Our guest blogger is Reuven S. Avi-Yonah, the Irwin I. Cohn Professor of Law at University of Michigan Law School.
For a while, Senator John McCain has been advocating letting corporations expense (currently deduct) the cost of purchasing business equipment. This is touted as a way of helping the economy, despite the lack of any evidence that it would do so.
Sen. McCain’s original proposal involved open ended expensing with no limitations. As I pointed out in an earlier paper, this proposal would not only “bust the budget” because of its direct cost, but it would also open the door to an immense increase in tax sheltering.
That is because corporations could borrow funds and use these funds to buy business equipment. The whole amount of the investment would be immediately deductible, as would the interest on the loan. The deductions would be larger than the size of the investment, generating extra deductions that could shield other income from taxes. Tax lawyers call this a “negative tax rate” and it is similar to the shelters that proliferated before the 1986 Tax Reform Act.
Sen. McCain has recently revised his proposal in the face of such criticism. He now proposes to limit expensing to equipment purchased between 2009 and 2013 and to limit the deduction of interest on loans incurred to purchase such equipment.
Ending the tax break in 2013 severely undercuts the proposal. If it is such a good idea, why let it expire? And since Sen. McCain claims that letting the Bush tax cuts expire to plug the looming budget deficit is a “tax increase,” can we expect him to apply a different standard to his own tax cuts and let them expire?
More importantly, the revised proposal is still open to massive tax sheltering. Limitations on interest deductibility have proven unworkable because money is fungible. If interest on loans incurred to finance business equipment purchases cannot be deducted, corporations would borrow to fund other expenditures and use the money freed up that way to buy the equipment.