Expensing.

• Author: Brannon, Ike
• Position: Working Papers: A SUMMARY OF RECENT PAPERS THAT MAY BE OF INTEREST TO REGULATION'S READERS - Book review

Expensing

"Information Sets and Dynamic Scoring," by Aaron Betz. SSRN, forthcoming.

For most people, the debate over depreciation schedules for investment is soporific. But for tax policy cognoscenti, the topic is incredibly contentious.

There are two broad approaches for the tax treatment of investment. One way would be to require companies to incrementally deduct an investment over the life of the asset. For instance, if a company buys a S100,000 truck that it expects to be in service for 10 years, then it would deduct $10,000 of expenses from its income each year for a decade. We call this "straight-line" depreciation.

The other approach would be to allow the company to fully deduct (or expense) the investment the year the company purchases the truck. We refer to this as "full expensing."

For C corporations, the U.S. government has typically done something between these two extremes. Since 2001, the United States has had some version of "bonus depreciation," whereby companies can immediately deduct some proportion (typically 50%) of new investment. Between 2008 and 2017, Congress extended or altered bonus depreciation eight times.

The 2017 tax reform implemented full expensing through 2025, although the authors of reform hope that a future Congress makes that permanent. Full expensing effectively reduces the cost of capital investment because firms receive the tax break sooner. For the $100,000 truck and a company paying an effective tax rate of 25%, full expensing provides $25,000 tax savings at once, rather than the $2,500 a year for the next decade. Companies would rather have their tax savings up front and put that money to work right away.

However, we do not know how much depreciation schedules matter. If we believe firms are fully rational, then the fact that expensing makes investment less expensive should mean that we would see more investment when bonus depreciation effectively reduces its cost, and even more if we allow full expensing. After all, that is the rationale for full expensing.

However, Betz argues that the data suggest bonus depreciation does not have much of an effect. If he and others who have made similar observations are correct, then we should focus our efforts on reducing the tax burden on business activity via lower corporate rates rather than maintaining and expanding bonus depreciation.

Betz gives two broad explanations for why we may not see the results we would expect from a move to bonus depreciation. The...