Last week, the Center for Budget and Policy Priorities released a report arguing that 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. should remain expired. They base this on three main claims:
- Bonus 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. was a temporary stimulus and should be allowed to expire
- Allowing bonus depreciation to continue is an overly-generous subsidy for business investment
- It does not align with the goals of 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. reform
The CBPP’s conclusions are based on a misunderstanding of bonus depreciation, its current place in the tax code, and its place in tax reform.
What is Bonus Depreciation?
Under current law, businesses are not able to fully deduct the initial cost of capital investments (buildings, machines, and other equipment) as they do with labor and raw material. Instead, they must write these costs off over several years or even decades, depending on the asset type.
Due to the delay between the purchase of the asset and its write-off, the business ends up not being able to fully account for the present value cost of the investment. This is due to the fact that a $20 deduction today is not as valuable as a $20 deduction ten years from now.
Bonus depreciation allows businesses to write-off 50 percent of the initial cost of the investment before depreciating the asset as it would under current rules. Because most of the initial cost is written off in the first year, the total present value of the write of ends up being larger than it was in the absence of bonus depreciation, but it still does not allow a complete write off.
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Example Calculation of a Capital Allowance on a $100 Investment, with and without Bonus Depreciation |
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Without Bonus Depreciation |
With Bonus Depreciation |
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Year |
Cost |
Nominal Write-off |
Present Value Write-off |
Nominal Write-off |
Present Value Write-off |
|
0 |
$ 100.00 |
$ 20.00 |
$ 20.00 |
$ 60.00 |
$ 60.00 |
|
1 |
$ – |
$ 20.00 |
$ 18.60 |
$ 10.00 |
$ 9.30 |
|
2 |
$ – |
$ 20.00 |
$ 17.31 |
$ 10.00 |
$ 8.65 |
|
3 |
$ – |
$ 20.00 |
$ 16.10 |
$ 10.00 |
$ 8.05 |
|
4 |
$ – |
$ 20.00 |
$ 14.98 |
$ 10.00 |
$ 7.49 |
|
Total |
$ 100.00 |
$ 100.00 |
$ 86.99 |
$ 100.00 |
$ 93.49 |
Bonus Depreciation Should Not Be Seen as a Temporary Stimulus
CBPP makes the claim that bonus depreciation is a temporary stimulus based on the fact that Congress enacted it during the two recessions of the past decade on a temporary basis. Thus, it should be allowed to expire in order to have the desired simulative effect in the future.
This is based on the view that bonus depreciation can be likened to some sort of demand-side stimulus, in which the federal government temporarily boosts economic activity through a quick and temporary change in policy.
While it may give a boost to the economy in the short run, bonus depreciation should not be considered a temporary stimulus. Instead, it should be viewed as a way to reduce the cost of investment relative to current law over the long run. In the above example, it allows a business to recover more of the cost of an investment than it would be able to in the absence of bonus depreciation. This lowers the cost of capital, leading to higher investment, a larger capital stock, and a larger economy.
Seen this way, it makes sense that it should be made permanent as a way to reduce the ongoing cost of investment.
Bonus Depreciation Does Not Create Negative Effective Tax Rates
CBPP also makes the claim that making bonus depreciation permanent would extend a large subsidy for corporations for investment. Specifically, they claim that bonus depreciation creates a negative effective tax rate on investment.
Their claim stems from the fact that bonus depreciation allows businesses to write-off capital investments faster than “economic depreciation.” The idea behind this is that because an investment produces a flow of income over many years, the full cost of the machine should not be written off the year it was made. Instead, the cost should be written off at the same rate the machine depreciates. Any faster, the tax code provides a subsidy.
While this is a useful accounting method, it is not how businesses realize costs. When a business makes a capital investment, such as buying a machine, it purchases that machine in the first year. The costs are not spread out over the life of the machine, as the CBPP’s analysis implies.
The result of delaying write-offs at all is that effective tax rates are higher than they otherwise would be.
Making Bonus Depreciation Permanent Moves Towards an Ideal Corporate Tax Reform.
CBPP’s last point is that Representative Dave Camp’s tax reform proposal did away with bonus depreciation therefore it is not compatible with tax reform.
One of the weak spots in Chairman Camp’s tax reform proposal was his treatment of capital investment. Not only did he get rid of bonus expensing, his plan lengthened asset lives, which would exacerbate the current mistreatment of capital investments. This is the primary reason why the plan netted little economic growth in the long run.
Instead, meaningful tax reform would move towards 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. , which would allow businesses to write-off the full cost of investments.
Making bonus depreciation permanent would be a step towards the proper treatment of investments: full expensing.
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