Return to main report card

EXTENSION OF BONUS DEPRECIATION

Key Points

·        Businesses would be allowed to deduct their cost of capital equipment more quickly. They could write off half the cost of new investment in the year it is purchased.

·        Temporarily reducing taxes on new investment encourages taxable businesses to make capital purchases now rather than delaying them. Increased investment now stimulates the economy.

·        The provision only benefits businesses with positive taxable income. Businesses running large net operating losses relative to past income, which many now are, receive no immediate benefit from additional deductions.

·        Previous experience suggests bonus depreciation has limited effectiveness, partly because accelerated deductions do not help companies with losses. Pairing this proposal with an extension of the net operating loss carry-back period for small businesses only does this little to change this.

·        JCT estimates that the proposal would cost $5.1 billion over 10 years.

Current Law

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 a fixed depreciation schedule.

Stimulus Proposal

The provision would speed up depreciation deductions by providing businesses with a “bonus” depreciation allowance equal to 50 percent of the cost of qualifying investments acquired in 2009. Businesses would deduct the remaining 50 percent of the investment’s cost according to regular depreciation schedules.

Discussion

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.

Over the past decade, Congress has repeatedly allowed faster depreciation of capital assets to stimulate business investment. 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 qualified 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 qualifying investments made during 2008.

Economic research suggests that bonus depreciation enacted in 2002 and 2003 had relatively modest effects (CBO 2008). 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.

Bonus depreciation could increase investment this year if businesses have projects they are willing to bring forward into 2009 and if they have income against which to use the deduction. However, many businesses are currently losing money and have no taxable income. A separate provision in the economic recovery package—the net operating loss carryback— would allow businesses with gross receipts of $15 million or less to offset up to five years of previous taxable income with current losses. That carry-back provision would extend the benefit to some businesses that were profitable in the past but are currently losing money, but most investments that could potentially benefit from bonus depreciation are made by businesses not eligible for the longer carryback period.

As recent history has made clear, Congress can turn bonus depreciation on and off as economic circumstances dictate. Paradoxically, that flexibility could render the policy less effective. If businesses expect that Congress will extend the provision as it has in the past, they may not accelerate their investment. As a result, the benefits of the provision may accrue primarily to investment that would have been made anyway, thereby undercutting the cost effectiveness of the tax incentive.

The temporary nature of the provision increases its strength as a stimulus but necessarily reduces its long-run impact. Expiration of bonus depreciation raises a firm’s net cost of new investment back to its previous level and removes any further incentive to invest now rather than later. In fact, because the provision primarily leads businesses to move their investment up in time and not to increase overall investment, it may lead businesses to reduce investment when the provision expires. If the economy is still in recession at that point, this could be especially undesirable.

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.

Grade: C

Previous experience with bonus depreciation is not encouraging.

Return to main report card