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Tax Perk to Boost Investment May Work—For Small Businesses

Dec. 17, 2019, 9:45 AM

Critics of a tax policy meant to spark capital spending and hiring say it only rewards investments companies would make anyway. That may be the case for big public corporations, but not for smaller, private businesses.

The policy, known as expensing or bonus depreciation, allows for a full or larger upfront write-off of capital expenses rather than a series of piecemeal tax breaks over time.

Public corporations don’t report the tax perk in their financial statements, however, as it’s a matter of when and not if they’ll get deductions. They can also use access to public markets to raise money for big expenses on machinery, equipment, and other capital. But for small, private companies unable to easily sell shares or issue loads of debt, the tax benefit acts like a much-needed cheap financing tool.

“It’s not just about re-timing. It’s kind of like giving them an interest-free loan to finance the purchase,” Eric Zwick, an associate professor of finance at the University of Chicago Booth School of Business, said of smaller companies. “For the firm that can’t raise money on the stock market, they don’t have equity readily available.”

The 2017 tax law allowed businesses to use full expensing, or 100% bonus depreciation, for both new and used assets, a benefit that begins phasing out in 2023. Republicans heralded it as a provision that would lead to a flood of new business investment that would buoy economic growth.

But some say it incentivizes investment in automation rather than creating jobs—a notion with some empirical support. Others say businesses might simply be front-loading their capital spending rather than spreading out investment over time as a result of the policy.

“I would suspect that, generally speaking, it looks like depreciation rewards companies that are making investments they would make anyway,” said Steve Wamhoff, director of federal tax policy at the Institute on Taxation and Economic Policy.

The economic ripple effects are difficult to quantify, as the policy’s always been temporary, and we’d need to compare today’s world to a world without them, all else equal, said Erica York, an economist at the Tax Foundation.

“And we don’t have that world,” she said.

Over the past couple of decades, companies could generally write off 50% or 100% of the cost of new property, except for a handful of years. The perk usually would expire after a couple of years, but then lawmakers would pass another extension.

‘Still Responsive’

In a 2016 study Zwick did of 120,000 public and private companies, small companies responded to bonus depreciation at almost twice the rate of big ones. The policy, the study shows, increased investment in eligible assets by 10.4% compared to ineligible assets between 2001 and 2004 and by 16.9% between 2008 and 2010.

But researchers have found that large, publicly traded corporations that are liable to their shareholders don’t take the benefit into account when making investment decisions to the same extent small and private ones do. Those shareholders see financial statements that don’t account for an upfront deduction of capital expenses rather than partial, spread-out deductions over the time the asset is used.

Studies have shown investment tax credits and a deduction for domestic manufacturing activity, which can actually lower companies’ effective tax rates on their financial statements, are more effective in terms of promoting investment. Those big corporations likely don’t disregard bonus depreciation entirely, however.

“I think the evidence is larger, publicly traded corporations are less responsive to bonus depreciation, but they’re still responsive,” said Eric Ohrn, an assistant professor at Grinnell College. In a July study of the manufacturing sector, he found that state adoption of bonus depreciation boosted investment by 18%.

For some companies, it’s a matter of knowing they will have income to offset with a depreciation tax break now versus later, said Andrew Silverman, a Bloomberg Intelligence tax policy analyst.

“The fact that it’s a timing issue ties in with certainty and the economy generally,” he said. “If you make a purchase and you know you’re going to be recapturing it over 15 years, you don’t know how you’re going to be doing in 15 years.”

Factors Blunting Impact

The GOP’s claim that 100% bonus depreciation would prop up investment has come under new scrutiny after data from the Bureau of Economic Analysis showed investment plunging in recent months.

While the trade war is an obvious culprit, a number of factors could diminish full expensing as an incentive for investment.

The Great Recession left many companies swimming in losses, which, if generated prior to the 2017 law, can be carried forward to shrink future tax bills for 20 years. The law also lowered the corporate rate, making those depreciation write-offs less valuable, and accidentally made interior renovations for brick-and-mortar businesses more expensive after-tax than they were before.

The U.S. economy is also turning toward intangible property, like patents and copyrights, as opposed to tangible ones used most by industries like manufacturing and telecommunications.

“More companies in the economy now are more intangibles-based,” said Michelle Hanlon, an accounting professor at the Massachusetts Institute of Technology’s Sloan School of Management. “It doesn’t matter as much as when we were a more manufacturing-based economy.”

To contact the reporter on this story: Lydia O'Neal in Washington at loneal@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com; Cheryl Saenz at csaenz@bloombergtax.com

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