If Republicans want to boost economic growth through the tax reform package that they’re crafting this year, one particular policy will be key to their success—permanent full expensing for capital investment.
Today’s US tax code places a burden on investing in capital and US-based research because it prohibits businesses from taking full deductions for what they spend on these productive activities.
Instead, the tax code arbitrarily sets complicated depreciation schedules that, because of inflation and diminishing value of money over time, erode the overall value of deductions allowed for spending on new equipment, facilities, and innovative activities.
The result is that our tax system depresses investment levels in the US, leading to smaller capital stock and lower productivity and wages than we would see if our tax system didn’t discourage investment.
Republicans hoped to solve this problem with full expensing for all capital investment in early drafts of what became the 2017 Tax Cuts and Jobs Act. Through the political process, however, lawmakers weakened the policy, settling on a temporary 100% deduction for certain types of investments such as machinery and equipment.
Unfortunately, the 2017 tax law made the bias against investment worse in some cases by preventing similar full deductions for research and development, while it made no improvements to the tax treatment of investing in factories, warehouses, and apartments.
Though the 2017 reforms fell well short of the ideal, 100% bonus depreciation was a major step in the right direction. The National Bureau of Economic Research found that full expensing for machinery and equipment generated more investment per dollar of tax revenue than all the other tax reforms made in 2017, echoing a Tax Foundation analysis showing full expensing offers the most bang for the buck of any other tax reform on the table.
But there’s a caveat. A higher level of investment only comes to fruition and produces lasting economic benefits if full expensing is around permanently. A temporary policy of full expensing may lead to a short-term benefit, but it “materially reduces capital accumulation in the long run,” according to an NBER report.
Our model at Tax Foundation estimates a temporary change to cost recovery will generate no long-run economic growth, because any temporary surge in investment shrinks back down as soon as the policy expires. Worse, uncertainty over the future of a temporary policy can further complicate matters, as businesses can’t plan whether new investments will be viable past the policy’s expiration date.
That’s why permanence is the key ingredient to crafting pro-growth tax reform this time around.
If lawmakers permanently provide full expensing for machinery and equipment investment, restore full R&D expensing, and extend better treatment to investment in structures, we estimate it would grow the US economy by 1.8% and reduce tax revenue by around $1.1 trillion over the next decade. That amounts to more than three times the economic growth expected from extending the expiring individual provisions for one-third of the revenue loss.
Fiscal pressures will dominate this year’s tax package, but lawmakers should respond with economically wise solutions. Prioritizing tax reforms such as full expensing that generate the most growth for the least revenue loss—and offsetting that revenue loss with simple, neutral base broadeners—will achieve fiscally responsible growth.
However, reducing the fiscal impact of the tax package by repeating the mistakes of 2017—such as restricting full expensing to certain types of assets and allowing it only temporarily—or making new mistakes such as relying on economically destructive tariffs, will undercut what would otherwise be a powerful economic incentive to invest in the US.
Removing the tax code’s bias against capital investment by implementing full expensing should be the cornerstone of lawmaker’s efforts to increase US investment opportunities. Compromising on the timing and availability of expensing—or offsetting the revenue losses by worsening other parts of the tax code—would squander an opportunity to craft a fiscally responsible, pro-growth tax reform.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
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Erica York is vice president of federal tax policy at the Tax Foundation.
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