Fed Economist Calls for Full Expensing to Revive Investment

The way businesses write off their investment expenses is one of the more arcane and obscure aspects of our tax code. It is also one of the biggest tax barriers to investment. Businesses are not allowed to write off investments immediately, as they do with labor expenses, but instead must delay those deductions for years or even decades, depending on the industry and the type of asset. Because a deduction delayed is a deduction reduced, it means the tax code is fundamentally biased against physical investment, in a big way.

It is one reason why the U.S. has nearly the lowest level of investment in the developed world. Another reason is the corporate tax rate, which is the highest in the developed world. Most reform efforts of late, including that of House Ways and Means Chairman Dave Camp, have opted to reduce the corporate rate but further delay investment deductions. In general, such a tradeoff is not good for investment.

This is why Congress has turned its attention to more targeted investment incentives, such as bonus depreciation, which would allow businesses to immediately expense 50 percent of the cost of equipment and software. The remainder would be written off in the normal manner, over a few years. Bonus depreciation is part of the so called tax extenders that expire every year and which are now up for renewal in the both the House and Senate. The Senate bill would extend almost everything for two years through 2015, including bonus depreciation.

Economists Robert Hall of Stanford University and Narayana Kocherlakota of the Minneapolis Federal Reserve recently described the benefits of moving toward a system of immediate expensing of investments:

A tax break for businesses that invest in research and development, new equipment and physical structures could be "an effective form of stimulus" for the U.S. economy, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Saturday.

"The future course of the U.S. economy is not predetermined by the events of the past seven years. Both history and theory have the same lesson: It is possible to undo what might now appear to be permanent changes," Mr. Kocherlakota said in remarks prepared for delivery Saturday at a National Bureau of Economic Research conference in Cambridge, Mass.

Mr. Kocherlakota was discussing a new paper by Stanford University economist Robert E. Hall titled, "Quantifying the Lasting Harm to the U.S. Economy from the Financial Crisis." Mr. Hall's paper concluded that lower labor-force participation and slower productivity growth may linger long after the 2007-2009 recession.

In response, Mr. Kocherlakota said economic models "imply that it is physically possible for future U.S. economic activity to be distinctly higher than what might be expected to unfold." The "key policy question," he said, is this: "Is the United States, as a society, willing to forgo the leisure, home production, and/or near-term consumption required to generate materially higher future economic activity?"

Assuming it is, he said, various macroeconomic models suggest "an effective form of stimulus" would be a lower government tax rate on "physical investment."

"I don't mean 'reducing the tax rate on the income from financial wealth."' Mr. Kocherlakota said. "Nor am I referring to reducing the tax rate on dividend income, capital gains, or corporate profits. Such reductions may have effects other than reducing the tax rate on physical investment.

"Rather, I'm referring specifically to reducing the tax rate on the process of transforming current goods into future goods. In practice, the government can accomplish such a reduction in a relatively targeted fashion by allowing businesses to completely expense any investments into equipment, structures, or R&D."

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