Tax Incentives & “Loopholes,” or how stupid can the tax code get???

No doubt the president will be proposing some business tax breaks on Thursday night, and that got me thinking – do these do any good, will they promote growth or job creation?  My short answer is no.  I say that not because I don’t think there are tax policies that might help businesses by promoting expansion and growth, it is just that few of these recently have been around long enough to take root.  To gain any traction a business tax incentive has to be in effect for (at least) several years, 6 month and 1 year incentives are not around long enough to become inculcated into business planning and yield the desired result.  Most small business owners don’t even become aware of some of these tax deductions before they expire!

Many of these incentives just drain treasury with not one iota of the desired result.  Some of the new business tax credits; employment credits for new employee retained for more than a year, the credit for providing employee health insurance, and the plethora of energy credits are examples of less than effective tax incentives.  Why do I say “less then effective?” – Because they probably do not change any business owner’s behavior, they just provide tax breaks after the fact when firms like ours prepare the companies tax return. 

Conversely let us look at a long standing tax incentive that is well known to many business owners, the section 179 depreciation deduction.  This election to write off a chunk of tangible equipment in a single year has been in the code for many years and has become a staple of small business planning.  Every year I have dozens of conversations with business client that start out with; “should I buy a vehicle/truck/equipment before the end of the year.”  This is an example of a tax incentive that is designed to foster investment in tangible assets and it clearly accomplishes that goal. 

I am not necessarily a fan of “tax incentives” as many are clearly loopholes designed by and for specific interests/entities by corrupt politicians.  Need some examples?: Hedge fund managers that (essentially) get to declare compensation as long term capital gains, corporate deferred compensation and stock option schemes, electric & alternative auto credits, accelerated depreciation on corporate jets and last but not least MOST of the corporate and personal energy credits and deductions (“energy” credits are the reason GE got a tax benefit/refund of $3.2 billion from the IRS, and I am sure they lobbied ferociously for each and every one of them! – see below).

When I Googled “tax loopholes” I got discussions on the mortgage interest & charitable donation deduction, tax free municipal bond interest and long-term capital gains rates, it made me think that for some a tax loophole is anything somebody else gets to take advantage of.  

Let us take the famous case of General Electric (from the NYT 03.24.2011);  

General Electric reported worldwide profits of $14.2 billion, and said $5.1 billion of the total came from its operations in the United States.

Its American tax bill?  None. In fact, G.E. claimed a tax benefit of $3.2 billion.

That may be hard to fathom for the millions of American business owners and households now preparing their own returns, but low taxes are nothing new for G.E. The company has been cutting the percentage of its American profits paid to the I.R.S. for years, resulting in a far lower rate than at most multinational companies.

Its extraordinary success is based on an aggressive strategy that mixes fierce lobbying for tax breaks and innovative accounting that enables it to concentrate its profits offshore. G.E.’s giant tax department, led by a bow-tied former official treasury named John Samuels, is often referred to as the world’s best tax law firm. Indeed, the company’s slogan “Imagination at Work” fits this department well. The team includes former officials not just from the Treasury, but also from the I.R.S. and virtually all the tax-writing committees in Congress.

While General Electric is one of the most skilled at reducing its tax burden, many other companies have become better at this as well. Although the top corporate tax rate in the United States is 35 percent, one of the highest in the world, companies have been increasingly using a maze of shelters, tax credits and subsidies to pay far less.

If there was ever an argument for tax simplification this might be it, when a huge company like GE spends millions in tax planning and lobbying to yield not only 0 taxes but an actual refund of $3.2 million dollars!  If you couple this with the fact that over 50% of American taxpayers pay no income tax or that General Electric’s Chairman and CEO, Jeffrey Immelt is now head of the President’s Council on Jobs and Competitiveness and you know you have an incredibly corrupt and broken system.

Illiminate MOST if not all tax incentives, credits and deductions in favor of lower tax rates, let GE fire its tax attorney staff and lobbyist (maybe they can go to work on rebuilding American infrastructure projects!) and allow the millions of small business owners to concentrate of running their business instead of keeping up with the idiotic, ever changing minutiae of our tax code.

Happy Labor Day 2011!