It is common knowledge that the United States has the highest 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. rate in the industrialized world, but it is less well known that our cost recovery system ranks poorly as well.
Currently, the U.S. 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. code only allows businesses to recover an average of 62.4% of a capital investment (investments in machinery, industrial buildings, intangibles, etc.). This is lower than the average capital allowanceA capital allowance is the amount of capital investment costs, or money directed towards a company’s long-term growth, a business can deduct each year from its revenue via depreciation. These are also sometimes referred to as depreciation allowances. of 66.5% across the OECD.
Looking at each category individually, the U.S. has below average treatment of industrial buildings and intangibles and slightly above average treatment of machinery.
- Industrial Buildings: U.S. average: 35 percent; OECD average: 43.6 percent
- Intangibles: U.S. average: 63.3 percent; OECD average: 73.4 percent
- Machinery: U.S. average: 87.7 percent; OECD average: 81.1 percent
In the early 80s, the U.S. average of 75.8 percent ranked near the OECD average of 77 percent. The 1986 Tax Reform Act drastically changed the treatment of capital in the U.S. and we have ranked below average since.
Ideally, businesses should be able to recovery 100 percent of their investment costs. We could achieve this by shifting to a system of full expensing (which allows complete write off of capital expenses in the first year) or introducing a system of Neutral Cost Recovery (which indexes the investment write-offs 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 a real discount rate). Any 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. system that does not allow the full write-off of an investment—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. —in the year the investment is made denies recovery of a part of that investment, incorrectly defines income, boosts the taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. , and increases the taxes paid by businesses.
It’s important to remember that tax rates are only part of the equation when reforming the country’s tax code in pursuit of economic growth – the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. is also very important.
Provisions that such worsen capital cost recovery (and take us further from the correct tax base), can be a drag on the economy, lowering investment and reducing productivity, employment, and wages.
On the flip side, a shift to 100 percent cost recovery – or even just a move towards it – would lead to greater investment, higher wages, and greater economic growth.
Click here to read our new report on Cost Recovery across the OECD.
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