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Obama’s Investment Equivalent of “Cash for Clunkers”

2 min readBy: Scott Hodge

The Obama administration seems poised to do to business investment what the ill-conceived federal policies aimed at helping the auto and housing markets did – incentivize short-term activity at the expense of future sales while failing to improve conditions for the long-term.

Undeterred by the boom and bust experiences of the “cash for clunkers” program and the first-time homebuyers tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. , President Obama will reportedly announce on Wednesday a new 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. plan aimed at jump-starting business investment by allowing firms to immediately expense new capital purchases made in 2011 rather than depreciate them over many years as they must do now under current tax rules.

While economists generally prefer expensing over 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. , the problem with the Obama plan is its short-term and temporary nature. To whatever extent the Obama plan encourages firms to buy new equipment or invest in new factories it will be simply be bringing those investments to the present from the future. At the end of the day, the economy may be no better off overall.

An analysis by University of Michigan economists of the 2002 “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. ” legislation – which allowed firms to immediately deduct a large fraction of their investment – found that it may have had little overall impact on increasing economic output (0.1 percent to 0.2 percent) or employment (100,000 to 200,000 jobs), but it did alter the composition of investment made during the period. The authors found that the policy shifted investment away from disallowed investments such as structures, to allowed investments such as equipment.[1] It is likely the Obama plan will have a similar effect.

Other economists have pointed out that investment incentives are pointless if firms have little free cash to invest during a recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. or if firms are in a net operating loss position and cannot use the tax benefit. Such was the case in 2002 and 2003 with the bonus depreciation program and such is likely to be a problem today.

Obama should be praised for recommending making the Research and Experimentation tax credit permanent. Congress’ on again, off again efforts to extend the credit has likely reduced its effectiveness in promoting R&D spending.

However, none of Obama’s proposals fix what ails the nation’s business climate and lagging global competitiveness – the fact that the U.S. corporate tax rate is so far out of step with the rest of the world. Economists at the OECD have determined that 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 the most harmful tax for long-term economic growth. Thus, a permanent cut in the corporate rate would be far more effective in promoting long-term economic growth than any of Obama’s proposals.

[1] Christopher House and Matthew D. Shapiro, “Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation,” National Bureau of Economic Research Working Paper 12514, September 2006.