Today, Sen. John Thune (R-SD) introduced the INVEST Act, a bill aimed at reducing 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. barriers to business investment. The bill contains several provisions that would speed up businesses’ ability to deduct their capital expenditures, especially for small- and medium-sized companies. Most importantly, the bill would make a soon-to-expire provision known as “bonus expensing” into permanent law, allowing all businesses to immediately deduct 50 percent of the cost of many of their investments.
Under the current U.S. tax code, businesses are not generally allowed to deduct the full cost of their capital investments – such as equipment, buildings, inventory, and intangible property – in the year that the investments are made. Instead, companies are required to deduct their investment costs over long periods of time, according to a set of depreciation schedules. Not only is the 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. system one of the most complicated aspects of the federal tax code, but there is also good reason to believe that requiring businesses to deduct their capital expenditures over such long periods of time discourages them from making investments in the first place.
In recent years, Congress has enacted a temporary provision known as bonus expensing, which allows businesses to immediately deduct 50 percent of the cost of their investments in equipment, machinery, and other short-lived property. This is a significant provision: about 67 percent of all business investment is eligible for bonus expensing, and economists have found strong evidence that the provision has led to higher private investment levels overall.
However, bonus expensing has never been a permanent part of the federal tax code. It was first enacted in 2002, expired in 2005, was renewed in 2008, and has been extended on a temporary basis six times over the past nine years. The persistent uncertainty over the last decade about the fate of bonus expensing has likely been detrimental to businesses planning future investments. Currently, bonus expensing is set to begin phasing out in 2018, and is set to expire at the end of 2019.
Sen. Thune’s bill would make bonus expensing a permanent feature of the tax code. This change would significantly reduce the cost of investing in equipment and machinery beginning in 2018, and would provide certainty to businesses going forward. It should also be noted that nearly all of the benefits of bonus expensing go toward businesses that make new investments, rather than rewarding businesses for old investments they have already made. As a result, moving to permanent bonus expensing would be an especially efficient tax change, providing a large economic “bang-for-buck” at relatively little long-run cost to federal revenue.
While making bonus expensing permanent is an important step in the right direction, lawmakers should keep their eyes on a larger prize: 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. for all business investment. Under full expensing, businesses would be able to immediately deduct 100 percent of the cost of all their capital expenses – not just short-lived assets, like equipment and machinery. Consequently, full expensing would lower the cost of business investment even more significantly than bonus expensing, removing nearly all barriers to business investment from the federal tax code.
To give a sense of the magnitude of the difference between bonus expensing and full expensing, it is useful to refer to a paper that the Tax Foundation published last year, “Cost Recovery for New Corporate Investments in 2012.” We calculated that in 2012, corporations were able to deduct 87.14 percent of the cost of their investments, in present-value terms. If bonus expensing had not been in effect, then that figure would have been lowered to 83.08 percent. On the other hand, under full expensing, corporations would have been able to deduct 100 percent of their investment costs in present-value terms. In other words, bonus expensing moves the federal tax system only about a quarter of the way toward full expensing.
Still, it is very encouraging that members of Congress are focused on increasing the ability of businesses to deduct the cost of their capital investments as quickly as possible. Permanent bonus expensing is a step in that direction.
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