Yesterday, Republican leaders from Congress and the White House released a joint statement outlining principles for 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. While the statement did not include a great deal of detail, it did set out a few specific goals for a tax reform effort this fall:
The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas.
One of the objectives outlined in this yesterday’s statement is to allow “unprecedented capital expensing.” What does capital expensing mean, and what would an unprecedented level of it be?
Under the current U.S. tax code, businesses are usually allowed to immediately deduct their regular business costs. However, this is not the case for capital investments, such as equipment, machinery, and buildings. When a business makes a capital investment, it is required to deduct the cost over several years, according to a set of 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. Not only is the system of depreciation deductions quite complicated, but there is good reason to believe that requiring businesses to deduct their capital expenses over time acts as a significant barrier to business investment, economic growth, and job creation.
“Capital expensing” refers to any law or proposal that would allow businesses to immediately deduct some or all of the cost of a capital investment.
Currently, there are two important provisions in the U.S. tax code that allow businesses to expense some of their capital investments:
- Bonus expensing allows businesses to deduct 50 percent of the cost of eligible machines and equipment. However, bonus expensing does not apply to all business investment, because investments in buildings and other structures are not generally eligible for the provision. In addition, bonus expensing is set to expire at the end of 2019.
- Section 179 allows small businesses to expense up to $500,000 in capital investments. However, section 179 begins to phase out for businesses with over $2,000,000 in capital investments, and businesses with over $2,500,000 in investments are ineligible for the provision. Additionally, section 179 also does not generally apply to structures, such as buildings.
However, in the past, the tax code has allowed greater use of expensing for U.S. businesses. For instance, beginning in September 2010, the U.S. tax code allowed 100 percent bonus expensing for equipment and machines placed into service before January 2012. Nevertheless, this level of bonus expensing was only temporary, and the provision reverted to 50 percent bonus expensing, where it currently stands.
If lawmakers are interested in offering “unprecedented capital expensing,” they would probably, at a minimum, have to allow for 100 percent permanent bonus expensing for equipment and machinery. They would also have to maintain or expand the current section 179 thresholds. Lawmakers should also improve businesses’ ability to deduct the cost of structures, such as buildings, which do not generally qualify for section 179 or bonus expensing.
Many lawmakers have proposed going further than these proposals, and enacting a policy 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. ,” allowing businesses to immediately deduct the full cost of all of their capital investments. For instance, full expensing was a central part of the House Republican tax plan, released last summer. Full expensing would create a level playing field between all sectors of the economy, and would only help businesses that are undertaking new investments, which makes it one of the most pro-growth tax proposals currently under consideration.
However, yesterday’s joint statement shied away for calling explicitly for full expensing. Perhaps this may be due to lawmakers’ concerns about the potential federal revenue loss from moving to full expensing (although these fiscal costs are often overstated).
If lawmakers do not pursue full expensing for all assets, they may still be able to reduce the negative effect of the tax code on investments that cannot be expensed. For instance, lawmakers could increase the depreciation deductions that businesses receive in the future for their capital investments, adjusting the deductions for 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. This approach is known as neutral cost recovery, and it would cause less of an up-front revenue loss for the federal government than full expensing.
Either way, it is encouraging that lawmakers have made increasing capital expensing one of their priorities for tax reform.
 To give a sense of what “unprecedented capital expensing” would look like, under current law, businesses are able to immediately deduct an average of 34.4 percent of the cost of their physical capital investments. In tax year 2011 – when 100 percent bonus expensing was under effect for equipment and machinery – U.S. businesses were able to immediately deduct 49.8 percent of their physical capital expenses. This is probably the figure that lawmakers have to beat if they wish to offer U.S. businesses “unprecedented capital expensing.”
(Calculations done by author using IRS statistics).Share