Getting Rid of Depreciation with Full Expensing
January 30, 2015
America's tax code is confusing, to say the least. Often, businesses are not treated equally under the U.S. tax code, in part because of the way that they are required to "depreciate" their assets. A new report from Jason Fichtner and Adam Michel of the Mercatus Center explains the situation: While one might expect that businesses -- like any person -- deduct their expenses from their revenue each year in order to determine their profits, they don't. Instead, the tax code requires them to take certain expenses -- capital purchases, such as equipment or buildings -- and deduct them slowly, over time.
The tax code classifies the "life" of all sorts of assets, and depreciation schedules are based on those lives. Tax-wise, the federal government benefits from depreciation, because it gives them more dollars to tax than if an investment were expensed, which Fichtner and Michel equate to an "interest-free loan." Businesses, on the other hand, suffer, and their investments lose value: Fichtner and Michel note that a $1 investment expensed immediately means a $1 tax write-off. But if that $1 investment is depreciated over a 39-year period, the tax write-off ultimately ends up being worth just 37 cents.
What's an answer to this problem? Fichtner and Michel advocate for "full expensing" -- allowing businesses to deduct their expenditures in the year that they are purchased. This would make investment more attractive, improve the profitability of assets and treat all investments equally (Fichtner and Michel note that the current depreciation system allows for special treatment of favored industries, because all investments are treated differently).
Ultimately, full expensing would mean more economic growth -- the report cites figures from the Tax Foundation finding that full expensing would raise GDP by more than 5 percent, increase capital stock by more than 15 percent and raise Americans' wages by more than 4 percent -- not to mention creating more than 885,000 new jobs.
Source: Jason J. Fichtner and Adam N. Michel, "Options for Corporate Capital Cost Recovery: Tax Rates and Depreciation," Mercatus Center, January 29, 2015.
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