Taxes Matter II: Lower Taxes on Capital Investment

In today’s Wall Street Journal, Thomas F. Cooley and Lee E. Ohanian make the case for lowering federal taxes on capital investment.  Here’s their bottom line:

Taxing capital income at a permanent average rate of 20% instead of the current average of 37% would yield substantial benefits. After several years of higher investment, we estimate that output would increase by about 8%, that employment would increase by about 3%, and that wages would increase by about 5%. Moreover, most of these increases would be realized within the first 10 years following such a reform.

Our estimate of the benefits of lower capital taxes is conservative, as we consider only the impact of lower capital taxes on the accumulation of physical capital. It is likely that lower taxes would also stimulate increases in research and development and other inventive activities, increase entrepreneurship, increase the accumulation of human capital, lead to more immigration of high-skilled workers, and encourage foreign firms to locate in the United States.

Additionally, beyond the tax rate itself there are other ways to make the tax code more capital-friendly.  Following on the provisions in the Bush tax cuts such as Section 179 Expensing and Bonus Depreciation, I would expand those to all businesses in the individual and corporate income tax code–in other words, enact Immediate Expensing (pdf).

In particular, immediate expensing would give a shot-in-the-arm to America’s entrepreneurs.  Since most small businesses never survive beyond 5 years, what use is it to them to have to depreciate capital purchases over 10 or 20 years.  All it becomes is a short-term windfall to government coffers . . . a better policy is to help these small businesses become large businesses which would fill both private sector and government coffers.

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