The Pitfalls of Temporary Corporate Tax Rate Cuts

Although it is widely recognized that a temporary corporate tax rate cut will do less to encourage investment than a permanent rate cut, the temporary cut's limitations are actually even more severe. A temporary rate cut would discourage many types of investment during the period it was in effect and could have long-lasting, adverse consequences if it was deficit-financed. A temporary corporate tax rate reduction does not necessarily lower the lifetime tax burden on an investment made while the rate reduction is in effect. Although the rate reduction lowers the taxes collected on the asset's gross payoffs, it also shrinks the tax savings from the asset's capital cost recovery allowances. For investments with front-loaded capital cost recovery allowances, the latter effect can easily outweigh the former effect, resulting in higher lifetime tax payments. Adverse effects are most pronounced for investments that are expensed