Some Ignored Costs of Bonus Depreciation

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Some Ignored Costs of Bonus Depreciation

C. Eugene Steuerle

Published: March 03, 2008 || Availability: PDF | Printer-Friendly Version

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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Abstract

As part of the recent stimulus bill, Congress and President Bush decided to try to grant businesses bonus depreciation allowances for new purchases of equipment. For each $100 spent in 2008 on equipment expected to last at least five years, businesses would be able to deduct the vast majority of costs in the first year — $600, versus $240 under the old law. At a 35 percent corporate tax rate, for instance, corporations can get checks from the IRS for $210 instead of $84 in the first year for each $1,000 invested. There is one catch: They must have $210 of taxes already due to get $210 back, or $600 of profit against which to take a $600 deduction. Otherwise they will have to delay taking the deduction — which is the world they were already in.

Introduction

This article is not about whether bonus depreciation might temporarily increase investment. Instead it focuses on three longer-term negative effects that are largely ignored — the difficulty of timing when the incentive ends, the new incentive for businesses to delay their future investments in anticipation of the next round of bonus depreciation, and the anticompetitive effects of this method on new business. (See also "Can Policymakers Time the Ending of Macroeconomic Incentives?" parts 1 through 3, Tax Notes, April 1, April 15, and April 29, 2002, and Martin Sullivan, "Beyond the Conventional Wisdom: Rate Cuts Beat Expensing," January 28, 2008.1)

The Timing

The classic case for providing fast depreciation for new assets is well established. It lowers the cost of capital or the effective tax rate on new investment, thereby inducing additional investment, and it provides additional cash flow. What better time is there to induce investment than when it is low?

Think again. If you believe it is hard to time when to send out checks to citizens, bonus depreciation has the problem in spades. The complication comes about largely on the back end. Individuals get their money, then they don’t get it. But with bonus depreciation, the firm getting $210 today instead of $84 — that is, $126 more in 2008 — then owes $126 back in future years (although without interest).

The Joint Committee on Taxation demonstrated this effect in its revenue tables. With individuals, there is a negative cash flow in fiscal 2008 and fiscal 2009 of $116.7 billion, but zero effect in the years thereafter. (Some effects carry over to the 2009 fiscal year, which starts in October 2008.) Bonus depreciation, on the other hand, is expected to result in a positive cash flow to businesses of $49.5 billion in fiscal 2008 and 2009, but a negative cash flow of $27.1 billion in the succeeding three years alone. The stimulus will end arbitrarily at the end of 2008, one reason the Congressional Budget Office predicts slower growth in 2009 and faster growth in 2008 because of the stimulus.

(End of excerpt. The entire paper is available in PDF format.)