On Tax Cuts

President Obama is adding to his new economic plan today, with a proposal to help small businesses with some tax relief. Tax cuts for small businesses are what many—including the occasional Reason blog post—have been calling for since the administration took over. But the way the government goes about letting small businesses retain more of their earnings matters a lot in terms of effectiveness. From WSJ:

President Obama is expected to lay out a proposal on Wednesday that would allow companies to write off 100% of any amount they spend on qualifying equipment in 2010 and 2011. But already, small businesses that spend less than $800,000 a year on certain equipment can write off up to $250,000 according to an existing tax ruling, known as Section 179 expensing. As a result, small businesses would have to spend more than $250,000 on equipment this year or next to see an additional tax boost.

So this particular type of tax break is designed to get small businesses to spend and consume, not necessarily allowing them to use their earnings for what they deem best. It is a classic case of trying to engineer a recovery by directing capital to a politically perceived good. In this case, there may not be as much interest in buying more equipment:

“You don’t see a lot of small businesses making that type of investment,” says Maureen McGetrick, a partner in New York with BDO Seidman LLP, a national tax advisory firm. For example, she says the average small retailer or consulting firm simply doesn’t need to spend more than $250,000 on equipment in any given year.

In most cases, small businesses will only buy new equipment to replace badly worn out machinery or expand their enterprises. But because of the sour economy, few small companies have enough cash on hand to do either right now, even if they’ll be able to write off their investments in just a few months, says Bill Rys, tax counsel for the National Federation of Independent Business, a Washington, D.C., trade group. “They don’t have customers coming through the door. They don’t have contracts to fill,” he says.

Some argue from this that the focus should be on the consumers themselves. GOP House leader Rep. Boehner has suggested a payroll tax, along with a spending freeze, to boost the economy. Some economists argue this is the way out of recession, consumer spending. But while a payroll tax, if fully paid for, wouldn’t hurt the economy and would allow individuals to have more of their own cash, it wouldn’t get us out of recession. Many would use the extra money to pay down debt or to save it. These would be good things, since savings is too low and debt is too high. But it means that the consumer spending path out of the recession is a very, very long one.

There really is no easy way to fix the economy. Cutting government spending in order to reduce taxes is one good thing to do. Fixing the Dodd-Frank Act to add more certainty would help. And reforming the housing finance system to get rid of government subsidies for housing would allow that sector of the economy to finally clear out its toxicity and begin a natural recovery. All of this takes time though, and patience may be the biggest thing our leaders can help us with.

See the whole WSJ piece here.