Baucus Capital Cost Recovery Plan Would Hurt Investment

April 2, 2014

Senator Max Baucus unveiled a series of income tax reform proposals at the end of 2013. One of the central aspects of the Baucus plan involved abolishing the capital cost recovery system that is currently in the income tax and developing a new one. Income is based on receipts minus costs. For most labor costs, that calculation is easy -- you simply subtract the cost from receipts. With capital investments, however (such as equipment, machines, buildings, property, etc.), those costs must be depreciated over time, says Michael Schuyler, a fellow at the Tax Foundation.

  • The standard depreciation system for tangible assets is MACRS (the Modified Accelerated Cost Recovery System). The time period will vary, depending upon the type of asset, but most cost recovery periods for non-structure assets are between three years and 20 years. Five years to seven years is the most common. The type of depreciation method (such as declining balance or straight-line) also varies.
  • MACRS creates an anti-investment bias from the beginning, because it delays write-offs relative to when the costs are actually incurred. This means that the costs spent on an asset will be understated. As such, when those costs are deducted from receipts, a business's income will be overstated.
  • Income, of course, is then taxed. Because income is overstated, that extra tax can make some investments unprofitable entirely, meaning that the United States sees fewer new investments than would otherwise be the case.

What does the Baucus plan do?

  • The Baucus plan proposes a new depreciation system that would pool similar types of assets together and then depreciate those pools, rather than depreciate individual assets. (This is not the case for structures and some utility property -- those would be depreciated individually.)
  • The proposed system would be even more biased against investment because it further increases the delay between the actual incurring of costs and when businesses can write those off on their taxes.
  • Notably, the proposal would be retroactive, and most existing assets would have to be depreciated in the new system rather than the current system -- many businesses will therefore have to wait many years longer than expected to fully recognize an asset's cost.

Looking at the long-run effects of the proposal on capital formation, employment, incomes, output and revenue, Schuyler found that the Baucus system would negatively impact investment, reduce wages and employment, and lower national output.

Moreover, the slower economic growth that it would produce means that it would not increase federal revenue. While proponents contend that federal revenue would increase by $33 billion annually, the plan would actually lower revenue by a whopping $64 billion.

Source: Michael Schuyler, "Slower Growth through 'Tax Reform': The Baucus Capital Cost Recovery Proposal," Tax Foundation, March 25, 2014.

 

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