One of the best features of the 2017 Tax Cuts and Jobs Act was the introduction of “expensing” for capital investments. Translation: Corporations that made capital investments could deduct (i.e., expense) those costs from taxable income in the year they made those expenditures. The only condition for expensing was that the asset had to have a “life” of 20 years or less and had to be purchased after September 27, 2017, but before January 1, 2023.
Unfortunately, starting this year, the 2017 law also phases out the ability to expense. The phaseout will be complete on January 1, 2027. As expensing phases out, the effective tax rate on capital will rise substantially. That, in turn, will lead to less investment. With less investment, the capital stock won’t grow as quickly as it would have. That means that worker productivity won’t grow as much, which means that real wages won’t grow as much.
These are the opening two paragraphs of my short article “The U.S. Tax Rate on Capital is Rising,” TaxBytes, Institute for Policy Innovation, June 14, 2023.
Read the whole thing, which is not long. Thanks to Adam N. Michel of the Cato Institute for explaining something in a Canadian study that he referenced.
READER COMMENTS
Vivian Darkbloom
Jun 14 2023 at 2:25pm
The difference between expensing and depreciating the cost of an asset is timing. If the rate of tax is constant, the amount of tax ultimately paid (in nominal terms) also remains constant. You acknowlege this is the article, of course. But, did you attempt to actually calculate the effect of this timing difference on the “effective tax rate”? If so, and even if not so, how did (would) you go about doing this compared with, say, the accelerated depreciation typically available prior to the 2017 Act? In other words, how “substantial” is effective tax rate hike you refer to in your article? You reference studies done by others and write “Michel has also done the math. He points out, for example, that if an asset with a life of 10 years is depreciated over 10 years, then, even with zero inflation and assuming a real interest rate of 3 percent, the present value of the deduction is 91 percent of the amount invested.”
More completely, the present value is the amount invested *times the corporate tax rate*. Thus, with the same assumptions and a corporate tax rate of 21 percent, the present value would be .91 x .21 =19.1 percent. This is a reduction (in value) of less than 2 percent. Very few corporate assets purchased prior to the introduction of the Act were depreciated on a straight-line basis, so I would guess the 2 percent estimate is on the high-end.
We can throw into this the additional complication that if Congress raises the corporate income tax rate from 21 percent (not unlikely), those future tax deductions might ultimately be more valuable than the timing benefit from immediate expensing an asset purchased prior to January 1, 2023.
The idea of the phase-out built in to the original bill was likely to game the CBO’s 10 year revenue estimate and/or to coincide favorably with election cycles. Unfortunately, both parties do this. Other than the 10-year budget window, I’m not sure that the CBO even attempts to calculate the timing benefit of expensing versus depreciation. I’m agnostic on the expensing versus depreciation issue; however, I do view consistency over time as a real benefit.
Jose Pablo
Jun 14 2023 at 2:59pm
however, I do view consistency over time as a real benefit.
Yes, indeed!!
The amount of very valuable man-hours spent in implementing all this (mostly irrelevant) changes is huge!
And these are very capable minds that should be put to better (productive) use.
Samething happens in the HHRR camp (but the alternative use of these minds is way less valuable, I think)
David Henderson
Jun 15 2023 at 10:47pm
Thank you. Your reasoning looks to be correct.
Thomas Hutcheson
Jun 14 2023 at 2:42pm
Business income should not be taxed. Period. At best it could be neutral among different activities. And even at that it would tax incomes of owners with otherwise different marginal tax rates at the same rate. Impute business income (expensing investment is probably cleanest, avoiding arbitrary differences in depreciation rules) to owners and collect the revenue there. The whole idea that “capital” income is different from “ordinary” income is pretty absurd.
Jose Pablo
Jun 14 2023 at 7:21pm
The whole idea that “capital” income is different from “ordinary” income is pretty absurd.
Capital income is different from ordinary income because capital income has already been taxed.
Actually many times: as ordinary income, as corporate profits and as dividends and/or capital gains
And in the system you are advocating (if I understand it right) as ordinary income (you first need to earn the capital you invest, and you pay income taxes when you earn it)
Thomas Hutcheson
Jun 15 2023 at 6:02pm
But that is the other part of the reform. Tax income (or better still consumption) just once, but progressively. Privilege uses of income, not its source.
Jose Pablo
Jun 16 2023 at 12:08pm
Hear! Hear!
But … why progressively?
Use a flat rate consumption tax and send a “flat” US$ rebate to each citizen (instead of every single welfare program already in place)
You will get:
a) A one-page tax-code, which will allow a huge number of highly skilled professionals dedicate themselves to productive (and less boring) activities (instead of to reading, understanding, implementing and gaming thousands of everchanging nonsensical tax rules)
b) A zero-page welfare program since the flat check would allow us to end all welfare programs and the endless useless discussion about “disincetives to work”, mean tests, etc…
With this you can even consider firing half of existing congressmen since they will have so much less to do … another, not minor, blessing! … maybe some of them are able to do useful things in the real world
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