I am about to write and post a blog entry regarding yesterday's first session of the 2017 Tax Policy Colloquium, at which we discussed Lily Batchelder's paper, Accounting for Behavioral Biases in Business Tax Reform: The Case of Expensing. But here I just thought I'd mention a corporate tax reform idea that I came up with while thinking about this paper, and that I believe ought to be on the list that people consider over time.
There has been a lot of discussion in recent years of the distinction between (a) the "normal" return on investment that businesses expect to get when they invest, and (b) rents or extra-normal returns. Everyone agrees that the latter should be taxed, and there are grounds for trying to tax them at a high rate. Income tax advocates want to tax the former as well, while consumption tax advocates want to exempt the former.
Even if one doesn't exempt the normal return (an issue that Lily's paper helps to illuminate), there are strong grounds for taxing it a lower rate than rents. But how could one do this in practice, given the difficulty of telling them apart case by case?
One of the main virtues of Edward Kleinbard's business enterprise income tax (BEIT) proposal is that it does exactly this. But here is a simpler, less elegant way of addressing the same issue. Or more precisely, here is a way of using the cost of capital allowance (COCA) feature from BEIT without including all the rest. While this probably leads to a worse proposal than Kleinbard's (or at least a far more skeletal one at this point), it's worth having on the list simply so thoughtful people will have more possible choices to consider (e.g., if they think that BEIT is not politically feasible). It would go as follows.
1) Use economic cost recovery rules, rather than expensing or accelerated cost recovery - the classic income tax approach.
2) Allow interest on unrecovered basis, increasing its amount. If we stop here, this converts the seeming income tax back into a consumption tax. This, so far, is the proposal that David F. Bradford ended up favoring. He preferred it to expensing, to which it is present value-equivalent if one gets the interest rate right, because it works better at avoiding anomalous transition effects when the tax rate changes. (Without the Bradford transition issue, once one allows interest on basis - if at the proper rate - it doesn't actually matter whether one is following economic depreciation correctly or not.)
3) The twist, borrowed from BEIT & COCA: Treat the interest on basis as taxable to the business, but at a lower rate than that under the business or corporate tax generally. In principle, this should result in one's taxing the normal return (i.e., the interest return on basis) at a rate that is positive but below that for the rents, which in principle should be facing the regular corporate tax.
This leaves a whole lot of other things to be considered separately. E.g., what should we do about interest deductions. And I am not pushing it against BEIT; rather, I'm suggesting that one piece of BEIT could be adopted by itself even if one didn't do the rest.
What BEIT does instead of this is tax the normal rate of return to owners, rather than to the businesses, based on their "outside" basis rather than the business's "inside" basis. The reason for using inside basis instead, and in effect placing it in a separate tax base to which a separate rate applies, is simply to have more options on the table. Suppose, for example, that this proved optically superior to full-out adoption of BEIT and COCA, even if substantively inferior.
For more on BEIT and COCA, see this and this.