How to Encourage Long-term Capital Investments
July 11, 2001
The Internal Revenue Service used to allow companies to decide over what period they should depreciate capital expenditures, says Bruce Bartlett. But law and practice have put all equipment into rigid depreciation categories, where they are written off in from three to 20 years, depending on the asset. This depreciation policy has a significant effect on capital investment.
- The problem is that $1 written off in year 20 is worth a lot less than $1 deducted in year one -- even in the absence of inflation -- because money in the future is clearly worth less than money today.
- Interest, the price society charges for the time value of money, does not apply to depreciation, even though it is worth less each year that goes by.
- For instance, at a 10 percent interest rate, $1 of depreciation in year 20 is only worth about 16 cents.
The result of this depreciation policy is to bias investment against long-lived assets. It also biases investment against equipment that becomes obsolete, and hence worthless, faster than depreciation schedules allow it to be written off. The result is less investment than the economy needs, and misallocation of the investment it gets.
Many economists say businesses should be allowed to deduct all capital equipment immediately, known as expensing, the same way labor and raw materials are treated now. This would eliminate the tax bias against capital and certain types of capital relative to others.
Rep. Richard Neal (D-Mass.) and Rep. Phil English (R-Penn.) have proposed legislation to shorten depreciation schedules for new investments in technology equipment. Although it applies only to high-tech equipment, because such equipment now accounts for more than half of total private fixed investment, it is a significant movement toward expensing all capital equipment.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, July 11, 2001.
Browse more articles on Tax and Spending Issues