Unhappy New Tax Year for U.S. Business The Democratic Congress’s parting gift to American employers is new taxes on investment that start in 2023.
Happy New Year, or, if you’re in business, unhappy new tax year. American employers are getting hit in 2023 with a variety of tax increases even as the risk of recession rises along with interest rates.
The tax hikes arrive for two reasons: provisions of the 2017 GOP tax reform that are phasing out, and big tax increases that passed as part of the Democrats’ Inflation Reduction Act. The Biden Administration doesn’t want to tell you this, so we thought we’d list the unmentionables:
• Capital expensing. The biggest business tax hit is the end of full, immediate expensing for equipment. The 2017 tax reform spurred investment by letting businesses immediately deduct the full cost of hardware like trucks and machines, but that policy is set to phase out. The maximum early deduction drops this year to 80%, and it will continue to decrease each year until it disappears in 2026.
“Delayed deductions effectively shift taxes forward in time,” says a Tax Foundation report, resulting in “less capital formation, lower productivity and wages, and less output.” The change won’t help business investment, which fell 22% from April to October.
• R&D expensing. This big hit has already arrived. January 2022 marked the end of full expensing for corporate research and development, a benefit that began in 1954. Companies could previously deduct R&D spending from their next tax bill, but they now have to spread the deduction over several years (five years for domestic spending, 15 for international).
In a letter to Congressional leaders last spring, the CEOs of 36 large companies estimated that the spaced-out research deduction would cost businesses $29 billion by year end.
• Interest expensing. The cap on the business interest deduction dropped last year when the formula changed to exclude amortization. This is justifiable as part of tax reform, since the tax code shouldn’t have a subsidy for debt over equity. But the timing now is bad.
The cost of borrowing is climbing in step with the Federal Reserve’s interest-rate hikes, and the smaller deduction compounds the pain. That’s especially true for manufacturers and other capital-heavy companies with significant multiyear costs.
All of these are the phased detonation of charges laid in 2017. Congress passed tax reform under the budget reconciliation process and had to keep the package revenue-neutral within a 10-year window. That meant including delayed tax hikes, such as R&D amortization, to offset immediate cuts to personal and corporate taxes.
But Republicans always planned to make the best provisions permanent. Rep. Kevin Brady, the soon-to-retire GOP leader on House Ways and Means, sought to restore the immediate R&D deduction in March, and he has pushed repeatedly to extend and expand full capital expensing.
Many Democrats support these policies in principle, which is why they included full capital expensing in the Build Back Better Act that passed the House last year. But Democrats now want to hold business tax cuts hostage to a $1 trillion expansion of the child tax credit. The child credit does nothing for the economy, and last month the Joint Committee on Taxation estimated that reviving the enlarged credit would shrink the labor force by at least 300,000.
Meantime, two provisions of the Inflation Reduction Act also took effect Jan. 1:
• A new corporate minimum tax. This 15% levy hits large U.S. firms earning more than $1 billion in book income annually. The tax will fall heavily on industries like real estate and mining that currently benefit from Congressional carve-outs, according to the Tax Foundation. The levy will raise the average effective tax rate on corporate income to 19.3% from 18.7%.
• The stock buyback tax. This 1% tax applies to repurchases of stock by publicly traded companies. This is essentially an alternative way of taxing dividends and is a drag on the efficient allocation of capital. It will cause more cash to sit longer on company books rather than going toward investment.
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The overall economic impact of these new taxes is hard to estimate, but the more you tax investment the less investment you get. This won’t help an economy that needs more supply-side investment to counter the demand-side damage from higher interest rates. Hold on tight because the 2023 economic ride could be bumpy.
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