The Case for Permanent Expensing
October 22, 2010
Lower taxes on investments allow more capital to be created and employed. Permanent expensing fits the need and is consistent with real tax reform, says Stephen J. Entin, president and executive director of the Institute for Research on the Economics of Taxation.
The federal individual and corporate income tax typically requires businesses to depreciate their investments in plant, equipment and other buildings over many years, meaning that a business cannot deduct from that year's taxable income the full cost of the investment. But the present value of a dollar written off in the future is worth less than a dollar write-off today.
- A dollar spent on a seven-year asset gets a write-off worth only $0.91 cents in present value (if inflation is zero).
- A dollar spent on a building (written off over 39 years) gets a deduction worth just $0.55 cents in present value.
- The cost of the delay rises with the inflation rate -- for example, at a 5 percent inflation rate, the seven-year asset's write-off is worth only $0.81 and the building's write-off value drops to $0.30.
Permanent expensing results in a permanent increase in capital creation, which also raises employment and wages. For example:
- In 2003, Congress raised the expensing percentage to 50 percent, and reduced the top rate on capital gains and dividends to 15 percent.
- As a result, equipment spending began to soar.
Raising expensing from 50 percent to 100 percent would increase the after-tax return on capital by about 2.5 percentage points. That alone, if permanent, would boost investment. It is critical that it be accompanied by extending the 15 percent tax rate caps for dividends and capital gains. Otherwise, the improvement from expensing would be wiped out twice over, says Entin.
Source: Stephen J. Entin, "The Case for Permanent Expensing," National Center for Policy Analysis, October 22, 2010.
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