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Budget Header 2011

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Extend Temporary Increase in Expensing for Small Business

Under Section 179 of the Internal Revenue Code, businesses may expense, or immediately deduct, the first $25,000 of investments in machinery and equipment. The amount of qualifying investment eligible for the deduction decreases dollar for dollar for amounts in excess of $200,000, so that businesses investing more than $225,000 receive no immediate deduction.

In 2003, Congress increased the amount of Section 179 expensing to $100,000 and raised the start of the phase-out range to $400,000 for 2003, 2004 and 2005. For years after 2003, the limits were indexed for inflation. The American Jobs Creation Act of 2004 extended the limits through 2007. The economic stimulus package that Congress enacted in January 2008 raised the limits for tax year 2008 to $250,000 and $800,000. The American Recovery and Reinvestment Act of 2009 extended the 2008 limits through the end of tax year 2009.


Section 179 Limits under Current Law

Year(s)

Expensing limit

Start of phase-out

End of phaseout

2007

$125,000

$500,000

$625,000

2008-2009

$250,000

$800,000

$1,050,000

2010

$125,000

$500,000

$625,000

2011 and later

$25,000

$200,000

$225,000

The president would extend the 2008 and 2009 limits to qualified property placed in service in 2010. While the increases in expensing enacted in 2003, extended in 2004, and increased and extended in 2008 and 2009 are scheduled to expire at the end of 2010, the Administration’s tax receipt baseline assumes permanent extension of current law rules for 2010 (a maximum deduction of $125,000 and a phase-out level of $500,000 both indexed for inflation). By placing the extension of 2010 law in the baseline, the President removes the cost from the PAYGO rules.


Proposed Section 179 Limits in 2011 Budget

Year(s)

Expensing limit

Start of phase-out

End of phaseout

2010

$250,000

$800,000

$1,050,000

2011 and later

$125,000

$500,000

$625,000

Section 179 expensing reduces the cost of capital for businesses that use qualifying machinery and equipment and reduces compliance costs by eliminating the need to apply tax depreciation rules and keep track of the adjusted basis of assets. It produces little benefit for those whose capital consists mainly of structures or inventory and no benefit for businesses whose investment exceeds the phase-out limit ($1,050,000 in 2010 under the President’s proposal, for example). By providing an immediate deduction for the entire cost of equipment, expensing generates a larger benefit for longer-lived equipment than for shorter-lived equipment, such as computers, that could otherwise be amortized over three years.

It is hard to know how much this proposal would boost the economy. There have been no studies on the effect of Section 179 expensing on the long-term level or timing of investment. Lower capital costs should encourage some additional investment, but much of the tax benefit would go to investments that would have been undertaken even if taxpayers had to depreciate them over longer periods. A temporary tax incentive could accelerate some investment. However, since generous expensing rules have been in place for several years, some capital purchases that may otherwise have been accelerated already have occurred.

Some believe that expensing should be the rule for all investments, not just those made by small businesses. Expensing is equivalent to exempting the normal return on investment and would be the norm if the tax base were consumption rather than income. However, enacting expensing alone, without making other conforming changes, such as eliminating deductions for interest expense, can create inefficient arbitrage opportunities. Under such a system, investments could be profitable even if they earned sub-par returns because of the tax deductions that they generate. This is a primary concern about expanding the scope of small business expensing provisions. The gains from simplicity have to be weighed against the costs of expanding tax-shelter opportunities.

While the proposal is designed to be temporary, the higher limits originally enacted in 2003 were extended in 2005 and then raised in 2008 and 2009. If taxpayers believe the higher limits in 2010 will be permanent, their short-term stimulus effect would be smaller because taxpayers would have no incentive to accelerate the timing of investments.