The Congressional Research Service published a report on July 15, 2013 on bonus depreciation and expensing allowances. The report is available here.The report is lukewarm at best as to the economic benefits of these tax incentives.
Expensing arising under Section 179 and permits a taxpayer to deduct in full its first $500,000 of investment in new equipment it places in service in 2013. It is of little interest to tax equity investors, so the remainder of this post will focus on bonus deprecation.
The bonus depreciation rules permit a taxpayer to deduct in 2013 50 percent of the cost of new equipment placed in service in 2013; provided the equipment has a recovery period of twenty years or less. Renewable energy assets qualify, as do gas fired power plants and electric transmission lines. In addition to the 50 percent deduction, the taxpayer is entitled to claim the applicable MACRS percentage deduction on the remaining 50 percent of the cost.
The report had little good to say about the ability of bonus depreciation to stimulate the economy. Here are key excerpts:
The forces constraining the stimulative potential of accelerated depreciation, particularly in a weak economy, suggest that the two expensing allowances examined here would have relatively little bang for the buck as a means of boosting economic activity. (p. 13)
Basically, the studies concluded that accelerated depreciation in general is a relatively ineffective tool for stimulating the economy. (p. i)
Furthermore, there is anecdotal evidence that the current bonus depreciation allowance has made little or no difference in the investment plans of some companies, while accelerating the timing of planned investments by other companies to take advantage of the tax savings. (p. 13)
Since 2002, seven bills have been enacted to extend or enhance the bonus depreciation allowance. Each one was intended, in part, to spark an increase in small business investment, as part of a broader government-financed effort to stimulate the economy. (p. 10)
According to corporate income tax data made available by the IRS through its website, corporations claimed a total of $609.8 billion in depreciation allowances for the 2009 tax year. Of that amount … bonus depreciation allowances came to $137.4 billion (or 22.5% of the total amount). (p. 12)
Bonus deprecation [has] the potential to distort the allocation of resources in an economy by driving a wedge between [eligible] assets and all other assets regarding their profitability. (p. 14)
Some of these points may be valid; however, it is difficult to give the report too much credence as it has internal contradictions as to the economic benefit of accelerated depreciation. The report provides: “Allowing a firm to expense the cost of an asset is equivalent to the U.S. Treasury providing the firm with a tax rebate equal to the firm’s marginal tax rate multiplied by the cost of the asset.” (p. 11) This statement contradicts a later reference in the report and the economic (and accounting) theory of the value of accelerated depreciation as being equivalent to an interest free loan from the U.S. Treasury (as opposed to a tax refund (i.e., a cash payment that may be permanently retained)).1
The rationale for accelerated depreciation being equivalent to an interest free loan from the U.S. Treasury is that a corporation would be able to eventually deduct the cost of a capital expenditure (regardless of what type of asset was acquired), but for an asset that qualifies for accelerated deprecation that same tax deduction is available earlier. The report later correctly provides,
Yet the allowance does not change the actual marginal rates at which this income is taxed. Accelerated depreciation … does not reduce the federal taxes paid on the stream of income earned by an asset over its useful life. Rather, it allows firms to take a larger share of depreciation deduction for an asset in the first year or two of use than would be possible under MACRS. This forward shift of acceleration in depreciation allowances raises the present discounted value of the tax savings from depreciation (emphasis added). (p. 16)
The report also overlooks the fact that under the rules of how Congress calculates the deficit impact of legislation that bonus depreciation is a stimulative measure that has one of the smallest deficit costs.
In “scoring” legislation for its deficit impact, Congress treats as zero cost any tax expenditure that cancels itself out in the first ten years. Therefore, if bonus depreciation means that an asset that would otherwise be depreciated using double declining balance depreciation over five years is substantially depreciated in the first two years, there is no scoring impact. This is due to the fact in any event the asset would have been fully depreciated (reducing the taxpayer’s taxes and the U.S. Treasury’s collections) in five years and that is within the scoring period for deficit calculation purposes.
The only scoring impact from bonus depreciation is with respect to assets with 15 and 20 year recovery periods: for those assets bonus depreciation “pulls” deductions into the first ten years, when they would otherwise accrue after ten years. There are few assets with these recovery periods; the leading examples are electric transmission lines and gas fired power plants.
When the economy starts to signs of needing some fiscal medicine, Congress enacting bonus depreciation is like a parent reaching for baby aspirin for a child with a warm forehead. Both remedies are low cost, low risk and effective for some ailments but little good in stopping systemic bleeding.
1 Borris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts ¶23.1.3; Toby Cozart, Equipment Leasing: Substance and Form, D. (BNA-Port 544).