Everyone knows the tax code needs to be fixed. But how? That’s the vexing question.
In recent months several proposals for reforming corporate taxation have been put forth in Washington. Others, meanwhile, have argued for a tax system that does more to reduce the nation’s income inequality.
A new paper by a pair of researchers from the Tax Policy Center and Urban Institute frames the question differently, however. It asks: Does the tax code impact investments in new and innovative businesses, and if so, how?
The authors, Donald Marron and Joseph Rosenberg, conclude that differences in tax treatment currently “distort investment decisions and reduce total economic output.”
To analyze today’s system, they created a single measure—a marginal effective tax rate—that combines the various features of the federal tax code, from rates and deductions to credits and other benefits. The higher the METR, the more pretax profit a venture needs to generate in order to produce a return for investors.
They found the code clearly favors certain industries over others. Take these examples: For manufacturing firms, the METR ranges from 20 percent to 25 percent, and for whole and retail trade businesses, it’s 31 percent. But for chemical and pharmaceutical companies, the METR is roughly 10 percent.
Some other findings detailed in the paper: The tax code decidedly favors debt over equity, and its credits and special provisions often are out of reach for startups that aren’t well into the black.
“Greater reliance on equity financing eats away at the advantages offered to innovative firms and to startups,” the authors note. “(And) limits on the ability to use tax losses can significantly increase the cost of capital and marginal effective tax rates.”
In an article outlining their findings, the two researchers acknowledge that “tax reform must inevitably balance competing goals.” But any reform worthy of the name should contain changes that create a more level playing field for new and innovative ventures.
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