TaxProf Blog

Editor: Paul L. Caron, Dean
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Monday, June 19, 2017

Hayashi Reviews Batchelder's Accounting For Behavioral Considerations In Business Tax Reform

Jotwell (Tax) (2016)Andrew Hayashi (Virginia), Do Taxes Motivate Corporate Managers? (JOTWELL) (reviewing Lily Batchelder (NYU), Accounting for Behavioral Considerations in Business Tax Reform: The Case of Expensing (2017)):

Tax scholarship is interdisciplinary. To evaluate tax policy it helps to know at least a little about economics, a little about philosophy, something about budget processes, and a lot about the dizzying creativity of the marketplace in exploiting loopholes and facilitating tax-advantaged transactions. In her recent article Accounting for Behavioral Considerations in Business Tax Reform: The Case of Expensing, Lily Batchelder shows us that we must add financial accounting and firm (and corporate managers’) behavioral considerations to the mix.

The article evaluates which of three policies, adopted on a revenue neutral basis to replace our current regime of accelerated depreciation, would cause the largest increase in new investment by the corporate sector. The three policies are: expensing of new investments combined with higher statutory corporate rates; lower statutory rates combined with more gradual and economically accurate economic depreciation; and an investment tax credit combined with economic depreciation.

The conventional wisdom is that the first of these options, allowing for current expensing of new investment, will have the biggest bang-for-the-buck. But the analysis that yields this conclusion assumes that corporate managers choose investments to maximize the after-tax net present value of the investment returns. If that were true, managers would care about the marginal rate applicable to the investment, which is zero (at least as to the normal returns) if the investment is equity financed and the cost of the investment is expensed. The key insight that Batchelder shares is that managers don’t look at the marginal rate. The financial accounting literature shows that they make their decisions based on either the statutory rate or their “book” tax rate, because these are what affect income for financial reporting purposes. Neither rate reflects the value of tax deferral, so managers tend not to incorporate the benefits of tax deferral when making investment decisions. The best of the three policies is instead to eliminate accelerated depreciation and use the revenue to finance a statutory rate cut.

This paper makes two significant contributions. The first is to bring evidence on the tax variables that affect managers’ decisions to a live debate about how to increase investment. Batchelder not only canvasses relevant accounting theory and empirics, but also corroborates the incentives created by financial accounting standards by talking with corporate managers. The care with which she buttresses this important premise of her argument makes her conclusions about the ineffectiveness of expensing that much more credible. The second contribution is her argument that the optimal investment policy—at least in terms of maximizing the increase in new investment—is one that minimizes the capital-weighted relevant rate on new investment.

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The behavioral implications of tax policy is the only area worthy of "empirical research," everything else is mental masturbation.

Posted by: Dale Spradling | Jun 20, 2017 12:20:24 AM