Why Full Expensing is a Critical Tool for Sparking Economic Growth
Economist Erica York breaks down the benefits of the policy
Erica York is a senior economist at the Tax Foundation, a leading independent tax policy nonprofit, and a research manager with the Tax Foundation’s Center for Federal Tax Policy. In those roles, she’s researched full expensing and the effect the tax policy has on the broader economy.
Erica talked us through how full expensing works, why it matters and more.
What is full expensing?
The tax system is designed to tax businesses on their profit. To get a measure of profit, the company adds up all its revenues and then subtracts its expenses. When talking about full expensing, sometimes called 100% bonus depreciation, we’re talking about how the tax code lets businesses recognize the costs they spend on capital investments. That’s physical stuff – equipment, new computers or software.
With most expenses, businesses get to take a deduction in the same year. But for those capital investments, the tax code requires those deductions to be spread out for three to 39 years, a period called a cost recovery schedule.
Bonus depreciation allows companies to take a certain percentage of the deduction in the year the expense happened instead of spreading it over that longer period. So, with 100% bonus depreciation, a company can recognize their entire expense immediately.
Full expensing is scheduled to be phased out soon unless Congress acts. What would you expect to see if it were phased out?
Phasing out full expensing would lead to less investment because the cost of investment would be higher. Let me back up a bit to explain why.
If I asked someone, ‘do you want me to give you $100 today or $100 in five years,’ everyone would say ‘I want that money now.’ We all implicitly understand that it’s more valuable to have money now than it is in the future. That’s for two reasons. One, inflation means that $1 in the future will be worth less. And two, because of the opportunity costs. The $100 now could do something productive and earn a return on it. Waiting on that money means giving up that opportunity.
Those exact same factors are at play for a business. If a company spends $100 purchasing a new machine today but can’t take that deduction for five years, that raises the cost of the machine.
When investment costs are higher, we see less investment. When we have less investment, workers have fewer tools to use in their jobs to be productive, so wages don’t grow as much.
The Tax Foundation ran an analysis on what making full expensing permanent would do to the economy. When we used the Congressional Budget Office's inflation forecast as a given, which assumes that inflation quickly gets back to normal, we found it would grow the economy by 0.4% in the long run.
It would increase the size of capital stock — all the physical assets businesses own — by 0.7% and create 73,000 jobs.
Those percentages may sound small, but we're talking about economic aggregates, so it’s actually billions of dollars’ worth of economic benefit.
Full expensing is one of the most, if not the most, pro-growth tax policy changes that lawmakers can make, because it's entirely targeted at new investment.
When we examined the effect if inflation remained high, there’s an even bigger impact. At inflation scenario of 4%, the GDP boost is 0.5%, the capital stock boost is 0.9% and the employment boost is 94,000 jobs.
What types of projects does full expensing incentivize?
Bonus depreciation applies to assets with a cost recovery schedule of 20 years or less, so that’s most types of machinery and equipment.
Say you have a manufacturing facility with a machine that produces widgets, if the company buys another machine and 100% bonus depreciation is in effect, they get to deduct the entire cost. Or if a farmer buys a new combine harvester, they can deduct the entire cost that year.
How does full expensing affect workers?
The economic benefits of full expensing carry out through the entire economy and ultimately help workers. That’s because when firms are investing in new capital, their workers become more productive. And, in the long run, wages are a function of that productivity. With full expensing, we can see long term improvements in wages.
What’s the impact of full expensing on communities?
Investment is one of the key drivers of long-run economic growth. So, when a business makes an investment, that creates opportunities. When a business creates a new factory or makes upgrades, that has immediate and long-term benefit for workers. It expands employment opportunities, whether it’s moving up in a job, creating an entirely new job, growing employment or bidding up wages. All of those are beneficial things and they are all driven by investment.