Restoring The Three Martini Lunch Tax Deduction Won’t Feed The COVID-19 Economy

One of President Trump’s demands for the next COVID-19 relief bill is restoration of the tax deduction for business meals and entertainment expenses. Since the president has a long history in the hospitality business, his affinity for this tax subsidy isn’t surprising. But as a tool to stimulate the current troubled economy, this tax break is, as the president himself might say, a total loser.

What good will it do to subsidize business meals and entertainment when almost no one is traveling or meeting in person? Or while hotels, restaurants, golf courses, and the like largely remain shuttered? And when those that do reopen are operating are far below capacity? Until the pandemic is controlled, who will do business over lunch?

The three martini lunch

The tax break, fondly known as the three martini lunch deduction, has been a long-standing boondoggle for decades. Corporate executives and small business owners routinely used it to write off personal expenses as costs of doing business. Want to take your spouse to a fancy anniversary dinner? Charge it to the business and take a deduction. Want to shoot a round at the country club? Take a client—and claim a deduction.  The tax scam has been around so long that martinis had time to be fashionable, become passe, and turn trendy all over again.

Congress slowly scaled back the deduction over the years, most recently in the 2017 Tax Cuts and Jobs Act (TCJA). The TCJA generally repealed the deduction for business entertainment, such as, say, greens fees at golf courses or tickets to sporting events. But business meals remained on the tax break menu, though slimmed down.  

There was some initial confusion about the meals deduction.  But in 2018, the IRS issued interim guidance that said taxpayers generally still may deduct 50% of client-related business meals if food and beverages are purchased separately, or at least reported separately on a bill or invoice. This guidance, updated last February,  does not exactly impose onerous requirements on firms.

Especially pointless

For example, a golf club intent on maximizing deductible expenses for its members presumably could reduce non-deductible greens’ fees but jack up prices for deductible dinner and drinks at the 19^th hole as long as it is billed separately.

Not only has the business meal deduction been a favorite tool for tax avoidance and thus dubious tax policy, but restoring it now seems especially pointless.

There is no doubt that hotels, resorts, and restaurants have been hit hard by COVID-19. Even before governments shuttered these businesses to prevent spread of the disease, customers largely stopped going out. Business conferences were cancelled. Hotel bookings collapsed, and restaurants could do little more than provide carry-out.

These industries all could use help. But will tax incentives provide much assistance?

It seems unlikely. Try this thought experiment: Would you be any more likely to host a business dinner tonight if you could deduct the full cost, rather than half? Would anyone attend? Seems unlikely.

Joe’s Bar and Grill

Even as some restaurants are slowly reopening, most will be required to keep diners six feet apart for the foreseeable future, significantly reducing occupancy and revenues. There is real doubt about how many can survive with that low volume of business.

There is little evidence that business diners will flock to expense account restaurants any time soon.  And the meals deduction will do nothing to help small neighborhood establishments. Mom’s Dinette and Joe’s Bar and Grill were not doing much expense account business before COVID-19 and won’t do much after. This deduction primarily helps high-end white tablecloth joints. And probably not very much.

There isn’t a lot of academic research about the economic effects of tax breaks on demand for meals and entertainment. But we do have the results of a natural experiment. When the TCJA slashed the meals deduction to 50 percent, there was little evidence that overall demand for restaurant meals slowed. If anything, the industry was quite robust in 2018 and 2019.

For real help, control the pandemic

According to the National Restaurant Association, US restaurant receipts grew from $799 billion in 2017 (pre-TCJA) to $833 billion in 2018 and to $862 billion in 2019. Full service restaurant revenues grew from $263 billion in 2017 to $274 billion in 2018 and $285 billion in 2019.

The most important step government can take to revive the hospitality business is to get the COVID-19 pandemic under control. Short of that, it is hard to see what will help keep many of these businesses viable. But one thing is clear: Restoring the tax break, as President Trump demands, won’t do much more than increase the reward for business execs who game the system.