The U.S. Ranks Poorly on Cost Recovery

It is common knowledge that the United States has the highest corporate income tax rate in the industrialized world, but it is less well known that our cost recovery system ranks poorly as well.

Currently, the U.S. tax code only allows businesses to recover an average of 62.4% of a capital investment (investments in machinery, industrial buildings, intangibles, etc.). This is lower than the average capital allowance of 66.5% across the OECD.

Looking at each category individually, the U.S. has below average treatment of industrial buildings and intangibles and slightly above average treatment of machinery.

• Industrial Buildings: U.S. average: 35 percent; OECD average: 43.6 percent
• Intangibles: U.S. average: 63.3 percent; OECD average: 73.4 percent
• Machinery: U.S. average: 87.7 percent; OECD average: 81.1 percent

In the early 80s, the U.S. average of 75.8 percent ranked near the OECD average of 77 percent. The 1986 Tax Reform Act drastically changed the treatment of capital in the U.S. and we have ranked below average since.

Ideally, businesses should be able to recovery 100 percent of their investment costs. We could achieve this by shifting to a system of full expensing (which allows complete write off of capital expenses in the first year) or introducing a system of Neutral Cost Recovery (which indexes the investment write-offs for inflation and a real discount rate). Any cost recovery system that does not allow the full write-off of an investment—full expensing—in the year the investment is made denies recovery of a part of that investment, incorrectly defines income, boosts the taxable income, and increases the taxes paid by businesses.

It’s important to remember that tax rates are only part of the equation when reforming the country’s tax code in pursuit of economic growth – the tax base is also very important.

Provisions that such worsen capital cost recovery (and take us further from the correct tax base), can be a drag on the economy, lowering investment and reducing productivity, employment, and wages.

On the flip side, a shift to 100 percent cost recovery – or even just a move towards it – would lead to greater investment, higher wages, and greater economic growth.

Click here to read our new report on Cost Recovery across the OECD.