How To Fix Tax Reform So It Doesn’t Favor Robots Over Humans

May 30, 2017 | By: Robert A. Green, CPA


How To Fix The Tax Code So It Doesn’t Favor Robots Over Humans

In one of my favorite books on behavioral economics, “Freakonomics” authors Steven Levitt and Stephen Dubner tell many stories about how the best-laid incentive plans may go awry and have the opposite economic effect. Case in point today: Proponents of tax reform claim it will increase job creation, but I’m concerned it will increase automation instead.

President Trump and his team call their tax plan a “jobs” bill. Treasury Secretary Steven Mnuchin says it’s a tax cut for the middle class, even though there isn’t much tax savings for middle-income taxpayers. The plan skews to the wealthy and business owners. Mnuchin expects companies to utilize significant business tax cuts for job creation, which helps the middle class. Mnuchin promises the economy will grow over 3% per annum and a rising tide will lift all boats. But it’s a bit of a stretch to call it a middle-class tax cut.

Job market
The American labor market remains under significant competitive pressure. Global companies make a great profit using cheaper foreign labor, avoiding American employee benefits, safety, and environmental standards. The U.S. unemployment rate is at a historic low, and many Americans gave up looking for a job because they lack necessary skills. President Trump promised to rein in the H1-B visa program importing foreign workers. The trend toward automation is increasing rapidly.

Tax reform “full expensing”
Full expensing means a business may expense the cost of investment in plant, equipment, fixed assets, and intangible assets on a cash flow basis. If the company purchases these items in 2018, it may expense the full cost in 2018.

Under current law, a business may expense tangible property, like computers, if the item does not exceed $2,500. Section 179 depreciation (full expensing) is allowed on qualifying equipment up to a limit of $500,000. If the business purchases more than $2 million of qualifying equipment, the Section 179 deduction phases out dollar for dollar. These breaks are intended for smaller companies. Bigger companies using robots exceed Section 179 limits. Without these code sections, companies depreciate machinery and equipment over its useful life, varying from five to 22 years.

The tax reform full expensing provision should be successful in encouraging businesses to invest in new plant and equipment in America, but that includes robots and other automation. The leading robot manufacturers are located in Japan and other foreign countries, not in America.

Contrast investment in robots vs. investment in job creation. Companies will expense the cost of purchasing a robot in year one, but only write off job costs as incurred during the duration of employment. Front-loading tax breaks for robots are a huge tax advantage, and it will sway companies in that direction.

Tax reform “repatriation of foreign cash”
The current U.S. tax system subjects U.S. corporations and individuals to U.S. taxation on worldwide income. Companies may defer U.S. taxes until repatriating profits back into the U.S., although this break does not apply to passive foreign investment companies (PFIC). The unintended consequence is that operating companies hoard assets offshore to defer U.S. taxes for a long time. President Trump and Congress want to fix this problem, encouraging companies to bring income back to reinvest in America.

Corporate tax reform includes changing to a territorial system, standard with U.S. trading partners. This change would mean U.S. companies would not owe U.S. taxes on profits earned outside the U.S. As a one-time tax in converting to a territorial system, President Trump, and Congress would offer businesses a significantly lower tax rate on repatriated income, deferred under the former regime.

Global companies may prefer to keep foreign factories operating at full capacity with foreign workers. With a territorial system, these companies would only owe foreign country taxes, which may be competitive with the U.S. after a corporate tax cut. As a result, companies may move out of high-tax locations, either back to the U.S. or other low-tax countries.

Corporate tax reform may encourage businesses to build new highly automated factories in the U.S. rather than invest in automation offshore where there is a risk of nationalization or geopolitical interference. America is an ideal place for automation with low energy prices used for running robots and other equipment. Businesses won’t want old factories they abandoned decades ago. There will be plenty of construction jobs building these automated facilities and some jobs to operate them.

Tax reform should include a payroll tax cut
Employees are subject to payroll taxes, whereas robots are not. Payroll taxes include a 12.4% social security tax, applied to wages up to the social security base ($127,200 for 2017) and a 2.9% Medicare tax without a base or limit. Payroll taxes also include federal and state unemployment insurance and state workmen’s compensation costs. The IRS raised the social security base by 7.3% for 2017, and it will likely increase it again for 2018. It’s an unpublicized tax increase falling heavily on middle-income taxpayers. Employees and employers split the costs of social security and Medicare taxes, giving companies another reason to consider robots instead.

In my October 2015 blog post “Human Jobs Under Attack By Tax Code Favoring Robots Over People,” I suggested Congress consider a payroll tax cut and transfer some of that burden paying payroll taxes to companies using robots. I also suggested a human jobs depletion allowance similar to the depletion allowance on energy resources. With full expensing, Congress may repeal the depletion allowance.

Front load employment deductions
Perhaps Congress can allow a business to deduct several years of wages in the initial year of job creation to front load the deduction and put it on par with investment in robots with full expensing.

My ideas can level the playing field between job creation and robots. The transfer payment of payroll taxes ensures that workers can also benefit from robots, not just business founders, shareholders, management and the government who collects taxes on profits.

Republicans face a tough battle selling tax reform to the American people. I hope Congress considers my ideas, which can help sway the middle class.