Three Facts Straightening Out the Debate Over Bonus Depreciation

US capital investment is booming above projections, in large part from the buildout in AI and associated infrastructure. That investment boom is interacting with a handful of provisions from the 2025 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. law (OBBBA, the One Big Beautiful Bill Act) that corrected a long-standing issue with the rules for deducting capital expenditures. Firms can once again fully and immediately deduct the cost of short-lived investments from their taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. Taxable income differs from—and is less than—gross income.  .  

Yes, this applies to AI servers and HVAC components for data centers, but it also applies neutrally to a much broader set of assets that are unrelated to AI. 

The growth in investment is reducing corporate tax receipts, which have fallen about 25 percent over the past year. The popular discussion about the drop in corporate tax receipts includes three common misunderstandings about 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.: treating it as a permanent tax cut instead of a timing change; overestimating its long-run fiscal cost to the federal government; and framing it as a subsidy for businesses when it merely removes a tax penalty on investment.   

1. Expensing Allows Firms to Deduct Investment Costs Now, Not Later 

When designing a business tax system, lawmakers must decide whether capital investments should be counted as costs and deducted immediately when they are bought or be spread over many years.  

Under prior US tax law, firms had to deduct investment costs 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 disco schedules, instead of immediately in the year the investments occurred. The OBBBA made three changes to cost recoveryCost recovery refers to how the tax system permits businesses to recover the cost of investments through depreciation or amortization. Depreciation and amortization deductions affect taxable income, effective tax rates, and investment decisions., moving in the direction of 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.: 

• 100 percent bonus depreciation for short-lived investment, which was temporarily provided under the 2017 tax law but had been phasing out. 

• Full expensing for domestic R&D, which was the norm until the 2017 tax law introduced amortization for R&D; the OBBBA includes options for small businesses to retroactively expense their R&D back to when amortization began (tax years beginning after December 31, 2021) or to accelerate remaining amortization deductions over a one- or two-year period. 

• Temporary 100 percent expensing of qualified structures, allowing full deductions for investment in certain buildings if they are in a qualifying sector, constructed before the start of 2029 and placed in service before the start of 2031. 

The OBBBA’s expensing provisions are a timing change, not a special tax cut. Firms take the same nominal dollars of deductions under expensing as they are permitted to take under depreciation over time. Rather than a “generous tax break,” expensing simply matches tax deductions with actual expenditures. 

This produces an economic benefit: depreciation delays no longer artificially increase after-tax costs. When firms must wait to take deductions, 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 spendin and the time value of money erode their real value, understating real costs, overstating real profits, and increasing the after-tax cost of capital. Aligning the timing of deductions with the timing of investment expenses removes this tax penalty, reducing the cost of capital and leading to more investment.  

The OBBBA’s timing fix for tax purposes runs counter to the timing used in other instances of corporate finance, particularly for calculating book profits on financial statements. Accounting standards generally require firms to deduct a portion of the investment expenses each year. This can give rise to book-tax gaps, and in the near-term, tax payments may decline even as firms appear profitable on financial statements. Over a longer horizon, book-tax gaps caused by timing differences for deducting capital expenditures will fade. 

2. 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. Receipts Dip in the Short Run, but Mostly Recover Later 

Accelerating depreciation deductions reduces how much tax firms owe in the short run relative to the baseline, since deductions that would have been spread over time can be taken all at once. 

The cost is greatest in the first few years of the transition, as firms take accelerated deductions for new investment and depreciation deductions for prior investments. As old investments are fully written off, the long-run cost declines to roughly the increase in the present value of business tax deductions.  

For example, Tax Foundation estimated the revenue loss of permanence for bonus depreciation under the OBBBA would fall from $79.5 billion in 2026 to $21.5 billion in 2035, with revenues stabilizing much closer to the pre-2025 tax law CBO baseline near the end of the budget window. From 2025 to 2035, Tax Foundation estimated bonus depreciation would reduce federal revenue by $473.1 billion on a conventional basis. We estimated temporary structures expensing would reduce revenue by about $27 billion over the window while R&D expensing would reduce revenue by $178 billion, heavily concentrated in the first two years due to the retroactive restorations. 

So far, actual corporate revenues appear to be tracking our projections. Investment may rise more than our estimates projected, driven by factors beyond the new tax law, such as the ongoing AI boom. In that case, corporate tax receipts could dip more than we projected as investment rises in the near term, but then we would expect tax revenues to benefit as taxable profits rise in the future. 

The picture looks better when we account for the economic effects of permanent bonus depreciation. For example, our conventional score for bonus depreciation overestimates the real cost because it excludes the income and payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. feedback that results from a larger economy—we estimated permanent bonus depreciation would increase long-run GDP by 0.6 percent. On a dynamic basis, Tax Foundation projects the policy will cost $44 billion from 2025 to 2035, a fraction of the conventional revenue cost.  

Focusing on the immediate dip in corporate tax receipts ignores that expensing is a timing change that will be largely recovered—and that a growing economy produces higher individual income and payroll tax revenues.  

3. Expensing Is Not a Subsidy 

Expensing is not a carveout designed to encourage certain investments. It is a broad-based, structural improvement that treats investment neutrally.  

A business will pursue an investment project only if its expected return clears the firm’s hurdle rate, or the user cost of capital. A tax system based on depreciation increases the user cost of capital, causing some projects that would otherwise be viable to be abandoned for tax reasons. In contrast, a tax system based on full expensing has no impact on the user cost of capital for a marginal investment, removing the income tax distortion from the equation altogether. 

Correcting the tax treatment of investment by providing permanent bonus depreciation does not mean that firms invest in the United States because of a tax deductionA tax deduction allows taxpayers to subtract certain deductible expenses and other items to reduce how much of their income is taxed, which reduces how much tax they owe. For individuals, some deductions are available to all taxpayers, while others are reserved only for taxpayers who itemize. For businesses, most business expenses are fully and immediately deductible in the year they occur, but ot; it means that the tax code no longer creates a barrier for marginal investment.  

Many investments are not “the marginal investment.” These investments promise large returns, whether from innovation, first mover advantage, or some other reason. In these cases, firms may expect returns that far exceed investment costs and will accordingly face positive tax liabilities.  

Even in the presence of inframarginal investment opportunities, which may describe much of the AI investment we’re seeing across the economy, expensing remains the correct tax treatment to ensure the tax system does not place a burden on marginal investment. Under expensing, all firms will deduct their investment costs upfront, resulting in an immediate reduction in tax liability; firms will then pay tax on all the resulting profit, and if investments turn out better than expected, the government will also share in those returns. 

Conclusion 

The new tax law changed the timing of business deductions for capital investment, accurately matching tax deductions with actual expenditures by providing permanent bonus depreciation. The timing change is leading to an anticipated decline in corporate tax receipts in the near-term, reflecting the transition cost from depreciation to expensing. This comes as the US is experiencing an AI investment boom largely unrelated to federal tax policy, potentially causing a larger dip in tax receipts than projected.  

The ongoing investment boom does not undercut the policy rationale for expensing; expensing is a structural improvement to the tax code ensuring it does not burden marginal investment. Under expensing, the government will still collect revenue on profitable investments while it avoids discouraging marginal investment. 

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