Obama’s $200 Billion Tax Cut Problem: What Will Companies Buy?

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Cell phone tower builders could get a stimulus benefit

If you think a plan called, “Cash for Cell Phone Towers,” or “Cash for Internal Combustion Engines,” sounds kind of clunky, that may be the problem.

On Wednesday, President Obama in a speech in Cleveland, Ohio, officially announces a bonanza of a business tax cut that could boost business spending by $200 billion in the next 16 months. It is the latest of a string of proposals the President has rolled in the past few days that he says will rescue the nation’s so far tepid, and potentially failing, economic recovery. The plans are a mixture of tax cuts and infrastructure spending. Together this second smaller stimulus package would ring in at, depending on the estimate, anywhere from $180 billion to $350 billion. But no matter how you price it, the proposed business tax cut that Obama announces today has the potential to offer the biggest boost to the economy. That’s a problem. Here’s why:

The $200 billion plan is to allow businesses to write off the full value of most business investments made from now until the end of 2011. Companies can always use the cost of those purchases to lower their taxes, but they normally have to do so over a number of years, anywhere from 5 to 39, depending on what they buy. Obama is betting that companies will spend money now in order to get the immediate tax cut.

In theory, the tax cut could be a relatively cheap way to stimulate the economy. Afterall, companies will be saving taxes now, but they will be reducing the tax write-offs they can take in the future. Eventually, hopefully, those companies, if they are around, will end up paying those taxes eventually. So the plan will do little to worsen the nation’s deficit problem.  Corporations have a record amount of cash sitting on their balance sheets that is not being spent because either Obama is not business friendly, or of the weak economy, depending on what you believe. So if what is really more of a tax deferment than a tax break is able to get them to spend that money now rather than wait, it could really help the economy. But the question as to how stimulative this proposal will be comes down to how many companies will really bite, and how much extra will they spend?

A few years ago University of Michigan professors Matthew Shapiro and Christopher House studied a similar plan, and came away with this conclusion:

While the policy noticeably increased investment in types of capital that benefited substantially from bonus depreciation, the aggregate effects of the policy were modest. The analysis suggests that the policy may have increased output by roughly 0.1 percent to 0.2 percent and increased employment by roughly 100,000 to 200,000 jobs.

So how can the policy both noticeably increase investment and produce modest economic results at the same time? What the professors found is that types of purchases that would benefit the most from the acceleration of the tax benefit were the ones companies were least likely to make.

Companies get the greatest benefit from the plan from items that normally take the longest to write off. The cost of an office building, for example, has to be written off over 39 years. That’s because office buildings tend to be around and valuable for a long time. Cars and computers, for example, lose their value quickly. So companies get to take the tax write-off on those items in five years. Office towers and other buildings, though, are likely to be exempt from Obama’s proposal. In the past, tax deferment policies have only applied to items that are fully expensed in 20 years. So the sweet spot of this tax plan are items on which companies normally have to be expensed for tax reasons over 15 to 20 years.

What will companies be buying with their tax credits? Cell phone towers. The tax benefit of buying cell phone towers normally has to be spread over 15 years. Other items in that tax expense category are electrical or utility towers, engines and turbines that don’t end up in cars or airplanes and farm structures.

The problem companies don’t normally spend a lot of money on that stuff. For much of the past 20 years, Shapiro and House found that nearly 30% of all business investment goes toward buying cars, computers and other office equipment, which is the type of purchase that benefit little from Obama’s proposed tax cut. Building costs eat up another 40% of the total, again outside of this plan. Farm, rail and electrical power structures typically make up just over 2% of business investment. Telephone and utility poles combine for another 1.6%. Yes, those sectors because of the tax cut could grow to soak up a larger portion of business investment dollars this year. But even if the demand for both of those types of items double, that will only boost business investment by 3.6%.

But the point is that Obama’s tax deferment stimulates industries that are typically pretty small, rather than giving a boost to the parts of the economy like the technology sector, which employs a lot of people and many think is our nation’s future engine of growth. Even if the cell phone tower business grows rapidly in the next year, most of us are unlikely to notice the benefit to the economy.

Obama has faced critics of his past stimulus efforts. Cash for Clunkers and the Home Buyer Tax Credit did a great job of boosting demand. But critics of the two plans say they only pulled demand forward, causing a large drop off in sales when the two plans ended and no lasting boost to the economy. But at least those programs were targeted to produce demand in two sectors, automobiles and housing, that make a significant contribution to our economy and were in need of a boost. Some people have already negatively compared Obama’s proposed $200 billion business investment tax cut to cash for clunkers. In fact, this plan is worse.