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Canada May Follow the United States’ Lead on Improving Tax Depreciation for Investment

3 min readBy: Stephen J. Entin

Canada To Adopt Expensing and Accelerated Cost Recovery

TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. competition at its best.

Politico reports that the Canadian federal government will allow accelerated depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. for some investments to compete with the U.S. expensing provision that was implemented as part of the U.S. Tax Cuts and Jobs Act (TCJA). The Canadian government has been concerned that the U.S. move has made the U.S. a more attractive location for investment, and that Canada must improve its capital recovery rules to avoid a loss of business to the U.S.

The Canadian government may feel pressured into making this move, but it is good tax policy, and the government should be grateful for the political cover afforded by the TCJA. Additional growth in the U.S. would help, not hinder the Canadian economy. Accelerating depreciation in Canada would boost Canadian capital formation, not merely preserve it against U.S. competition.

The province of Ontario has announced that it will conform its capital recovery rules to the Canadian federal change. U.S. states take note: conform to the U.S. federal change, or you will lose business to other states and Canada.

Half measures due to budget concerns

The TCJA permits full immediate write-off of equipment outlays for the next five years. The Canadian provision is reported not to go as far as immediate expensing. It is said to permit some acceleration of the write-off, but the deductions are still to be spread over time. The Politico source said the more limited improvement in cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. was due to budget concerns. This is short-sighted.

Expensing advances write-offs that would occur over time. There is a near-term dip in revenue as firms bring their deductions forward, but no permanent loss over the life of the asset.

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However, the faster write-off shifts the after-tax profit forward, which makes the investment more attractive to the businesses because of the time value of money. Investment will be larger under the new provision, and the added investment will raise productivity, wages, employment, and GDP. Because of the increase in Canadian GDP, tax revenue would be higher after the adjustment period than under current law, all else being equal.

The Canadian government would need to borrow a bit more in the first few years of the accelerated deductions. However, the rate of return on investment in the private sector is far greater than the borrowing rate faced by the government. Canadian GDP, taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. , and tax revenue would expand by much more that the small amount of added annual interest on the additional government debt. The Canadian budget would be better off, not worse off, over time, and the people of Canada even more so.

The U.S. expensing provision is also limited due to budget concerns. Expensing is set to expire after five years to comply with the net tax cut amount allowed under the budget reconciliation instructions that governed the TCJA. The irony is that the expensing provision should increase U.S. revenue over time, due to growth, but the budget forecasts fail to fully account for the growth effects.

An added benefit for the U.S. from the Canadian response

The temporary, uncertain nature of the U.S expensing provision may hamper its effectiveness in boosting investment. The sooner it is extended, the more certain it will be, and the more investment, growth, and long-run revenue it will generate. If Canada’s more limited provision is permanent, it may be as effective as the U.S. expensing provision. Though smaller in magnitude, it would be more certain. Furthermore, if the Canadian provision is made permanent, it may put added pressure on the U.S. Congress to extend the expensing provision here, lest Canada gain an advantage after the U.S. expensing expires. The extension would be a great benefit to U.S workers and savers.

However far this “tax competition” goes, it will benefit workers and consumers in both countries. It would help the governments too, and it could be pushed further, sooner, if only they were savvy enough to realize it.

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