The American Jobs Creation Act of 2004 allows businesses to deduct from their taxable income a percentage of what they earn from qualified domestic production activities. The deduction rose in steps to 9 percent for tax year 2010 and thereafter. The Emergency Economic Stabilization Act of 2008 reduced the deduction rate for oil-related qualified production activities to 6 percent for tax years after 2009.
Various activities qualify for the deduction:
- Lease, rental, sale, exchange, or other disposition of tangible personal property, computer software, or sound recordings, if they are manufactured, produced, grown, or extracted in whole or significant part in the United States;
- Production of films (other than those that are sexually explicit);
- Production of electricity, natural gas, or potable water;
- Construction or renovation of real property; and
- Performance of engineering or architectural services.
The list of qualified activities specifically excludes the sale of food or beverages prepared at retail establishments; the transmission or distribution of electricity, natural gas, or potable water; and many activities that would otherwise qualify except that the proceeds come from sales to a related business.
The deduction for domestic production activities was created in part to replace the tax code’s extraterritorial income exclusion—which allowed businesses to exclude income from certain types of transactions that generate receipts from trade with foreign countries. According to the World Trade Organization, that exclusion violated its agreements by subsidizing exports. The deduction was intended to reduce the taxes on income from domestic production without violating the organization’s rules.
This option would repeal the deduction for domestic production activities. Doing so would increase revenues by $192 billion from 2014 through 2023, the staff of the Joint Committee on Taxation estimates.
One argument in favor of this option is that it would reduce economic distortions. Although the deduction is targeted toward investments in domestic production activities, it does not apply to all domestic production. Whether a business activity qualifies for the deduction is unrelated to the economic merits of the activity. Thus, the deduction gives businesses an incentive to invest in a particular set of domestic production activities and to forgo other, perhaps more economically beneficial, investments in domestic production activities that do not qualify.
In addition, to comply with the law, businesses must satisfy a complex and evolving set of statutory and regulatory rules for allocating gross receipts and business expenses to the qualified activities. Companies that want to take full advantage of the deduction may incur large tax-planning costs (for example, fees to tax advisers). Moreover, the complexity of the rules can cause conflict between businesses and the Internal Revenue Service regarding which activities qualify under the provision.
An argument against implementing this option is that simply repealing the deduction for domestic production activities would increase the cost of domestic business investment and could reduce the amount of such investment. Alternatively, the deduction could be replaced with a revenue-neutral reduction in the top corporate tax rate (a cut that would reduce revenues by the same amount that eliminating the deduction would increase them). That alternative would end the current distortions between activities that qualify for the deduction and those that do not. It also would reduce the extent to which the corporate tax favors noncorporate investments over investments in the corporate sector and foreign activities over domestic business activities.
|(Billions of dollars)||2014||2015||2016||2017||2018||2019||2020||2021||2022||2023||2014-2018||2014-2023|
|Change in Revenues||6||17||18||20||21||21||21||22||22||23||83||192|
Source: Staff of the Joint Committee on Taxation.
Note: This option would take effect in January 2014.