Expensing for Economic Growth

April 23, 2013

Financial Accounting Quirks Thwart Real Tax Reform

Washington, D.C., April 23, 2013—In order to achieve faster economic growth and greater job creation, Congress must look closely at rules governing expensing and depreciation for business investments, according to a new study by the Tax Foundation. The tax treatment of these accounting procedures could mean the difference between a larger, growing economy and an unproductive period of stagnation.

“The rules for how quickly a company can write off investments in plants, equipment, and buildings directly impact the cost of doing business,” said Tax Foundation Senior Fellow Stephen J. Entin. “The higher those costs are, the slower the economy will grow. The lower the cost, the bigger the economy will be, and with it the number of jobs and the level of wages.”

When the tax code allows businesses to account for the costs of major investments quickly – using “accelerated depreciation” or expensing to compute its income – the business receives a bigger deduction early in the life of the equipment and a smaller one later. It pays less tax in the early years and more in the later years. This increases the value of the business’s cash flow and means a higher return on the investment.

“Government officials prefer that businesses use lengthy depreciation rather than immediate expensing of costs when they occur mainly because it appears to bring in more tax revenue sooner. Whether at the federal or state level, governments generally want their revenue in the door as soon as possible,” said Entin. “That is unfortunate, because money left in the private sector for saving and investment normally generates a return of above 6 percent, which would provide an expansion of the economy that the public would consider well worth waiting for.”

Fixing the distortion in the tax base by moving toward expensing would redress some of the punitive treatment current law imposes on capital intensive industries and the blue collar jobs they provide. It would end the tax bias against long lived assets such as plants, commercial buildings, and multi-family housing. Lower corporate tax rates on the resulting, better-defined income would add a further boost to all types of innovation and expansion. Combined, they would break the economy out of its current sluggish pattern of inadequate investment and job creation.

Tax Foundation Background Paper No. 67, “The Tax Treatment of Capital Assets and Its Effect on Growth” by Stephen J. Entin is available here.

The Tax Foundation is a nonpartisan research organization that has monitored fiscal policy at the federal, state and local levels since 1937. To schedule an interview, please contact Richard Morrison, the Tax Foundation’s Manager of Communications, at 202-464-5102 or morrison@taxfoundation.org.

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