Investment, GDP Slow in First Quarter: Bad Weather or Bad Tax Policy?

May 05, 2014

It is always darkest after a false dawn. Investment spending popped in the fourth quarter of 2013 by 10.9 percent. Real GDP was up 2.6 percent compared to the third quarter. Some forecasters said that this boded well for a strong 2014.

We warned at the time that the investment surge might be short-lived; that it could be due to businesses’ rushing to use the 50 percent bonus expensing provision that was about to expire at the end of 2013. Bonus expensing lets firms deduct part of the cost of investment in equipment and software immediately, while depreciating the remaining half over time under ordinary cost recovery rules. It reduces the cost of adding or replacing these inputs.

In the first quarter of 2014, GDP rose at a slow crawl (0.1 percent above the fourth quarter of 2013). Some forecasters are blaming the slowdown on the weather. The weather was dreadful, and slowed shopping, construction, transportation, and exports. However, the Bureau of Economic Analysis GDP release reports that investment slowed especially hard compared to the previous quarter: “Equipment decreased 5.5 percent, in contrast to an increase of 10.9 percent. Intellectual property products increased 1.5 percent, compared with an increase of 4.0 percent.”

The slump in investment was almost certainly a reaction to the ending of the bonus expensing provision, and the consequent increase in the cost of equipment and software.

Washington hates to take responsibility for bad economic outcomes, and would love to blame the drop in investment and the slowdown in GDP on anything other than bad tax policy. Washington also hates to give up tax revenue (a.k.a. other people’s money) on a permanent basis, and often cuts taxes only temporarily during bad times. But faster cost recovery for investment boosts capital formation, productivity, wages, and jobs; the tax revenue from the stronger economy more than makes up the initial revenue loss from the faster write-offs.

Bonus expensing would do more to create investment and jobs, and would raise more tax revenue from growth, if it were made permanent. It does less good if it is applied as a counter-cyclical tool that is put on in bad times and taken off again as the economy recovers. That on-off policy does more to shift the timing of investment than it does to raise the total amount of capital in the country. 

A permanent improvement in GDP and income requires a permanent reduction in the cost of capital formation.  If the government were willing to invest a few dollars of short run tax money in letting the people make the country grow, the government and the people would both be richly rewarded in higher future incomes.

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