November 27, 2020

The tax burden on business investment under Joe Biden’s tax proposals | American Enterprise Institute

Key Points

  • Former Vice President and Democratic presidential candidate Joe Biden has proposed several tax increases that focus on raising taxes on business and capital income.
  • Taxing business and capital income can affect saving and investment decisions by reducing the return to these activities and distorting the allocation across different assets, forms of financing, and business forms.
  • Under current law, the weighted average marginal effective tax rate (METR) on business assets is 19.6 percent, but it varies significantly by asset type, business form, industry, and how the asset is financed.
  • Biden’s tax proposals would raise the METR on business investment in the United States by 7.8 percentage points to 27.5 percent in 2021. The effective tax rate would rise on most assets and new investment in all industries.
  • In addition to increasing the overall tax burden on business investment, Biden’s proposals would increase the bias in favor of debt-financed and noncorporate investment over equity-financed and corporate investment.

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Introduction

Former Vice President and Democratic presidential nominee Joe
Biden has proposed several tax increases that are estimated to raise about $3.8
trillion between 2021 and 2030.1 His
proposals would raise the corporate income tax rate, broaden the business tax
base, and repeal major provisions of the Tax Cuts and Jobs Act (TCJA) that
reduced taxes for high-income households. His proposals would also raise taxes
on capital gains and dividends by raising the tax rate and limiting the ability
to step up the basis of a gain at death.

Biden’s proposals focus on raising taxes on business and
capital income. Doing so means that Biden’s plan primarily raises revenue from
high-income households.2 However, it
also means his plan will affect incentives to save and invest in the United
States.

Business taxes can increase the required return on
investment and reduce the incentive to invest, eventually leading to a smaller
capital stock, lower labor productivity, lower wages, and lower total output.
Individual taxes on capital income can reduce the incentive for individuals to
save by reducing the returns they receive on their investments. Lower national
saving can reduce available financing for new investment and reduce ownership
of capital assets by Americans, which can lead to lower output and lower national
income.

The federal tax system can also distort the allocation of
investment across different types of assets and business forms. Provisions such
as bonus depreciation, the special 20 percent deduction for business income,
and the research and development credit apply to only certain capital assets
and businesses. As a result, assets such as equipment and intellectual property
products held in a pass-through business face much lower effective tax rates
than an office building held by a traditional C corporation.

In addition, taxes can distort how firms finance new
investments. Under current law, firms that finance new investment with debt
receive a deduction for interest payments to lenders. In contrast, firms do not
receive a deduction for dividend payments made to owners of equity. This
results in a bias in favor of debt-financed investment.

This report estimates the impact of Biden’s tax proposal on the effective tax burden on business assets in the United States using the Policy Simulation Library’s Cost-of-Capital-Calculator (CCC).3 The report begins with an overview of how capital is taxed in the United States and of Biden’s tax proposals. It then presents estimates of the marginal effective tax rate (METR) on investment under current law and under Biden’s proposals.

Read the full report.

Notes

1. Kyle Pomerleau, Jason DeBacker, and Richard W. Evans, An Analysis of Joe Biden’s Tax Proposals, American Enterprise Institute, June 15, 2020, https://www.aei.org/research-products/report/an-analysis-of-joe-bidens-tax-proposals/.

2. Pomerleau,
DeBacker, and Evans, An Analysis of Joe
Biden’s Tax Proposals
.

3. Cost-of-Capital-Calculator, https://github.com/PSLmodels/Cost-of-Capital-Calculator#readme.

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