Policymakers Should Reject Effort to Make “Bonus Depreciation” Permanent

PDF of this report (5 pp.)

By Chuck Marr

Updated July 8, 2014

The House is expected to vote this week on a Ways and Means Committee bill (H.R. 4718) that makes permanent a tax provision known as “bonus depreciation,” which lets businesses take bigger upfront tax deductions for certain new purchases such as machinery and equipment — and which, until now, policymakers have enacted only on a temporary basis to help revive a sluggish economy.  The Ways and Means Committee bill, which the Committee passed on May 29, is economically unjustified and fiscally irresponsible.  The Joint Tax Committee estimates the measure, which would expand the already generous tax treatment of these purchases, would cost the Treasury $276 billion in forgone revenues over ten years, adding to deficits and debt.

In April, the Ways and Means Committee began to consider a series of mostly business “tax extenders” — so named because Congress routinely extends them for a year or two at a time.  The cost of all the business tax cuts that Ways and Means has adopted, including bonus depreciation, now totals $581 billion, and includes not only extensions of tax provisions that have been routinely extended, but also generous expansions of some of those provisions.  The full House has already passed a number of these Ways and Means bills, including a measure to make permanent and expand the Research and Experimentation Tax Credit.  Now, the House will consider reinstating the bonus depreciation provision, which expired at the end of 2013, and making it permanent.  Bonus depreciation is not an “extender” and, historically, policymakers have enacted it only on a temporary basis when the economy is weak and allowed it to expire when the economy has recovered.

Ways and Means Committee Chairman Dave Camp’s support for this bill, by pushing it through his committee and bringing it to the House floor, reverses the course set in his own tax reform plan, which proposed to end bonus depreciation.

Policymakers should not reinstate, and make permanent, bonus depreciation for at least three compelling reasons:

  • Bonus depreciation was meant to be only a temporary incentive.  Congress enacted the provision in 2008 solely to bolster the economy during the recession, and not with the intent of making it a permanent feature of the tax code (or extending it year after year like a tax extender).  In the previous economic downturn, Congress enacted bonus depreciation in 2002 — and then a Republican President, House, and Senate let it expire after 2004, when the economy was stronger.  Moreover, studies have shown that bonus depreciation “is largely ineffective as a policy tool for economic stimulus,” according to the Congressional Research Service.
  • Making bonus depreciation permanent would be very expensive.  As noted, the bill would cost $276 billion in forgone revenues over 2015 to 2024, according to the Joint Committee on Taxation.   
  • Companies already receive generous tax treatment when they invest in equipment.  Under current law, companies pay far less than the statutory 35 percent corporate tax rate on the profits flowing from those investments.  In some cases, they pay nothing and actually receive a tax subsidy.  Bonus depreciation only increases this favorable tax treatment.

Bonus Depreciation Is a Temporary Provision of Limited Effectiveness

One of policymakers’ first steps to stimulate the economy during the Great Recession was to allow businesses to take bigger upfront tax deductions for certain purchases, such as for equipment.  Since enacting this temporary provision — called “bonus depreciation” — in 2008, they extended it several times as the economy struggled to recover.  The provision expired at the end of 2013.  

Policymakers have always viewed bonus depreciation as a temporary provision designed to help boost a weak economy.  Its treatment has always stood in sharp contrast to the standard group of tax “extenders,” which are repeatedly extended regardless of the state of the economy.

Although policymakers have enacted bonus depreciation as a way to try to stimulate the economy during recessions, some studies indicate that bonus depreciation is not a particularly cost-effective way to achieve that goal. 

  • “Three studies (two from 2006 and the other from 2007) provide additional support for the view that temporary accelerated depreciation is largely ineffective as a policy tool for economic stimulus,” the Congressional Research Service (CRS) concluded in a summary of the research.  CRS cited a Federal Reserve finding that “no more than 10% of companies deemed the [bonus depreciation] allowances an important consideration in determining the timing or level of qualifying investments.”[1]
  • Analyses by the Congressional Budget Office and Moody’s Economy.com have concluded that bonus depreciation has a fairly low “bang for the buck” as economic stimulus.  Estimates from Mark Zandi of Moody’s suggest that every $1 of tax revenue lost from bonus depreciation generates only 20 cents in economic activity.[2]  By contrast, Zandi estimates that extending emergency unemployment benefits, which the House Ways and Means Committee has failed to do, would boost the economy by about $1.50 for every dollar spent.[3]
  • A Goldman Sachs analysis earlier this year concluded that expiration of bonus depreciation at the end of 2013 “should have little effect” on the economy, while highlighting that “there are multiple indications that firms do not respond strongly to this incentive, for various reasons.”[4]

While recovery from the Great Recession remains slow and efforts to spur growth and job creation would be welcome, bonus depreciation isn’t an efficient way to do that, and the soundest course is to let this now-expired temporary tax break remain expired.[5]

Permanent Bonus Depreciation Would Be Fiscally Irresponsible

As noted, the Joint Committee on Taxation estimates that the bill — which not only makes permanent but also includes some expansions of bonus depreciation — would cost $276 billion over 2015 to 2024.  The Ways and Means Committee already has passed bills to make permanent a number of other business tax extenders, greatly expand others, and provide new tax cuts, at a cost of $581 billion over the coming decade.  That is enough to wipe out three-quarters of the $770 billion in revenue raised by the high-income provisions of the 2012 “fiscal cliff” legislation.  (See Figure 1.)[6] 

Furthermore, to the extent that a temporary bonus depreciation provision has some — albeit very modest — effect in spurring economic activity during an economic downturn, making the provision permanent would sacrifice that boost.  Whatever small boost occurs stems from the fact that the extra tax break which the provision provides applies only to purchases made during the temporary period it’s in effect.  The temporary nature of the break may induce a modest number of firms to accelerate some purchases.  If, however, the tax break is permanent, then there is no incentive for firms to accelerate purchases and to make them while the economy is faltering, because they will get the same tax break regardless of when the purchases are made.

Tax Treatment Without Bonus Depreciation Is Already Generous

Companies already receive generous tax treatment when they invest in equipment and buildings, particularly if they borrow the funds to finance this investment.  Bonus depreciation increases this already generous treatment.  (See Figure 2.)

When a company purchases of a piece of equipment, it deducts the cost of the purchase over time.  The deductions occur as the equipment ages and loses its value, a process referred to as depreciation.  If the deduction is aligned with the equipment’s actual depreciation, then the tax treatment is viewed as “neutral.” 

Current law provides for “accelerated depreciation,” which lets companies write off equipment investments faster than equipment loses value in real life.  This favorable tax treatment is the reason why accelerated depreciation is one of the largest corporate tax expenditures and why companies pay far less than the statutory rate of 35 percent on profits flowing from an equipment investment.

This tax advantage is magnified if a company finances its investments by borrowing (for instance, by taking out a bank loan or issuing a corporate bond).  Borrowing enjoys relatively favorable tax treatment because companies can deduct the interest payments on their debt.  When combined, the favorable tax treatment associated with accelerated depreciation and debt financing can yield a tax rate that is not only lower than the statutory 35 percent rate but is actually negative

A negative tax rate means that a company’s after-tax return on an investment is higher than its pre-tax return.  Instead of a company investing in equipment, making a profit, and sending a percentage of those profits to the government in taxes, the government in effect adds to the pre-tax profit of the company by providing a subsidy through the tax code.

The current accelerated depreciation tax treatment means that debt-financed investments face an actual (or effective) tax rate of negative 19 percent, as CRS has pointed out.[7]  In other words, companies do not pay taxes on the profits that flow from such investments but instead receive a tax subsidy of 19 percent, which can be used to eliminate other taxes owed.  Adding bonus depreciation on top of accelerated depreciation greatly expands this generous tax subsidy, pushing the effective tax rate to negative 37 percent.

Chairman Camp’s Policy Reversal

Making bonus deprecation permanent would be a move in the opposite direction from Chairman Camp’s tax reform plan, which he released on February 26 and which ended bonus depreciation.  In fact given the current circumstance described above, the Camp plan went further by scaling back the underlying accelerated depreciation.  Bonus depreciation is, in effect, an expanded version of accelerated depreciation.

Chairman Camp proposed in his tax reform plan to reduce the accelerated depreciation tax break so that it would “match closely the true economic useful life of assets.”[8]  The apparent reasoning for the proposal was that economics, not tax treatment, should drive investments.

Now, however, Chairman Camp has turned his plan to repeal bonus depreciation (his plan explicitly called for its repeal) on its head by calling to make the provision permanent.  The goal appears to be to shrink the amount of revenue that the tax code produces, despite the nation’s long-term fiscal problems — so that a tax reform bill can be said to be “revenue neutral” without curbing as many tax breaks, or with a deeper cut in tax rates, than Camp’s original tax reform plan provides.  This may reflect the chilly reception that the Camp tax reform plan received from the House Republican Caucus.

Chairman Camp’s original proposal — to allow bonus depreciation to expire — is the sound one.  Policymakers always intended bonus depreciation to be a temporary corporate tax cut.  Given its high cost and limited effectiveness, the now-expired provision should remain so.  With needed unemployment benefits lapsed, serious unmet needs in infrastructure, and an increasing squeeze on funding for key economic investments such as scientific research, it’s deeply disappointing that policymakers would move to make a largely ineffective policy permanent, at great cost to the Treasury.

End notes:

[1] Gary Guenther, “Section 179 and Bonus Depreciation Expensing Allowances:  Current Law, Legislative Proposals in the 113th Congress, and Economic Effects,” Congressional Research Service, May 23, 2014.

[2] Mark Zandi, “U.S. Macro Outlook:  Policymakers Must Get It Right,” Moody’s Analytics, July 16, 2012, https://www.economy.com/dismal/article_free.asp?cid=232471&src=mark-zandi.

[3] Mark Zandi, “An Analysis of the Obama Jobs Plan,” Moody’s Analytics, September 9, 2011, https://www.economy.com/dismal/article_free.asp?cid=224641.

[4] Alec Phillips, “US Daily: Business Investment: Bonus Depreciation Expiration Should Have a Limited Effect,” Goldman Sachs, February 25, 2014.

[5] Mark Zandi, “Bolstering the Economy:  Helping American Families by Reauthorizing the Payroll Tax Cut and UI Benefits,” Written Testimony Before the Joint Economic Committee, February 7, 2012, p. 7, https://www.economy.com/mark-zandi/documents/2012-02-07-JEC-Payroll-Tax.pdf; Douglas Elmendorf, “Policies for Increasing Economic Growth and Employment in 2012 and 2013,” Statement Before the U.S. Senate Committee on the Budget, November 15, 2011, http://www.cbo.gov/sites/default/files/cbofiles/attachments/11-15-Outlook_Stimulus_Testimony.pdf

[6] Chuck Marr and Joel Friedman, “House Efforts to Make ‘Tax Extenders’ Permanent Are Ill-Advised,” Center on Budget and Policy Priorities, May 7, 2014, http://www.cbpp.org/cms/index.cfm?fa=view&id=4140.

[7] Jane Gravelle, “Bonus Depreciation: Economic and Budgetary Issues,” Congressional Research Service, March 24, 2014, http://nationalaglawcenter.org/wp-content/uploads//assets/crs/R43432.pdf.

[8] Chairman Dave Camp, “Tax Reform Act of 2014, Discussion Draft Section-by-Section Summary,” Committee on Ways and Means, http://waysandmeans.house.gov/UploadedFiles/Ways_and_Means_Section_by_Section_Summary_FINAL_022614.pdf.

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