November 19, 2018 Steve Wamhoff

Director of Federal Tax Policy

November 19, 2018

Many Americans sense that the tax code is riddled with unnecessary and costly breaks for big business, but if asked to name one, few would reply “accelerated depreciation.” Accelerated depreciation allows tax filers to deduct the cost of investments in equipment more quickly than the equipment wears out. While they may seem arcane, tax breaks like “full expensing” and other types of accelerated depreciation are among the central problems in our tax code. A new report from ITEP makes the case that any serious tax reform would repeal or sharply curb these provisions.

What Is Accelerated Depreciation?

To tax business income essentially means taxing any increase in a company’s net worth. When a business purchases a $10,000 machine to make widgets, the company’s net worth initially does not change. It merely traded $10,000 in cash for a machine worth the same amount. Over time the machine wears out, causing the net worth of the company to decline, and each year the company can deduct a portion of the machine’s cost to reflect that.

Tax breaks for accelerated depreciation allow taxpayers to take those deductions more quickly than would be justified by the useful life of the investments (more quickly than economic depreciation).

At first glance, this may seem trivial because it seems to determine the timing, rather than the amount, of taxes paid. Corporations could deduct the costs of capital investments sooner rather than later. But the acceleration of these deductions is enormously important because of the time value of money, the fact that a dollar is worth more today than it is in the future. Taking these deductions earlier allows businesses to defer paying some portion of their taxes for several years, which is the equivalent of receiving an interest-free loan from the federal government.

The cost of these breaks adds up. According to the Congressional Budget Office, if made permanent, the full expensing provisions in the Tax Cuts and Jobs Act will lose $395.7 billion in revenue over the next 10 years.

Why These Breaks Fail to Boost Investment and Help Our Economy

The story of accelerated depreciation is complicated and strange. Some corporations have long used depreciation breaks to avoid the federal income tax, which logically should have pleased profit-motivated investors. But accounting rules governing how corporations report their profits, losses and taxes to investors ignore depreciation breaks, so, in a sense, investors never gave corporate managers credit for using them. The corporate managers responded by lobbying Congress for a reduction in the corporate tax rate — a tax break that is recognized under the accounting rules and would show up in their reports to investors.

Thus began the strange phenomenon of corporations lobbying Congress for a cut in the corporate income tax rate even though they were already largely avoiding that tax. They finally got their wish at the end of 2017 with the enactment of the Tax Cuts and Jobs Act (TCJA).

Yet Congress has also continued to provide accelerated depreciation and even expanded previous depreciation breaks into “full expensing” in TCJA. Because corporate managers largely ignore accelerated depreciation, it fails its stated goal of encouraging new investment and merely provides a hugely expensive tax subsidy for investment that would have occurred regardless of available tax breaks.

ITEP’s report explains that Congress should repeal TCJA’s temporary expansion of depreciation breaks into “full expensing” and ultimately go even further by repealing the permanent provisions in the code that provide accelerated depreciation.