Reducing the Bias Against Long-term Investments

May 8, 2020

Recently, Tax Foundation has been comparing various ways to improve the tax treatment of new capital investments. One of these options is a Neutral Cost Recovery System (NCRS), which reduces the bias in the tax code against long-term investments.

As my colleagues have written,

Improving capital cost recovery will be crucial to the post-pandemic effort to increase investment and economic growth. Under the U.S. tax code, businesses can generally deduct their ordinary business costs when figuring their income for tax purposes. However, this is not always the case for the costs of capital investments, such as when businesses purchase buildings. Typically, when businesses incur these sorts of costs, they must deduct them over several years according to preset depreciation schedules, instead of deducting them immediately in the year the investment occurs.

Delaying deductions means the present value of the write-offs (adjusted for inflation and the time value of money) is less than the original cost—how much less valuable depends on the rate of inflation and the discount rate. Thus, this system of tax depreciation, rather than full expensing, is highly unfavorable and increases the after-tax cost of making investments, leading to a lower level of investment and economic growth.

A NCRS is one policy tool to remove the penalty in the tax system of having to wait to deduct the cost of an investment that is paid for today. This can be done by taking an existing schedule of depreciation deductions and indexing them to inflation and a real rate of return. Over time the business can deduct the full cost of their investment rather than having the deductions be eroded by time and inflation.

Several countries have adopted policies that have similar economic implications to NCRS, but are motivated by a related, but different, policy rationale.

Which Bias Are We Removing?

Just as depreciation schedules are a common feature of tax systems around the world and create a bias against long-term investments, a tax bias in favor of debt-financed investment also exists. This is primarily due to the deductibility of interest costs when there is usually no comparable deduction for equity financing costs.

The debt bias has led several countries to adopt a form of an Allowance for Corporate Equity (ACE).[1] These policies are also often referred to as Notional Interest Deductions (NID). The ACE provides businesses with a deduction based on their invested equity at a rate comparable to interest costs. Proposals for such a policy have been around since the early 1990s.

Imagine a business wants to finance $10 million in new investments. It can borrow at 4 percent or raise new equity from its investors. In most tax systems, the deductibility of the interest costs would make the business favor borrowing. However, if an ACE provides a 4 percent deduction based on the new equity raised, the business would be neutral toward financing an investment by borrowing or raising new capital.[2]

Unlike a NCRS, the ACE is not tied to a specific asset, but rather a deduction against invested equity. Though the design is different, the underlying economics are similar. An ACE and a NCRS both address biases in tax systems which can worsen incentives for investments.

ACEs around the World

Some countries around the world have systems that provide an extra deduction for equity investment through an ACE or an NID, and the policies are summarized in the table below.

Notional interest rates range from 0.746 percent in Belgium to 27.04 percent in Turkey. And the base for calculating the deduction can be new equity (as in Belgium, Cyprus, Italy, Portugal, and Turkey) or the full equity stock (as in Malta and Poland).

Mexico provides an inflation adjustment to capital allowances which is closer in kind to a NCRS. Brazil provides a tax-deductible dividend which is calculated by multiplying a business’s net equity with the long-term government bond rate.

Examples of Countries with Allowances for Corporate Equity or Notional Interest Deductions
Country Period Details Notional interest rate (2019) Tax base (2019)


Since 2006

The notional interest deduction (NID) allows all companies subject to Belgian corporate income tax to deduct a fictitious interest calculated on the basis of their shareholders’ equity (net assets) from their taxable income. In 2013, legislative changes ruled out carrying forward of unused allowances. Small firms receive an additional 0.5% risk premium on their notional rate. This was initially capped at 6.5% and is now limited to 3%. Since 2018, the deduction no longer applies to the full equity stock. It includes anti-avoidance provisions to prevent the cascading of the tax benefit. The rate is based on the return on a Belgian 10-year state bond.

0.746% (0.5 pp higher for SMEs, i.e. 1.246%)

New equity



Brazilian companies are allowed to pay a “deductible dividend,” which is called interest on net equity (INE), to their shareholders, although a 15% withholding tax applies.

Long-term government bond rate

Net Equity


Since 2015

Applicable new equity is calculated over 2015 as a base year. The NID is limited to 80% of EBIT and applies only to fully-owned subsidiaries if their assets are used for business (non-financial) purposes. The notional interest rate is the 10-year government bond rate of the country where funds are invested, plus a 3% risk premium. The minimum government bond rate is the 10-year Cypriot government bond rate.


New equity


Since 2011*

The NID allows all companies subject to Italian corporate income tax to deduct a fictitious interest calculated on the basis of their shareholders’ equity (net assets) from their taxable income. The deduction does not apply for the purpose of the Italian local tax IRAP.


New equity


Allows businesses to adjust their capital allowances for inflation.

Inflation Rate

Capital Allowances


Since 2017

The notional return is deductible up to EUR 2 million and capped at 25% of a firm’s EBITDA. It applies to capital increases for 5 years, provided capital is not reduced in that period.


New equity


Since 2018

NID limited to 90% of chargeable income, which can be carried forward indefinitely. The notional interest rate is set to the rate of 20-year Maltese government bonds, plus a risk premium of 5%.


Full equity stock


Since 2019

The notional return is deductible up to around EUR 60,000 (USD $67,000). The notional interest rate is the National Bank of Poland’s reference rate (as applicable on the last day of the preceding calendar year), plus 1 pp.


Full equity stock


Since 2015

The NID allows all companies subject to Turkish corporate income tax to deduct a fictitious interest calculated on the basis of their shareholders’ equity (net assets) from their taxable income. 50% of the notional interest amount calculated over the cash increases of the paid-in capital of corporations is deductible from the corporate base. The rate is based on the annual weighted average interest rate applied to Turkish-denominated loans provided by banks.

27.04% (in 2018)

New equity

Note: *Italy’s NID was abolished in 2019 but reintroduced in 2020 applying retroactively to 2019, leaving no gap. See PwC, “Italy adopts digital services tax and reintroduces notional interest deduction,” Jan. 9, 2020,

Source: Christoph Spengel, Frank Schmidt, Jost Heckemeyer, and Katharina Nicolay, “Effective Tax Levels Using the Devereux/Griffith Methodology,” European Commission, November 2019,; European Commission, “Tax policies in the European Union,” 2020,; and EY, “Worldwide Corporate Tax Guide 2019,”

Though the proposal has not been adopted, it is worth noting that the European Commission’s proposal for a Common Corporate Tax Base (CCTB) in the EU includes an “Allowance for Growth and Investment” which works like an ACE. The allowance rate would be based on a 10-year government bond yield plus a 2 percent risk premium. A 2 percent floor would apply if the applicable bond yield is negative.

Lessons for the U.S.

Tax Foundation’s General Equilibrium Model shows the positive economic impacts of providing a NCRS for investments in long-term assets like buildings. Studies of ACEs and similar policies have generally focused on the impact on debt financing, finding that debt bias is reduced. An impact assessment of the CCTB proposal for the EU highlights the positive impact similar policies would have on investment.

Current tax policy in the U.S. provides full expensing for short-lived assets. Therefore, investments eligible for full expensing would not need an ACE to eliminate the bias in depreciation schedules. However, for investments not covered by expensing a NCRS could be adopted. Other countries have shown that providing deductions in line with invested capital costs can have positive impacts both on investment and on debt bias.

[1] The European Commission has also proposed an EU-wide ACE as part of its proposal for harmonizing tax rules for large corporations in the “Allowance for Growth and Investment” in the proposal for a Common Corporate Tax Base.

[2] A Notional Interest Deduction (NID) has the same mechanics and effects.

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