Obama’s Business Expensing Proposal Would Prove Expensive for States

President Obama has proposed a new tax break for business investment.  It’s intended to boost the economy, but it would have the unintended effect of worsening states’ already severe budget problems.  That, in turn, would force states to take steps that would undercut the hoped-for economic stimulus.

In September, the President proposed letting businesses deduct the full cost of machinery and equipment purchases immediately — rather than gradually over several years, as current law generally requires.  This proposal would reduce federal revenues by an estimated $200 billion over the next two years.  It would also reduce state revenues by up to $20 billion, as we explained in a recent report, because most states tie their tax codes to the federal code.  The table below lists each state’s potential revenue loss.

As many as 45 states and the District of Columbia would lose revenues in fiscal years 2011-2013 under the proposal.  The exceptions are Nevada, Texas, Washington, and Wyoming, which have no personal or corporate income tax, and California, which historically hasn’t followed federal rules on deductions for these investments.

States must balance their operating budgets, and they’re already far short of revenue due to the sad state of the economy.  Thanks to weak revenues and an almost certain decline in federal aid to states, projected shortfalls exceed $130 billion for state fiscal year 2012, which starts July 1, 2011 in most states.

If the expensing plan becomes law, states would have to deal with the revenue loss through budget cuts or tax increases — on top of the budget cuts and tax increases they’re already imposing to deal with the large revenue losses caused by the recession.  These additional measures would weaken the proposal’s overall stimulative effect by removing demand from the economy.

Over the next decade, states would recover most of their lost revenue, since businesses that deduct the full cost of their capital investments now would be prevented from deducting that cost in future years.  But that won’t help states now as they face a severe revenue crisis.