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1 Garrett Watson & Alex Muresianu, Supernormal Returns: An Overlooked Foundation of Tax Policy Debates 1 (2024)

handle is hein.taxfoundation/sprnlrsaov0001 and id is 1 raw text is: TAX FOUNDATION Supernormal Returns: An Overlooked Foundation of Tax Policy Debates Garrett Watson Senior Policy Analyst, Modeling Manager Alex Muresianu Senior Policy Analyst September 2024 Key Findings • Businesses invest now to earn future returns. For an investment to be worthwhile, it must at least break even, providing a risk-free return that covers the cost of capital, time, and inflation-known as the normal return to investment. • Businesses can also earn supernormal returns, which exceed the normal return, often due to unique advantages like market power, rent-seeking, investment risk, or temporary pricing power due to innova- tion. • The impact of tax policy on investment decisions depends on the type of return the investment gener- ates. Normal returns are the most affected by taxes, supernormal returns from risk and innovation are still responsive, and supernormal returns from market power are the least responsive. • To encourage investment, the tax system should exempt normal returns, as they directly impact new investments at the margin, or the breakeven point for businesses. • Taxing supernormal returns can still be economically counterproductive, as these returns often come from risky or entrepreneurial activity. • Accordingly, arguments that the corporate tax can be raised with few economic trade-offs because supernormal returns constitute a substantial share of corporate profits should be viewed with skepti- cism. • As Congress prepares to debate the upcoming expirations of the 2017 tax law, two policies under consideration would help exempt the normal return to capital: returning to expensing for research and development (R&D) costs and reinstating 100 percent bonus depreciation. • Raising the corporate tax rate and other taxes on business investment would negatively impact inno- vation, entrepreneurship, and economic dynamism in the US, discouraging these productive activities. The Tax Foundation is the world's leading nonpartisan tax policy 501(c)(3) nonprofit. For over 80 years, our mission has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity. TAX FOUNDATION 1325 G STREET, NW, SUITE 950, WASHINGTON, DC 20005 202-464-6200 1 laxfoundation.org