Kyle Pomerleau of the American Enterprise Institute offers a warning about pending changes in federal tax law.
Two major changes to the business tax base enacted as part of the Tax Cuts and Jobs Act (TCJA) will go into effect this year. First, businesses will be required to amortize research and development (R&D) costs over five years. Second, the limitation on net interest deduction will tighten from 30 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA) to 30 percent of earnings before interest and taxes (EBIT) — a narrower definition of income. While both policies increase the tax burden on business investment, lawmakers should not view these policies the same way.
Amortization of R&D expenses and the limitation on net interest expense were enacted to help offset the ten-year cost of other business tax cuts in the TCJA and were two of the largest business base broadeners in the law. The Joint Committee on Taxation (JCT) projected that requiring businesses to amortize R&D expenses would raise $119 billion between FY2018 and FY2027. The limitation on net interest expense deduction was projected to raise $253 billion over the same period. …
… Both provisions will increase the tax burden on new investment. The effective tax rate on overall investment will increase from 2021 policy by 0.9 percentage points as a result of R&D amortization. This result is driven by the provision’s 16.8 percentage point increase in the tax burden on intellectual property. The EBIT limitation on net interest expense would increase the tax burden on overall investment from 2021 policy by 0.4 percentage points by making debt-financed investment more expensive across all asset types. …
… These business tax increases would move in opposite directions with respect to a more neutral cash flow tax. … Amortization of R&D would move farther away from the neutral tax treatment of R&D and would discourage this important type of investment. In contrast, limiting the deduction for interest moves in the direction of a cash flow tax. The stricter limitation on interest deductions helps reduce the corporate income tax’s bias in favor of debt-financed investment.