Key Questions on Tax Breaks: How Big? Who Gets Them?

Author: David Cay Johnston

Published: December 16, 2002

With more tax breaks for business a near certainty now that Republicans control both the administration and Congress, the issues are how big the cuts will be and which companies will reap the savings.

Individual taxpayers might also obtain some breaks because of a growing view in Washington, promoted by the three leading business lobbies, that the best way to stimulate the economy would be to provide something similar to the advance refunds of up to $300 a person that were mailed out after Congress passed the Bush tax cuts in 2001.

Whether the new device would take the form of a brief holiday from Social Security and Medicare taxes, a step that could let employers obtain half the tax break, or of a cut in the lowest tax bracket to 5 percent from 10 percent will almost certainly become a crucial issue between Republicans and Democrats.

Now that the federal budget surpluses that extended as far as the eye could see last year have turned into great waves of red ink, it is unclear how willing the more fiscally prudent members of Congress will be to borrow to finance tax cuts. The costs of security after last year's Sept. 11 attacks, not to mention the looming prospect of war in Iraq, could quickly wash Washington in still more red ink.

Even with no new tax cuts, corporate income tax collections next year are expected to be only a bit more than 1 percent of the gross domestic product, down from 2.5 percent in 2000 and 4.1 percent in 1965. Corporate income taxes are about 3.4 percent of the economies of the other industrialized countries in the Organization for Economic Cooperation and Development, yet American business leaders continue to say that they are at a disadvantage compared with foreign companies when it comes to taxes.

The sharp drop in corporate tax receipts is partly because of smaller profits. But it is also a result of widespread tax shelters, increased aggressiveness in claiming deductions in the face of a business-friendly Internal Revenue Service and a heavy sprinkling of favors for business scattered through the Homeland Security Act and other legislation.

The United States Chamber of Commerce, the Business Roundtable and the National Federation of Independent Business contend that more tax cuts are needed to stimulate the economy.

"We are most interested in a stimulus package," said R. Bruce Josten, the executive vice president of the United States Chamber of Commerce, which represents three million businesses, from mom-and-pop stores to industrial giants.

"We have an uneven and momentumless economy," he added. "We need stimulus."

Mr. Josten said most people had spent the advance refund checks of up to $300 apiece that they received last year. The refunds resulted from the creation of a new 10 percent tax bracket. The first part of everyone's taxable income is taxed at the lowest rate, and since that had been 15 percent until the Bush tax cuts were enacted in June 2001, taxpayers received a refund for money already withheld. That experience suggests that raising the limits on the income taxed in the 10 percent, 15 percent and 27 percent brackets may also stimulate the economy, Mr. Josten said, especially since there are no tax rate reductions scheduled in 2003.

Some Democrats are considering the idea of cutting the 10 percent tax rate in half, which would put up to $300 more in tax cuts on the table for all individual taxpayers with at least $6,000 of taxable income and for married couples with at least $12,000.

The drive for cuts for big business will almost certainly focus attention on the huge backdoor tax cut that Congress approved last year. In 2002 and the two following years, companies receive "bonus depreciation" that speeds up the write-offs of capital equipment. That subtle change amounts to a 25 percent tax cut for corporations during the three-year period, and businesses hope that the change will be extended or even made permanent.

Even though the 2001 tax cuts were a significant victory for President Bush, the law has a sunset provision: the cuts are to expire on Dec. 31, 2010. Now the biggest items on the president's agenda are getting new legislation to make the cuts permanent and enacting an estimated $20 billion worth of tax breaks in the energy policy legislation that was put on the back burner after 9/11.

The administration contends that making the cuts permanent and perhaps speeding up some provisions would be a stimulus. But economists like Eric M. Engen of the American Enterprise Institute and William G. Gale of the Brookings Institution say such steps would do little to strengthen the economy in the short run and could add to the government's red ink in the long run unless they spurred huge economic growth.

Making the Bush cuts permanent would result in growing federal budget deficits that in 2012 would reach $866 billion, the Congressional Budget Office reported this month.

Discussing another break favored by business, Mr. Josten said that increasing the amount of capital equipment that businesses could write off immediately, rather than depreciating it over several years, to $50,000 from the current $22,500 would stimulate investment by small businesses. And he said the chamber advocated that the size of businesses allowed to use cash accounting be doubled ? it is now limited to concerns with less than $5 million in revenues ? and that limits on money set aside in retirement plans be raised.

Jack Faris, president of the National Federation of Independent Business, which represents 600,000 privately owned businesses, said the federation also wanted to see the capital write-off limits raised. "Our members feel strongly about increasing expensing," he said. "We are very much supportive of a move up to $50,000, but we think that unless it is a real asset, like a new building, that you should be able to just write off a new truck or computer or whatever, in the first year."

He said that typical family-owned businesses, unlike public companies, were not trying to show a profit to shareholders. Family businesses generally seek to increase asset values, or wealth, he said, while keeping profits as low as possible to keep taxes down.

Since Mr. Faris was interviewed, the organization's chief lobbyist has called for raising the capital write-off expensing limit to $100,000 ? a proposal that indicates growing ambitions for business tax cuts.

The administration's proposal to make permanent the repeal of the estate tax is also hotly disputed. Many Democrats attack the proposal as a tax break for the rich, but many business owners support the president's plan because they hope to be able to pass intact businesses on to heirs.

Another major issue facing Congress will be a ruling by the World Trade Organization that a 15 percent income tax break on export goods is illegal. Unless Congress resolves this issue next year, it is widely expected that the trade organization will impose sanctions on the United States.

There is also strong support among investors for allowing more net investment losses to be deducted from ordinary income like salaries. Current law allows a $3,000 deduction for capital losses, a figure that has not changed since its enactment more than two decades ago. Although losses can be carried forward without limit, it would take someone with a $60,000 loss in the stock market and no future capital gains 20 years to deduct all the losses.