Extension of Bonus Depreciation
To determine taxable income, businesses subtract expenses from their receipts. While some business expenses are for items that are entirely used up during the year (e.g., materials and labor), other business expenses are for durable goods that last for many years. The expense for investment in capital equipment (e.g., tractors, computers and wind turbines) occurs over many years as the value of the investment is used up or depreciated. Under current law, businesses calculate taxable income by deducting capital costs over time according to fixed depreciation schedules.
Over the past decade, Congress has repeatedly allowed faster depreciation of capital assets to stimulate business investment by providing a “bonus” depreciation allowance in the year the asset is purchased. In 2002, Congress let businesses claim a “bonus” depreciation allowance equal to 30 percent of the cost of investment purchased between September 10, 2001, and September 11, 2002. The following year, Congress raised the deduction to 50 percent of investments purchased after May 5, 2003, and before January 1, 2005. The 2008 economic stimulus package renewed the 50 percent deduction again, this time for investments made during 2008. The American Recovery and Reinvestment Act of 2009 renewed the 50 percent deduction for investments made during 2009. Not all property qualifies for bonus depreciation. Qualified investments include tangible property with a recovery period of 20 years or less, water utility property, certain computer software, and qualified leasehold improvement property. Furthermore, only new property qualifies for bonus depreciation.
To stimulate investment, the president would renew bonus depreciation once again. Businesses would receive a bonus depreciation allowance equal to 50 percent of the cost of qualifying investments acquired in 2010. Businesses would deduct the remaining 50 percent of the investment’s cost according to regular depreciation schedules.
Accelerating depreciation deductions does not increase the total amount a company can write off for a given investment. Instead, it allows businesses to deduct more of the cost now and less in the future. That reduces their current tax liabilities at the cost of higher taxes later. Since deductions today are worth more to taxable businesses than deductions in the future, the provision lowers the effective tax rate on new investment making investment more attractive. Lower taxes also increase cash flow.
Economic research suggests that bonus depreciation enacted in 2002 and 2003 had relatively modest effects. There are at least three reasons why: Businesses may have expected that Congress would extend the provisions, thus blunting their incentive to speed up investment. It takes time for businesses to make major investments, making it hard to fit them into specified time periods. Finally, many businesses may have had too little income to offset with these additional tax benefits, a problem that is especially acute during economic downturns.
The revenue loss of the provision is front-loaded. Bonus depreciation decreases tax payments in the first years but increases payments in future years relative to current law. The administration estimates that the provision would lose revenue in 2010 and 2011 and then raise revenue in every subsequent year through 2020. The proposal would boost revenues by $20 billion during the 2011-2020 budget window but would lose an estimated $22 billion in 2010. The net cost of $1 billion over the 2010-2020 period would be even higher if the future revenue gains were discounted at a positive rate.
Additional Resources
Options for Responding to Short-Term Economic Weakness, Congressional Budget Office, January 2008
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