by legislators, Google would suffer in a relative sense what would be a certain tax subsidy for GM and FedEx.
To the above some might say forget about tax subsidies for equipment purchases, instead let's enhance the tax break for hiring workers with Google in mind. Its market cap is massive thanks to the human capital that arrives at the GooglePlex each day, unemployment is high as is, so legislators should work to rig the tax code to favor hiring as much as possible. It sounds nice, but any hiring subsidy (as is companies essentially deduct hiring, and this will be discussed) would similarly be problematic for the economy.
To understand why, it's useful to return to the story of Dennis Washington. He was able to start his now multi-billion dollar construction company precisely because there was equipment available for him to purchase on the relative cheap. This is important because when the tax code is written to encourage equipment buys through subsidy of same, the availability of capital goods is distorted. While FedEx may hold off on buying new delivery trucks absent tax subidies that lower the cost of doing so, it may enter the market for new capital goods if the subsidy is offered. If so, FedEx's accession of always limited equipment may deter a future Dennis Washington from buying what's needed to start a business thanks to the tax subsidy making competition for capital goods greater than it would otherwise be.
The same applies to hiring subsidies. Successful businesses constantly seek to do as much as possible with as little labor as possible, but if the tax code (this is arguably true even now) favors hiring, the availability of workers is distorted to the detriment of the economy. That is so because the start-up that's eager to grow into a corporate behemoth must compete for human capital made more expensive by the tax code. Rather than think about the ‘seen' which is the small or large company hiring more workers thanks to the tax benefits of doing so, we must consider the ‘unseen' whereby a future Dennis Washington doesn't take the entrepreneurial leap due to the high, and distorted, cost of labor.
To both of the previous scenarios, the more Keynesian minded among us may say so what, the economy needs more demand, so let's use the tax code to encourage the purchase of both employees and equipment. This may be appealing at first glance, but it too flies in the face of basic economic logic.
That's the case because no act of saving ever subtracts from demand. If Google, GM and FedEx find that the tax code favors neither buying equipment nor hiring new employees, and subsequently sit on their retained earnings, those funds don't disappear. Figure banks don't take on deposits so that they can warehouse them, rather they seek deposits so that they can lend them to others with near-term needs.
And that's why tax subsidies of equipment and hiring are so economically detrimental beyond what's been described. Remember, in order to start his business, Washington also borrowed $30,000. When businesses aren't having their cash decisions distorted in favor of consumption by the tax code, it means that other entrepreneurs and businesses in possession of ideas that will foster a return will have better access to the credit that will allow them to invest in plant & equipment, along with employees.
Advocates of equipment and hiring subsidies couch their support of both with tugs on our heartstrings about the jobs saved and the jobs created thanks to the subsidy, but lost on them once again is that saving isn't hoarding; rather it's a shift of consumptive ability elsewhere. And if the tax code is more neutral, the investment wrought by saving will more likely be of the highest economic value for it not being driven by tax subsidies. With capital allocated based on profits over tax code distortion, more growth will reveal itself that will lead to even more in the way of hiring and equipment purchases.
Notable here, and my detractor at ATR would probably agree, is that corporations would in a perfect world not be taxed at all. Corporations are really just individuals, and as they already pay way too much in the way of personal income taxes, a corporate tax smacks of double dipping.
But if politicians can't bring themselves to do what's right, it seems the least bad alternative would be to strip out all subsidy from the corporate tax code in favor of a small levy on gross receipts; ideally one that has a ceiling in terms of how much tax any corporation can pay. Small businesses might blanch at the latter, but in nominal terms they'd pay much less in the way of taxes than would their larger competition, plus a cessation of equipment and hiring subsidies would lower their investment costs overall. No tax is ideal, but the relative neutrality of a tax on gross receipts would surely be an improvement on the monument to industrial policy that is our present corporate code.
Until then, to deny as some do the simple truth that equipment depreciation is a subsidy is willful blindness. And it's also anti economic growth.