The Washington Post has denounced the inclusion of 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. in the just-passed tax extenders bill for 2014. The correct term is “partial expensing.” There is nothing “bonus” about it. The partial expensing allows businesses to deduct immediately (expense) half the cost of their equipment spending in the year it is made, with the rest to be written off over time. The Post calls it an investment subsidy. The Post states:
“[T]he 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 has long permitted companies to deduct gradually the costs of new equipment, buildings, and the like: the sound economic principle is that big-ticket items produce output over time, so the expense of acquiring them should be “matched” with that revenue stream. Bonus 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. allows companies to claim a much higher than usual percentage of those deductions up front.”
These critics are misinformed. The “matching” of the write-offs with the time frame over which the asset produces income is an arbitrary accounting convention adopted for the convenience of the bookkeepers and the sake of appearances. It evens out the reported flow of expenses to make profits look less volatile, which might needlessly scare the shareholders, and it avoids carrying losses on the books if a big lumpy outlay is undertaken. But it is not a “sound economic principle.”
The sound economic principle is that a cost occurs the year the money is spent, and it should be counted at that time. That is when the money is tied up in the asset and is not available for other uses. In economic terms, the “opportunity cost” is immediate and should be recognized as such. That is real “common sense.”
Nor is lengthy depreciation “usual.” In the old days, before WWII, firms were allowed to write off their expenses in whatever pattern made the most sense for them. Only the need for more wartime revenue spurred the Treasury to start dictating procedures, “permitting” businesses to report costs only at the government’s convenience.
Making a business wait years to claim a business expense overstates the business’s income early in the period, and understates it later on. It accelerates the timing of the business’s apparent earnings, and thereby brings the business’s tax liability forward for the benefit of the government. It artificially raises the cost of equipment and buildings by making companies wait to realize costs, as if the time value of money were zero. That is not good economics.
As a result of the higher cost of equipment and buildings, less investment is done, especially in longer-lived assets. Less capital is accumulated, workers are less productive, wages are lower, and jobs are fewer than would be the case in a non-distorting tax system. This became blatantly obvious during the 1970s 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. , when the inflation slashed the real value of the delayed write-offs below replacement costs, and investment fell behind the growth of the work force, resulting in plunging productivity and after-tax wages.
Long-lived depreciation was enacted to raise more money for the government, and has since been rationalized as a tax on capital income on the theory that it would enhance the redistribution of wealth. Its real effect is to slow capital formation and hurt the working population, especially in capital intensive manufacturing, mining, the energy industry, and the construction trades. The government ends up losing money due to the weaker economy and the smaller incomes of the population.
Major tax reform proposals such as the Flat TaxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. , the Personal Expenditure Tax, the Nunn-Domenici USA Tax and its successor introduced by Congressman English, the National Retail Sales TaxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. , and the Bradford X-tax have all moved in the direction of expensing (immediate write-off of investments). Their goal is to end the tax bias against long-lived assets, generate more capital formation, higher wages, and more jobs.
The Post has correctly expressed concern over the lagging wages of the middle class over the last decades. Well, one of the contributing factors to the weak wage growth is our depreciation policies that have led to underinvestment in capital goods and encouraged companies to manufacture off-shore. Regaining a vibrant middle class requires putting better tools and equipment in the hands of blue collar workers—which will only happen with expensing as a normal part of the tax code.
The only legitimate complaint in the Post editorial about the extenders bill is that the extension of partial expensing came at the end of the year, leaving people unsure what the tax treatment and cost of capital would be in 2014. If people doubted the extension, and did not invest earlier in the year, it is too late now to incentivize them for 2014. The partial expensing provision should be enacted on a permanent basis if it is to have the greatest impact on reducing the cost of capital and prospectively encouraging more investment and job growth in the years ahead. Even better would be 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. of all investment, not just half of equipment outlays. Instead of criticizing faster depreciation as a give-away to business, the Post should endorse a permanent extension of expensing as a means of raising middle income wages.Share