Lexecon Study Concludes That Economic Evidence Does Not Support Change in the Tax Treatment of Advertising

At the request of The Advertising Coalition, the economic consulting firm of Lexecon, Inc., and its affiliates, Nobel Laureates Dr. Kenneth Arrow of Stanford University and the late Dr. George Stigler of the University of Chicago examined the economic effect of a change in the tax treatment of advertising expenditures. The Tax Code permits businesses to deduct the cost of advertising as a current expense. It has been suggested that some portion of advertising costs be amortized and deducted over several years. This concept appears to be based on the mistaken view that advertising is either wasteful and should be discouraged, or that advertising generally produces benefits that last for more than one year.

Advertising provides important economic information to consumers and others and serves a pro-competitive function in society

Advertising is a powerful tool of competition. Advertising keeps prices low and facilitates the entry of new products and new firms into the market. It provides valuable information about products and services in a cost-­‐effective manner and helps the economy to function smoothly. Since the information conveyed by advertising is valuable, Congress should be particularly cautious about imposing taxes that would raise the cost, and hence lower the quantity and quality of advertising. Such taxes would reduce the overall flow of economic information available to consumers. As a result, we expect that prices would rise, the variability in prices for particular products would increase, and consumers would be less able to find goods that satisfy their preferences.

The existing economic evidence does not support the conclusion that advertising is long-lived

Studies of the durability of advertising have reached such different conclusions that they cannot be used as a coherent basis for formulating tax policy. Moreover, we have found that these studies suffer from technical flaws that render their conclusions meaningless.

Some economists hypothesize that if advertising creates future value it will be reflected in the difference between a firm’s market value and the value of its tangible assets. While they attempt to measure the relationship between a firm's advertising expenditures and its intangible capital, they ignore the fact that there are many economic factors other than advertising that determine the market value of a firm. The most important of these is the value of the firm’s product - its effectiveness or its “innovativeness,” like the desktop “Finder” which Apple advertises it provides on its Macintosh personal computers to make them user friendly. Apple’s advertising is not the intangible here - it is only a tool that has helped Apple realize the value of the true intangible, the quality and innovativeness of the Finder.

Based on an analysis of the issues and a comprehensive review of the existing literature in the field, Lexecon concludes that proposals to change the tax treatment of advertising are not supported by the economic evidence.

To view the full report, click here.