Are Accelerated Write-Off Provisions Effective?

Two of the biggest items among the tax extenders that Congress may consider before the end of the year are two provisions that allow accelerated write-offs of investments: section 179 expensing and bonus depreciation. Section 179 expensing provides an immediate write-off for small businesses for a certain amount of investment; both the amount and the level at which the favorable tax treatment phase out decreased significantly when the extenders expired at the end of last year. Bonus depreciation allows all businesses to write off half of certain investments immediately. Both provisions are among the costliest in the tax extenders package, costing a combined $315 billion over ten years if extended permanently.

These two policies, and in particular bonus depreciation, are generally justified as stimulative measures, and since they effect only the timing of write-offs, their temporary nature is central to their effectiveness in that regard. However, the Congressional Research Service's Gary Guenther in a recently updated report finds limited short-term economic benefit.

Though there appear to be no studies that address the economic effects of the enhanced Section 179 allowances enacted in the previous eight years, several studies have examined the economic effects of the 30% and 50% bonus depreciation allowances that were available from 2002 to 2004. The findings indicated that accelerated depreciation is a relatively ineffective tool for stimulating the economy during periods of weak or negative growth. [emphasis added]

Guenther sees many reasons why the effect of accelerated write-offs may be limited, including both their design and the economic context.

Neither allowance has affected investments in inventory, structures, and land. And among qualified assets, each provides a greater tax benefit for investment in longer-lived items (such as machine tools) than it does for investment in shorter-lived ones (such as computer systems). Consequently, spending on assets eligible for the allowances tends to account for a small slice of business investment. One measure of this relationship is the value of depreciation allowances claimed by businesses in a tax year. According to corporate income tax data made available by the IRS through its website, corporations claimed a total of $609.8 billion in depreciation allowances for the 2009 tax year. Of that amount, Section 179 allowances amounted to $7.8 billion (or 1.3% of the total amount) and bonus depreciation allowances came to $137.4 billion (or 22.5% of the total amount).

In addition, expensing is likely to have less of a stimulative effect when an economy is mired in a recession or growing too slowly to reduce the unemployment rate than when it is growing robustly. This is because business investment in general is driven more by the short-to-medium term outlook for sales and economic growth than it is by temporary tax incentives. Thus, an increase in an expensing allowance when the economy is contracting and more and more companies, large and small, have excess capacity is more likely to affect the timing of planned qualifying investments than the amount of those investments. [emphasis added]

The report also pointed to survey data showing that bonus depreciation may have not had much effect on investment when it was in effect in the early 2000s.

A second study found that though over half of all C and S corporations claimed bonus depreciation in the 2002-2004 tax years, a variety of surveys indicated that no more than 10% of companies deemed the allowances an important consideration in determining the timing or level of qualifying investments. This suggested that many of the investments in that period that benefited from bonus depreciation would have been made without it. [emphasis added].

Although evidence for the short-term economic benefits of bonus depreciation is limited, some proponents of extending the policies have argued that they would produce significant long-term benefits by lowering the effective marginal tax rate on investment. In fact, the Joint Committee on Taxation found that making bonus depreciation permanent could increase real GDP by 0.2 percent over the next ten years and perhaps more over the long run. Outside groups such as the Tax Foundation believe there would be a much larger effect.

But as we've explained before, simply extending bonus depreciation and section 179 would be a sloppy and costly way to move toward full expensing. Generally, proposals to move toward full expensing are done in conjunction with eliminating or curtailing interest deductions – in order to minimize the revenue loss and reduce the subsidy for leveraging – and in conjunction with changes to remaining depreciation schedules, inventory rules, various other tax preferences, and the overall tax rate. In other words, a permanent move toward full expensing should take place in the context of comprehensive reform, not through piecemeal changes.

Other Suggested Reading