New Study Finds Bonus Depreciation Boosts Investment

September 24, 2014

U.S. business investment has been severely depressed for many years, and, as a share of GDP, it remains well below that found in most developed countries. Investment is an important driver of productivity and, as a result, workers’ wages. It is therefore not a stretch to connect the protracted investment slump with the similarly protracted slump in wages.

As a result, many economists have called for immediate expensing or accelerated depreciation to speed up write-offs of investment. Accelerated depreciation for equipment and software is known as bonus depreciation, and it has been in place on a temporary basis off-and-on for about 12 years. Bonus depreciation expired at the end of last year and Congress has been debating whether to extend it again on a temporary basis or extend it permanently.

One question is to what degree bonus depreciation, as implemented in the past, actually boosted investment? We found in simulations that if it were extended on a permanent basis it would grow the capital stock by over 3 percent. We also found evidence that over the last 12 years it boosted investment in equipment and software, but a proper analysis would control for all the other major things happening in the economy.

A new study does just that, and it finds that bonus depreciation has provided a huge boost to investment, i.e. without it the U.S. economy would have been in much worse shape.

The authors are Eric Zwick, of the University of Chicago, and James Mahon, of Harvard, and they conclude that “bonus depreciation raised eligible investment by 17.3 percent on average between 2001 and 2004 and 29.5 percent between 2008 and 2010.” This is more than double the effect that previous studies have found, which the authors attribute to the fact that previous studies excluded the effects on small and medium-sized firms.

The authors find small and medium-sized firms are especially responsive to bonus depreciation in part because they are liquidity constrained, i.e. they don’t have sufficient access to capital markets or cash on hand to otherwise make these profitable investments.

This is a very thorough analysis that provides compelling evidence that bonus depreciation works. It confirms that accelerated depreciation and expensing have powerful effects on investment.

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