The 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. Cuts and Jobs Act (TCJA) made significant progress in improving the 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. treatment of business investment by enacting 100 percent bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings, in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. . Full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. , or the immediate write-off of all business investment, is a key driver of future economic growth, and can have a larger pro-growth effect per dollar of revenue forgone than cutting tax rates. However, the TCJA expensing provision will only be in effect for five years before it begins phasing down; as lawmakers continue efforts to reform the tax code, permanence for full expensing should be on their radar.
Full expensing is a powerful, pro-growth provision because it alleviates a bias in the tax code that discourages investment in the United States.
Generally, when businesses calculate their income for tax purposes, they subtract business costs. This makes sense because the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. is a tax on business profits, or generally, revenues minus costs. However, businesses are not always allowed to subtract the amount they spend on capital investments, such as when businesses purchase equipment, machinery, and buildings. Typically, when businesses incur these sorts of costs, they must deduct them over several years according to preset 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. schedules, instead of deducting them immediately in the year the investment occurs.
This is problematic because, due to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and the time value of money, a dollar in the future is worth less than a dollar today. So, delaying deductions for the cost of business investments means that the actual value of the deductions is less than the original cost. The table below illustrates what this looks like for a variety of assets at different rates of inflation.
|5-year asset||15-year asset||20-year asset|
Source: Author’s calculations. Assumes half-year convention, 3 percent real discount rate, plus inflation.
|MACRS at 0% inflation||$92.97||$78.64||$75.50|
|MACRS at 2% inflation||$88.75||$69.32||$63.87|
|MACRS at 3% inflation||$86.77||$66.69||$59.07|
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe
Ultimately, this treatment means that the corporate income tax is biased against investment in capital assets to the extent that it makes the investor wait years or decades to claim the cost of machines, equipment, or factories on their tax returns. This results in less capital formation, lower productivity and wages, and less output.
The Tax Cuts and Jobs Act significantly improved the ability of businesses to recover the costs of their investments by enacting 100 percent bonus depreciation for assets with cost recovery periods of 20 years or less. Through 2022, businesses can immediately deduct the full cost of eligible investments, such as machinery and equipment, just as they would with any other business expense, rather than stretching deductions over many years. But after 2022, the provision will begin phasing down, which is why the provision doesn’t contribute to long-run economic growth. And, if Congress doesn’t make the provision permanent, it would result in an increase in the cost of investing in machinery and equipment in the United States.
In our recent paper, we estimate that making the 100 percent bonus depreciation provision in the Tax Cuts and Jobs Act permanent would increase the size of the capital stock by 2.2 percent and long-run GDP by 0.9 percent; the larger economy would result in a 0.8 percent increase in wages and 172,300 full-time equivalent jobs. And it would improve the economy in a cost-efficient manner. We’ve estimated that permanence for the TCJA expensing provision generates about 4.5 times more economic growth per dollar of revenue cost than permanence for the TCJA’s individual provisions.
Source: Taxes and Growth Model, April 2018
|Private Business Capital Stock||+2.2%|
As lawmakers continue efforts to improve the tax code like Tax Reform 2.0, they ought to explore ways to make the TCJA 100 percent bonus depreciation provision permanent well before it expires.Share