The Economic and Budgetary Effects of Full Expensing of Investment

April 21, 2014

The reasons for America’s sluggish economic growth in recent years are many fold, but a big part of the problem is high taxes on investment. It is not just the high corporate tax rate – the highest in the developed world – but also the fact that businesses cannot generally write off their investment expenses immediately. Instead, businesses must wait years or decades to take these deductions, based on a complicated system of depreciation by asset and industry. Further, the depreciation system in the U.S. is more punitive than that of most developed countries.

As a result, many economists recommend letting businesses fully expense all investment purchases in the first year, as businesses currently do with labor costs. The case for full expensing was made last week by Narayana Kocherlakota, the President of the Federal Reserve Bank of Minneapolis. Today, it is Ed Lazear’s turn, in the pages of the Wall Street Journal:

Lower corporate tax rates is a move in the right direction, but it is not as effective in stimulating investment as is full-expensing. The bang-for-the-buck was estimated by Treasury to be about four times as high for full-expensing than for lowering rates. The reason? Lowering corporate rates reduces taxes for all capital, old and new alike. An investment that was made 10 years ago gets the benefit of lower rates as does one that is made tomorrow. But full expensing applies only to new investment because it is only investment going forward that is deductible. As a result, all of the power of reducing taxes works for new investment in the case of full expensing.

Full expensing will likely be labeled a "trickle down" policy that will not help the working American. This is unfortunate because labor would benefit greatly. Investment is crucial for increasing labor productivity and higher productivity is necessary for higher wages. Productivity and wages move together. Without productivity increases wages cannot grow.

There are many changes that would improve the efficiency of the tax code, but cutting the tax on investment heads the list.

Read the rest of the article here.

Our simulations also point to a higher bang-for-the-buck for expensing versus cutting the corporate tax rate. We find cutting the corporate tax rate 10 points would increase GDP about 2 percent, once all adjustments are made (about 5 to 10 years). However, full expensing would boost GDP about 5 percent. Further, the larger GDP translates into larger personal incomes, and since most federal tax revenue comes from taxes on personal income and payroll, total federal tax revenue per year would be about $97 billion higher. Lastly, we find the benefits accrue disproportionately to the low end of the income scale, due to the growth of jobs, productivity, and wages. These results are shown in the table below.

FULL EXPENSING: ECONOMIC AND BUDGET CHANGES VERSUS 2013 LAW

(billions of 2012 dollars except as noted)

 

 

 

 

GDP

5.21%

 

 

 

Private business GDP

5.41%

 

 

 

Private business stocks

15.62%

 

 

 

Wage rate

4.42%

 

 

 

Private business hours of work

0.94%

 

 

 

Federal revenue (dynamic)($ billions)

$96.5

 

 

 

Federal spending ($ billions)

$30.9

 

 

 

Federal surplus (+ = lower deficit) ($ bil.)

$65.7

 

 

 

Static revenue estimate ($ billions)

-$69.6

 

 

 

% Revenue reflow vs. static

-238.6%

 

 

 

$GDP ($ billions)

$813.1

 

 

 

$GDP/$tax increase (dollars)

$8.43

 

 

 

 

 

 

 

 

Weighted Average service price

Change

% Change

 

Corporate

-1.33%

-9.43%

 

 

Noncorporate

-0.83%

-7.44%

 

 

All business

-1.16%

-8.83%

 

 

 

 

 

 

 

 

 

 

 

 

DISTRIBUTION EFFECTS

 

 

 

 

(billions of 2012 dollars except as noted)

Average after-tax income per return

All Returns

Static

Static

Dynamic

Dynamic

AGI Class

Change

% Change

Change

% Change

< 0

-$28

0.03%

-$4,803

5.45%

0 - 5,000

$0

0.00%

$140

5.23%

5,000 - 10,000

$0

0.00%

$412

5.11%

10,000 - 20,000

$2

0.01%

$800

4.95%

20,000 - 30,000

$5

0.02%

$1,296

4.81%

30,000 - 40,000

$6

0.01%

$1,801

4.75%

40,000 - 50,000

$10

0.02%

$2,240

4.58%

50,000 - 75,000

$18

0.03%

$3,090

4.61%

75,000 - 100,000

$39

0.04%

$4,315

4.59%

100,000 - 150,000

$107

0.08%

$5,820

4.46%

150,000 - 200,000

$390

0.21%

$7,620

4.11%

200,000 - 250,000

$977

0.41%

$9,666

4.02%

250,000 - 500,000

$2,165

0.60%

$14,773

4.10%

500,000 - 1,000,000

$5,825

0.80%

$30,584

4.20%

> 1,000,000

$23,453

0.67%

$145,830

4.16%

 TOTAL FOR ALL

$142

0.23%

$2,782

4.43%

 

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