The U.S. income tax is supposed to be a net income tax, not a gross income tax. A net income tax includes deductions for the costs of producing income, such as wages, raw material inputs, tools and equipment, transportation both for raw materials and finished goods, signs, advertising, etc.
The net income tax derives from an even more basic principle that business taxation should be as neutral as possible, treating all businesses the same. A gross income tax without those deductions discriminates against high volume, low margin businesses, such as grocery stores, retail stores and restaurants.
These principles are implicated in the current debate over expensing for capital investment. All the other costs of producing income are deducted in the year they are incurred. But for capital investment, such as for tools and equipment, factories, office buildings, shopping malls, the expenses must be deducted over many years, under arbitrary depreciation schedules of up to 30 years.
The wages of workers are deducted in the year they are paid. But if you buy them desktop or laptop computers to be more productive, those costs can only be deducted over 5 to 10 years.
That discourages capital investment, reducing worker productivity and in turn restraining growth in worker wages. Current tax reform bills all adopt “expensing” for capital investment, while abolishing arbitrary depreciation. Such expensing would allow deductions for the costs of capital investment in the year they are incurred, like for all other costs of producing income.
Tax Foundation studies show expensing would have an even bigger impact in promoting economic growth, jobs and rising wages than would a reduction in tax rates. That should not be surprising, given that the foundation of capitalism is capital.
But the mantra of “revenue neutrality” has given rise to proposals for the opposite policy concerning deductions for advertising. Former Ways and Means Chairman Dave Camp included a provision allowing deductions for only 50 percent of advertising expenses in the first year, with the rest deducted over the following five years or more.
That was estimated to raise $169 billion in revenue over 10 years. But taxing advertising would result in less of it, reducing competition with less information for consumers. Similar taxes and restrictions in the past have meant less price competition, which resulted in higher prices.
Less advertising would also result in reduced demand from consumers, who would be less aware of available products and services, translating into lower sales. That is recessionary. Indeed, some economists in the past have advocated varying advertising taxes and restrictions as a countercyclical policy, raising them to slow the economy when it seems to be overheated, reducing them when the economy needs a boost.
But if an advertising tax slows the economy, that would sharply reduce, if not eliminate, any revenue gains. The economy overall affects all tax revenues powerfully, reducing them when the economy slows, increasing them sharply when the economy booms. That broad effect would swamp the effect of any advertising tax.
If the economy booms, as tax reform intends, that could result in revenue neutrality by itself, or even in huge gains in federal revenues, as resulted with the Reagan tax reforms in the 1980s, the Kennedy tax cuts in the 1960s, and Treasury Secretary Andrew Mellon’s tax cuts in the 1920s, which created the Roaring 20s.
Pro-growth tax reform should not include counterproductive tax increases for revenue neutrality, like the advertising tax. What is needed is to maximize resulting growth through a big pro-growth tax cut, following the same enormously successful policies of Presidents Reagan and Kennedy, Secretary Mellon.
Pro-growth tax reform is the foundation for restoring long overdue booming economic growth, which was the goal of President Trump, House Speaker Ryan, and the Republican Congressional majorities. Taxing advertising is not part of that growth train.
[Originally Published at the Washington Examiner]