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Why Neutral Cost Recovery Is Good for Workers

By: Alex Muresianu

The COVID-19 pandemic has damaged the American economy, as unemployment has skyrocketed. Despite job growth in May, the unemployment rate still sits at more than 13 percent, its highest point since the Great Depression. But even before the pandemic, American workers had experienced slow wage growth, for a variety of reasons.

Policies to create jobs immediately are important, but policymakers shouldn’t forget about the long-term structural problems that have impacted American workers for decades. One policy that can at least help with both is improving 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. treatment of capital investments, which can stimulate investment, creating jobs in the short run and higher productivity and wages in the long run.

Ideally, companies should be able to deduct the full cost of their investments the year they’re made, instead of spreading those deductions over several years, depending on the type of asset. Under current law, spending on research and development and equipment can be deducted immediately, but those provisions are scheduled to phase down soon. Structures, meanwhile, must be deducted over decades: 27.5 years for residential buildings, 39 years for commercial buildings.

The problem with spreading these deductions over many years is that companies cannot deduct the full present value of their investments—thanks to both 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, the value of a deduction 20 or 30 years down the line is worth much less than a deduction made in the first year. As a result, companies face higher taxes on investment, and sometimes have to pay taxes on income that doesn’t exist. A solution to this problem would be to establish neutral cost recovery, where companies would be able to increase the size of their deductions over the life of the asset by inflation and the time value of money.

How does 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.  relate to workers then? In the short term, neutral cost recovery means jobs. According to the Tax Foundation’s model, establishing neutral cost recovery for structures and making temporary expensing for equipment permanent would create 44,000 additional jobs in 2020 and up to 188,000 jobs by 2024.

In the long run, improved cost recovery matters for wages because expensing increases investment, which is key to productivity growth, and productivity growth drives long-term wage growth. There’s strong evidence for various accelerated 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. policies—those that allow companies to deduct investments faster, although not necessarily immediately—growing capital investment. Analyses of temporary 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. enacted in the 2000s in the United States, such as Zwick and Mahon (2017) and House and Shapiro (2008), support this theory. In China, meanwhile, permanent tax incentives for investment increased both investment and productivity growth.

Productivity growth, furthermore, is the driver of long-term economic growth and wages. And a large cause of slow wage growth has been slow productivity growth. Contrary to some skepticism, the link between productivity and wages remains strong: as a recent paper from Harvard economists Anna Stansbury and Lawrence Summers found, from 1973-2016, a 1 percent increase in productivity has been associated with a .7 to 1 percent increase in median and average compensation.

Existing studies of accelerated depreciation have shown that it helps increase wage growth. A recent paper from economist Eric Ohrn in the Journal of Public Economics examined how manufacturing fared in different states based on whether they adopted accelerated depreciation policies passed at the federal level. The paper found that states that implemented accelerated depreciation in their tax codes led to a 2.5 percent increase in compensation per employee in manufacturing, relative to states that did not. 

Reforms like neutral cost recovery are especially helpful for manufacturing and other capital-intensive industries. Not allowing full deductions for capital investment means the tax code favors capital-light companies and disfavors manufacturers. As politicians raise concerns about the decline of American manufacturing employment, a good way to reignite domestic manufacturing and help these workers is improving cost recovery, by making expensing for equipment permanent and extending neutral cost recovery to structures.

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