Strategic decisions are influenced by real and hypothetical economic conditions, with tax implications playing a crucial role in the process
The only constant is change, they say — and this is the nature of life, and by extension businesses. Those leaders who must make strategic decisions based on reality and hypothetical economic conditions, including consideration of any tax implications, often face a constant swirl of change.
There are numerous factors that impact the economy — locally, nationally, and globally — and some leaders have to consider the impact tax policies have on economic growth or contraction. Indeed, the message around tax and the economy is also a strong message for politicians.
Factors impacting tax strategies
A recent presentation by EY looked at three leading factors that businesses and their internal tax departments need to consider as they make their strategic plans for the remainder of the year. In the United States, real GDP increased 2.8% in the second quarter of 2024, up from 1.4% in the first quarter, and it seems this pace will continue into the second half of the year. Further, employment appears to be stable even though there has been a slight decline in job additions in recent months.
Economic growth
This economic growth and stabilization in employment have significant tax implications. Higher economic growth generally leads to increased corporate profits and personal incomes, which in turn boosts tax revenues. As businesses expand and hire more employees, the tax base broadens, leading to higher totals being paid in the form of corporate taxes and individual income taxes. Additionally, higher employment rates mean more people are contributing to payroll taxes, further enhancing tax revenues.
Inflation and interest rates
Inflation now appears to be gradually declining, with the Consumer Price Index showing a 3.0% increase from 12 months ago as of June. The Federal Open Market Committee is expected to lower interest rates by 50 basis points at some point this month. These changes in inflation and interest rates have profound effects on tax policy.
Lower inflation reduces the cost-of-living adjustments that are often built into tax brackets and deductions, potentially resulting in higher effective tax rates for many taxpayers. On the other hand, lower interest rates can reduce the cost of borrowing, encouraging investment and spending.
This can lead to changes in tax incentives and deductions as policymakers adjust to promote economic activities that align with the new interest rate environment. For instance, there could be increased incentives for capital investments or adjustments in mortgage interest deductions to reflect the lower borrowing costs.
Legislative developments
The political landscape of tax legislation is also evolving, with significant changes being considered for the Tax Cuts & Jobs Act (TCJA), which passed in 2017, and the Child Tax Credit (CTC), which is facing procedural challenges in the Senate. These legislative efforts could extend several business tax provisions in the TCJA and increase the refundable CTC amount.
Legislative changes can have direct and immediate impacts on tax liabilities for both businesses and individuals. For businesses, for example, extensions of tax provisions under the TCJA could mean continued benefits from lower corporate tax rates and other incentives that could potentially impacting their tax planning and financial strategies.
IRS developments
Included in the Inflation Reduction Act, passed in 2022, is significant funding for the U.S. Internal Revenue Service. These funds will be allocated to not only enforcement efforts but other IRS programs such as the Direct File program and updates on Employee Retention Credit (ERC) claims. And, not surprisingly, these developments will have an influence how taxes are filed and processed.
For example, the Direct File program aims to simplify the tax filing process, potentially reducing the burden on taxpayers and improving compliance rates. Its purpose is to encourage more accurate and timely tax filings, enhancing the efficiency of tax collection. Updates on ERC claims, on the other hand, highlight the IRS’s focus on scrutinizing tax credits and ensuring their proper utilization.
Navigating the dynamic tax environment
The interplay between economic growth, inflation, legislative changes, and IRS developments creates a dynamic and complex tax environment. Businesses and individuals need to stay informed and adapt their tax strategies to navigate these changes effectively. For businesses, this could mean revisiting their tax planning strategies in order to leverage new incentives and comply with updated regulations.
Tax leaders have lamented that one of the top worries that keeps them up at night is staying up to date with regulations. As the economic landscape continues to evolve, staying proactive and informed is crucial for businesses that want to manage their tax obligations and find new opportunities where available.
Today, tax department leaders will have to work differently in someways just to keep up, and more importantly, to be a strategic partner to their organization.
You can find more about the geopolitical and economic environment in 2024 here.
