Deductible Excess
Wednesday, April 8, 2009
We are awash in a steady stream of news articles detailing corporate excess, typically in the forms of salaries, bonuses, lavish office decorations and company retreats. Excess of another kind, however, has received less attention, but is equally pernicious: deductible expenses for business entertainment.
Suppose that Penny, an administrative assistant, and her husband, Buck, go to a professional basketball game, paying $50 a seat to sit in the nosebleed section. Rich, Penny’s boss, attends the same game, accompanied by a client. Unlike Penny and Buck, Rich and the client sit courtside in seats that cost $500 each, paid for by Rich’s company. Under current law, Rich’s company can deduct half of the price of the tickets. This means that Uncle Sam has contributed hundreds of dollars to subsidize their seats.
Deductions of this sort have several ramifications. The most immediate is a considerable loss of tax revenue. Exact dollar figures are not readily available, but plausible estimates of business entertainment deductions range from $5 billion to $7 billion annually.
First, the assumption underlying business deductions is that the expenses in question relate solely to business, yet it's clear that attendance at events such as concerts and games yield considerable personal enjoyment to both the business host and guest.
Second, because audit resources are very limited, it is impossible for the IRS to distinguish between those entertainment expenditures that have a meaningful business purpose and those that don’t.
Third, this deduction is utilized almost exclusively by high-bracket taxpayers -- corporate executives and their bankers, lawyers and board members. Is it any wonder why this opportunity to enjoy expensive entertainment on a deductible basis would be widely resented by ordinary taxpayers.
A final item to consider is that business entertainment expenses are generally incurred in an implicit effort to subvert the rational economic decision-making of the party being entertained -- an effect that is both economically inefficient and morally corrosive. Business entertainment attempts to forge bonds and attract potential and existing clients to purchase the host’s services or products on grounds that have nothing to do with the quality or price of the services or products being offered.
With deficits now out of control, President Obama and Congress need to eliminate deductions that are costly, lack coherent justification, cannot be policed, result in inequities and have a questionable moral dimension. The deduction for business entertainment expenses suffers from all of these faults, and should be among the first items pruned in any tax reform effort.
President Kennedy called for elimination of deductions for business entertaining almost half a century ago. His appeal generated some reforms, but the core of the problem remains. It’s time to finish the job.