Amazon shortlisted both Pittsburgh and Philadelphia as potential locations for its new headquarters, but a week before Christmas, the state Department of Revenue made both bids much less attractive, not just for Amazon HQ2, but for all businesses. While other states are positioning themselves to attract new investment, Pennsylvania quietly adopted a policy—by way of a Department of Revenue bulletin—which heavily penalizes investment in the state.
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. es, at both the federal and state level, are intended to be levied on net income. To that end, deductions are allowed for “all the ordinary and necessary expenses paid or incurred during 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. able year in carrying on any trade or business” (IRC § 162(a)). This is why there are deductions for compensation and for costs of goods sold, and for paying down debt. The major outlier is capital expenditures, where 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. deductions are taken instead.
By allowing an immediate deduction for other business expenses, but not for capital expenditures, the tax code disincentivizes investment. 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. erodes the value of these tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state/local taxes paid, mortgage interest, and charitable contributions. s, so they wind up understating the cost of the equipment and overstating corporate returns. We have estimated that, over time, corporations are only able to deduct about 87 percent of costs of investment.
Depreciation schedules also do a poor job of aligning with the real world: equipment may become outdated, and thus subject to replacement, long before it physically wears out.
Faster cost recovery favors the future over the past, whereas long depreciation schedules benefit companies that aren’t actively investing or creating jobs. Improvements on 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. also equalize the treatment of different types of investment, avoiding distorting economic decision-making.
For all these reasons and many others, accelerated cost recovery has been an important goal of tax reformers for years. It is a highly pro-growth policy. At the federal level, there have been many changes to depreciation over the years, but the two most pertinent ones are the introduction of so-called “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. ,” which allowed 50 percent of the cost of short-lived assets, like machinery and equipment, to be deducted in the first year, and the 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. for those same short-lived assets, provided for in the new tax law.
Pennsylvania, like many other states, chose to decouple from federal bonus depreciation rules for revenue purposes. Now, while other states are deciding whether to conform to the new full expensing provisions, Pennsylvania is having a very different debate: whether to treat machinery and equipment purchases worse than other investments, and indeed worse than such investment is treated in any other state.
The bonus depreciation addback statute is not a model of clarity. I don’t think there’s any doubt that the legislative intent was to require companies to add back the accelerated depreciation and instead operate under traditional depreciation schedules. That’s the interpretation the Department of Revenue has operated under until now. In December, however, the Department of Revenue issued a tax bulletin adopting a new interpretation yielding a policy result that few, if any, would champion.
Under the new interpretation, the full deduction must be added back for investments subject to bonus depreciation—or, now, full expensing—at the federal level. Businesses would no longer even receive the depreciation deductions, substantially raising the cost of investment in Pennsylvania.
Both Pittsburgh and Philadelphia are finalists for Amazon HQ2. It’s hard to imagine that the tech giant would be enthusiastic about a policy that dramatically overtaxes investment. Such a policy, though, affects companies of all sizes, particularly those involved in manufacturing or other machinery-intensive operations. No other state penalizes investment the way that Pennsylvania does following the issuance of that tax bulletin.
House Bill 2017 is designed to resolve the existing statutory ambiguity and restore depreciation deductions for machinery and equipment. It does not provide for the old bonus depreciation regime, let alone full expensing. It merely restores the system under which Pennsylvania operated until very recently. Such legislation should not have been necessary. But in the wake of a bulletin which upends the tax treatment of investment, it is suddenly very necessary that something be done. While other states are working to promote investment and growth, Pennsylvania is headed in the other direction.Share