Repeal the Deduction for Domestic Production Activities

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Change in Revenues 9.6 17.8 18.0 18.2 18.2 18.1 18.3 18.3 18.5 18.8 81.8 173.7

Source: Staff of the Joint Committee on Taxation.

This option would take effect in January 2017.

Most businesses can deduct from their taxable income 9 percent of what they earn from qualified domestic production activities. The design of the deduction makes it comparable to a 3 percentage-point reduction in the tax rate on income earned from U.S.-based manufacturing. Various activities qualify for the deduction if they occur largely in the United States:

  • Lease, rental, sale, exchange, or other disposition of tangible personal property, computer software, or sound recordings;
  • 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.

This option would repeal the deduction for domestic production activities. Doing so would increase revenues by $174 billion from 2017 through 2026, 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. 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.