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The Section 179 and Bonus Depreciation
Expensing Allowances: Current Law and
Issues for the 114th Congress
Gary Guenther
Analyst in Public Finance
March 13August 6, 2015
Congressional Research Service
7-5700
www.crs.gov
RL31852
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Section 179 and Bonus Depreciation Expensing Allowances
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Summary
Expensing is the most accelerated form of depreciation for tax purposes. Section 179 of the
Internal Revenue
Code allows a taxpayer to expense (or deduct as a current expense rather than as
a capital expense) up to
$25,000 of the total cost of new and used qualified depreciable assets it
buys and places in service
in 2015, within certain limits. Firms unable to take advantage of this
allowance may recover the
cost of qualified assets over longer periods, using the appropriate
depreciation schedules from
Sections 167 or 168. While the Section 179 expensing allowance is
not targeted at small firms,
the limits on its use effectively confine its benefits to such firms.
In addition, Section 168(k), which provides a so-called bonus depreciation allowance, has
allowed taxpayers to expense a portion of the cost of qualified assets bought and placed in service
in recent tax years. Taxpayers that could claim the allowance had the option of monetizing any
unused alternative minimum tax credits left over from tax years before 2006, within certain
limits, and recovering the cost of the assets that qualified for the allowance over longer periods.
The allowance expired at the end of 2014.
Since 2002, the two allowances have been used primarily as tax incentives for stimulating the
U.S. economy. Though there appear to be no studies that address the economic effects of the
enhanced Section 179 allowances that were available from 2003 to 2014, several studies have
examined the economic effects of the 30% and 50% bonus depreciation allowances from 2002 to
2004. Their findings indicated that accelerated depreciation is a relatively ineffective tool for
stimulating the overall economy during periods of weak or negative growth.
Available evidence also suggests that the expensing allowances may have a minor effect at best
on the level and composition of business investment and its allocation among industries, the
distribution of the federal tax burden among different income groups, and the cost of tax
compliance for smaller firms. The allowances have advantages and disadvantages. On the one
hand, an expensing allowance simplifies tax accounting, and a temporary allowance has the
potential to stimulate increased small business investment in favored assets in the short run by
reducing the user cost of capital and increasing the cash flow of investing firms. On the other
hand, depending on its design, an expensing allowance may interfere with the efficient allocation
of capital among investment opportunities by diverting capital away from more productive uses.
The Tax Increase Prevention Act of 2014 (P.L. 113-295) extended through 2014 the Section 179
expensing allowance and the Section 168(k) bonus depreciation allowance that were available in
from 2013.
On February 13, 2015, the House passed a bill (H.R. 636) that would permanently set the
maximum Section 179 allowance at $500,000 and the phaseout threshold at $2 million and index
both amounts for inflation starting in 2016. It also would make qualified computer software,
heating and air conditioning equipment, and qualified real property (e.g., improvements to lease
hold property and restaurants) permanently eligible for the Section 179 allowance. Under H.R.
636, a taxpayer would have the permanent right to revoke an election made under Section 179
without the consent of the Internal Revenue Service. The estimated revenue loss of $77.1 billion
from FY2015 to FY2025 resulting from the bill would not be offset. It is unclear whether the
Senate will consider the bill, or something similar.
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Contents
Introduction...............................
The Senate Finance Committee favorably reported a bill (S. 1946) on July 23 that would
retroactively extend through 2016 the 50% bonus depreciation allowance and the option to
monetize alternative minimum tax credits from years before 2006 that were available in 2014. It
would also raise the maximum Section 179 expensing allowance to $500,000 and the phaseout
threshold to $2 million for 2015 and 2016, and index both amounts for inflation, among other
things.
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Section 179 and Bonus Depreciation Expensing Allowances
The Section 179 and Bonus Depreciation Expensing
Allowances: Current Law and Issues for the 114th
Congress
Introduction ....................................................................................................... 1 Error! Bookmark not defined.
Current Expensing Allowances. ....................................................................................................... 1
Section 179 ................................................................................................................................ 1
Maximum Expensing Allowance ........................................................................................ 1
Qualified Property ............................................................................................................... 21
Limitations on Use of the Section 179 Allowance .............................................................. 2
Claiming the Allowance ...................................................................................................... 2
Bonus Depreciation Allowance ................................................................................................. 3
Interaction with Other Depreciation Allowances, Including the
Section 179 Allowance ..................................................................................................... 4
Legislative History of the Two Expensing Allowances ................................................................... 5
Section 179 ................................................................................................................................ 5
Bonus Depreciation Allowance ................................................................................................. 7
Legislation in the 113th and 114th Congresses to Extend and Modify the Two Expensing
Allowances ................................................................................................................................... 98
113th Congress ........................................................................................................................... 98
Section 179 Expensing Allowance ...................................................................................... 98
Bonus Depreciation Allowance ........................................................................................... 98
114th Congress ........................................................................................................................... 9 10
Section 179 Expensing Allowance ...................................................................................... 109
Bonus Depreciation Allowance .......................................................................................... 10. 9
President’s Budget Request for FY2016 ................................................................................. 10
Economic Effects of the Section 179 and Bonus Depreciation Allowances .................................. 11 10
The Allowances as Tools for Economic Stimulus ................................................................... 1110
Efficiency Effects .................................................................................................................... 1514
Equity Effects .......................................................................................................................... 1716
Tax Administration .................................................................................................................. 1817
Tables
Table 1. Maximum Expensing Allowance and Investment Limitation from 1987 to 2015 ............. 3
Contacts
Author Contact Information ........................................................................................................... 19
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Section 179 and Bonus Depreciation Expensing Allowances
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Introduction
Under current tax law, firms may expense (or deduct as a current rather than a capital expense) up
to $25,000 of the total cost of new and used qualified assets they purchase and place in service in
2015 under Section 179 of the federal tax code. But they no longer have the option under Section
168(k) of expensing any portion of the cost of qualified assets they buy and place in service the
same year (or the following year in the case of assets with relatively long production schedules).
Many of the assets that qualify for the Section 179 allowance also qualified for the Section 168(k)
allowance, which was available from 2002 to 2005 and from 2008 to 2014.
Expensing is the most accelerated form of depreciation. It has the potential to stimulate business
investment by reducing the cost of capital for favored investments and increasing the cash flow of
firms undertaking such investments. As a result, economists see the two allowances as a
significant investment tax subsidy, especially since some firms were able to take advantage of
both allowances in the same tax year.
The American Taxpayer Relief Act of 2012 (ATRA, P.L. 112-240) increased the maximum
Section 179 allowance to $500,000 and the phaseout threshold to $2 million for qualified assets
acquired and placed in service in 2012 and 2013. ATRA also extended the 50% bonus
depreciation allowance from 2011 through 2013. Congress extended both allowances through
2014 by passing the Tax Increase Prevention Act of 2014 (P.L. 113-295). In the 114th Congress,
the House is considering a measure (H.R. 636) to permanently set the maximum Section 179
allowance at $500,000 and the phaseout threshold at $2 million and index both amounts for
inflation beginning in 2016.
This report examines the current status, legislative history, and main economic effects (including
their efficacy as an economic stimulus tool) of the Section 179 and bonus depreciation
allowances.
Current Expensing Allowances
Section 179
Section 179 of the Internal Revenue Code (IRC) gives firms in all lines of business and all sizes
the option, within certain limits, of expensing part or all of the cost of new and used qualified
property they acquire in the year when the assets are placed in service. Business taxpayers that
cannot (or choose not to) claim the allowance may recover capital costs over longer periods and
at slower rates by claiming the appropriate depreciation deductions under the Modified
Accelerated Cost Recovery System (MACRS) or Alternative Depreciation System (ADS).
Maximum Expensing Allowance
The maximum Section 179 expensing allowance is set at $25,000 for qualified assets bought and
placed in service in 2015. Assuming no change in current law, the allowance will remain at
$25,000 in each year after 2015 as well. (Table 1 shows the maximum allowances going back to
1987.)
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Qualified Property
Under current law, new and used tangible property—as specified in IRC Section 1245(a)(3)—
qualifies for the allowance if it is depreciable under IRC Section 168 (which contains the
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MACRS) and acquired for use in the active conduct of a trade or business. With a few minor
exceptions, this property consists of machinery and equipment used in manufacturing, mining,
transportation, communications, the generation and transmission of electricity, gas and water
distribution, and sewage disposal. Most buildings and their structural components (including
heating and air conditioning units) do not qualify for the allowance. But an exception to this rule
was made for the 2010 to 2014 tax years: taxpayers were allowed to expense up to $250,000 in
each tax year of the cost of qualified leasehold improvements, qualified retail improvement
property, and qualified restaurant improvement property they incurred; this treatment expired at
the end of 2014. Research and bulk storage facilities do qualify for the allowance, as do singlepurpose agricultural structures, storage facilities for petroleum products, and railroad grading and
tunnel bores. In addition, the cost of off-the-shelf computer software that is acquired and placed
in service from 2003 to 2014 could be expensed under Section 179; this treatment also expired at
the end of 2014.
Limitations on Use of the Section 179 Allowance
Use of the allowance is subject to two limitations: an investment (or dollar) limitation and an
income limitation.
Under the dollar limitation, the maximum allowance a taxpayer can take in a tax year is reduced,
dollar for dollar but not below zero, by the amount by which the aggregate cost of qualified
property a firm buys and places in service during that year exceeds a phaseout threshold. The
threshold is set at $200,000 in 2015 and thereafter. (Table 1 shows the thresholds going back to
1987.) As a result, a taxpayer may claim no Section 179 expensing allowance in 2015 when the
total cost of qualified property it acquires and places in service that year reaches or exceeds
$225,000.
The income limitation bars a taxpayer from claiming a Section 179 allowance greater than its
taxable income (including wages and salaries) from the active conduct of his or her trade or
business. The limitation is determined after the application of the investment limitation. For
example, if a company has $20,000 in taxable income in 2015 from its business but may claim a
Section 179 allowance of $25,000 under the investment limitation, it could expense up to $20,000
of the cost of qualified property and recover the remaining $5,000 under the MACRS or carry it
forward to a future tax year. Taxpayers are not allowed to carry forward any allowance from the
current tax year that cannot be used because of the investment limitation, but they may carry
forward indefinitely allowances that cannot be used because of the income limitation.
Claiming the Allowance
To claim the allowance, a taxpayer must specify on Form 4562 the items to which the election
applies and the portion of the cost of each item that is to be deducted immediately. Historically,
an election to claim the Section 179 allowance could be revoked only with the consent of the
Internal Revenue Service (IRS). But this rule was suspended for the tax years from 2002 to 2013,
and Congress extended it to cover elections made in 2014. During the period of suspension, a
taxpayer was allowed to revoke any portion of an election to expense qualified property without
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the IRS’s consent, regardless of whether the election was made on an original or amended return
(IRS regulation 1.179-5). To revoke an election, a taxpayer had to submit an amended tax return
for the tax year in question.
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Table 1. Maximum Expensing Allowance and Investment Limitation
from 1987 to 2015
Year
Maximum Expensing Allowance
Investment Limitation
1987-1992
$10,000
$200,000
1993-1996
$17,500
$200,000
1997
$18,000
$200,000
1998
$18,500
$200,000
1999
$19,000
$200,000
2000
$20,000
$200,000
2001 and 2002
$24,000
$200,000
2003
$100,000
$400,000
2004
$102,000a
$410,000a
2005
$105,000a
$420,000a
2006
$108,000a
$430,000a
2007
$125,000
$500,000
2008 and 2009
$250,000
$800,000
2010 to 2014
$500,000
$2,000,000
$25,000
$200,000
2015 and thereafter
Source: Internal Revenue Service, revenue procedures dating back to 1987.
a.
The $100,000 figure for the maximum allowance and the $400,000 figure for the investment limitation were
both indexed for inflation from 2004 to 2006.
Bonus Depreciation Allowance
Besides the Section 179 expensing allowance, taxpayers had the option of claiming an additional
first-year (or bonus) depreciation allowance (under Section 168(k)) for eligible property acquired
and placed in service from 2002 and 2014. This added allowance accelerated the depreciation of
qualified property, lowering the cost of capital for investment in those assets and increasing the
cash flow of companies making such investments. Congress created the bonus depreciation
allowance in part to spur increased business investment during periods of negative or sluggish
economic growth, such as the severe recession that lasted from late 2007 to mid-2009 and the
weak rebound that persisted into early 2014.
The initial bonus depreciation allowance was enacted in 2002 and was equal to 30% of the cost of
property eligible for depreciation under the MACRS with recovery periods of 20 or fewer years,
water utility property, off-the-shelf computer software, and qualified leasehold property. The
property had to be acquired and placed in service between September 12, 2001, and December
31, 2004. (Eligible property with relatively long production times and certain non-commercial
aircraft could be placed in service in 2005 and still qualify for the allowance.) Taxpayers claiming
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the allowance had to be the original user of the property. In addition, the allowance could be
applied against the regular income tax and the AMT with no adjustments.
The following year, Congress established a 50% bonus depreciation allowance for the same
property acquired and placed in service from 2003 through 2005. It expired at the end of 2005,
but Congress reinstated it in 2007 for property acquired and placed in service in 2008 (or 2009 for
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property with long production times and certain aircraft). As a result of several other extensions
and enhancements, a bonus depreciation allowance of 50% or 100% was available for eligible
property acquired and placed in service from 2009 through 2014 (or 2015 for property with
relatively long production times).
For tax years beginning between April 1, 2008, and December 31, 2014, C corporations had the
option under Section 168(k)(4) of using a portion of their alternative minimum tax (AMT) credits
carried over from tax years before 2006, in lieu of taking a bonus depreciation allowance. The
accelerated credit was refundable and limited to a corporation’s “bonus depreciation amount”
(BDA) for the tax year. This amount was equal to 20% of the difference between the total bonus
and regular depreciation that would be allowed on eligible property placed in service during a tax
year if bonus depreciation were claimed, on the one hand, and the total depreciation that would be
allowed if no bonus depreciation were claimed, on the other hand. But a taxpayer’s BDA could
not exceed a corporation’s “maximum increase amount,” which was the lesser of 6% of the sum
of its unused AMT credits from tax years before 2006 or $30 million. For the 2008, 2009, and
2010 tax years, corporations were also allowed to claim research tax credits carried over from tax
years before 2006, in lieu of a bonus depreciation allowance. Corporations choosing the
accelerated, refundable credit had to use the straight-line method over the appropriate period to
depreciate the property eligible for bonus depreciation they acquired and placed in service in the
current tax year.
Interaction with Other Depreciation Allowances, Including the
Section 179 Allowance
In the case of assets that were eligible for both expensing allowances, a taxpayer was required to
recover their cost in a prescribed order. The Section 179 expensing allowance had to be taken
first, lowering the taxpayer’s basis in the asset by that amount. The taxpayer then could apply the
bonus depreciation allowance to the remaining basis amount, further reducing her basis in the
property. Finally, the taxpayer was allowed to claim a depreciation allowance under the MACRS
for any remaining basis, using the double declining balance method.
A simple example illustrates how this procedure was supposed to work. Assume that the only
investment a company made in 2014 was the acquisition of 10 new machine tools at a total cost
of $700,000. Such a purchase qualified for both the Section 179 expensing and bonus
depreciation allowances for that year. Therefore, it was permitted to recover that cost for federal
tax purposes as follows:
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First, the company could take a Section 179 expensing allowance of $500,000 on
its federal tax return for that year, lowering its basis in the property to $200,000
($700,000 - $500,000).
•
Then it could claim a bonus depreciation allowance of $100,000 ($200,000 x
0.5), further lowering its basis to $100,000 ($200,000 - $100,000).
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•
Next, the company was allowed a deduction for depreciation under the MACRS
on the remaining $100,000. Given that the MACRS recovery period for machine
tools is five years and five-year property is depreciated using the doubledeclining-balance method, the company could claim an additional depreciation
allowance equal to 20% of $100,000, or $20,000, using the half-year convention.
•
The company could recover the remaining basis of $80,000 ($100,000 - $20,000)
by taking MACRS depreciation deductions over each of the next five years at
rates of 32%, 19.2%, 11.52%, 11.52%, and 5.76%, respectively.
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Thus, the company was able to write off nearly 89% of the cost of the machine
tools in the same year they were bought and placed in service.
Legislative History of the Two
Expensing Allowances
Section 179
The Section 179 expensing allowance began as a permanent first-year depreciation allowance that
Congress included in the Small Business Tax Revision Act of 1958 (P.L. 85-866). Its purpose was
no different from its purpose today: to reduce the tax burden on small business owners, stimulate
small business investment, and simplify tax accounting for smaller firms. The original deduction
was limited to $2,000 ($4,000 in the case of a married couple filing a joint return) of the cost of
new and used business machines and equipment with a tax life of six or more years.
No change was made in the allowance until the enactment of the Economic Recovery Tax Act of
1981 (ERTA; P.L. 97-34). ERTA raised the expensing allowance to $5,000 and laid down a
timetable for a gradual increase in the allowance to $10,000 by 1986. In spite of the substantial
increase in the allowance, few firms took advantage of it. Some analysts attributed the tepid
response to the limitations on the use of an investment tax credit that ERTA established. A
business taxpayer could claim that credit only for the portion of an eligible asset’s cost that was
not expensed; so the full credit could be used only if the company claimed no expensing
allowance. For many firms, the tax savings from the credit outweighed the tax savings from a
combination of the credit and the allowance.
In an effort to counter the rise in the federal budget deficit in the early 1980s, Congress passed the
Deficit Reduction Act of 1984 (P.L. 98-369). Among other things, the act postponed from 1986 to
1990 the scheduled increase in the expensing allowance to $10,000. Still, use of the allowance
rose markedly following the repeal of the investment tax credit by the Tax Reform Act of 1986.
The allowance rose to $10,000 in 1990, as scheduled, and remained at that level until Congress
passed the Omnibus Budget Reconciliation Act of 1993 (OBRA93; P.L. 103-66). OBRA93
increased the allowance to $17,500 (as of January 1, 1993) and created a variety of tax benefits
for impoverished areas designated as enterprise zones and empowerment zones. The benefits
included an enhanced expensing allowance for qualified assets placed in service in an EZ.1 To be
1
Firms placing qualified assets in service in an EZ were allowed to claim a maximum allowance that was $20,000
greater than the allowance available in other areas, with a phaseout threshold that was twice as large as that available in
(continued...)
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designated as an EZ, an area had to meet certain eligibility criteria relating to population, poverty
rate, and geographic size.
With the enactment of the Small Business Job Protection Act of 1996 (SBJPA, P.L. 104-188), the
regular allowance again was placed on timetable for scheduled increases. Specifically, under the
act, the maximum allowance was supposed to rise to $18,000 in 1997, $18,500 in 1998, $19,000
in 1999, $20,000 in 2000, $24,000 in 2001 and 2002, and $25,000 in 2003 and thereafter.
The Community Renewal Tax Relief Act of 2000 (P.L. 106-554) added “renewal communities”
(RCs) to the list of special economic development areas and granted businesses located in them
the same tax benefits available to businesses in EZs, including the enhanced expensing
1
Firms placing qualified assets in service in an EZ were allowed to claim a maximum allowance that was $20,000
greater than the allowance available in other areas, with a phaseout threshold that was twice as large as that available in
other areas.
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allowance. In addition, it increased the premium for the allowance for qualified assets placed in
service in special areas (including RCs) to $35,000 above the regular allowance.
In response to the economic losses associated with the terrorist attacks of September 11, 2001,
Congress established a variety of tax benefits through the Job Creation and Worker Assistance
Act of 2002 (P.L. 107-147). The benefits were intended to encourage new business investment in
the area in lower Manhattan in New York City that bore the brunt of the aerial attacks on the
World Trade Center. Owners of firms in the so-called Liberty Zone were allowed to claim the
same enhanced expensing allowance for qualified investments that was available to small
business owners in the EZs and RCs.
After the SBJPA, no changes were made in the regular allowance until the passage of JGTRRA.
Under the act, the allowance rose four-fold to $100,000 (as of May 6, 2003), stayed at that
amount in 2004 and 2005, and then reset in 2006 and beyond at its level before JGTRRA
($25,000). JGTRRA also raised the phaseout threshold to $400,000 from May 2003 to the end of
2005, indexed the regular allowance and the threshold for inflation in 2004 and 2005, and added
off-the-shelf software for business use to the list of depreciable assets eligible for expensing in
the same period.
The American Jobs Creation Act of 2004 (AJCA; P.L. 108-357) extended the changes made by
JGTRRA through the end of 2007.
In an effort to aid the recovery of the economies in the areas of Louisiana, Mississippi, and
Alabama devastated by Hurricane Katrina in 2005, Congress passed the Gulf Opportunity Zone
Act of 2005 (P.L. 109-135). Among other things, the act created a “Gulf Opportunity Zone,” or
GOZ, in those areas and offered a variety of tax incentives for business investment in the GOZ,
including an enhanced expensing allowance for qualified assets purchased on or after August 28,
2005, and placed in service by December 31, 2007. This allowance could be as much as $100,000
above the regular allowance, with a phaseout threshold that was $600,000 greater than the
phaseout threshold for the regular allowance. It also applied to a wider range of assets than the
regular Section 179 allowance.
The Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) extended the changes
in the allowance from JGTRRA through 2009.
(...continued)
other areas.
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Under the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Appropriations Act,
2007 (P.L. 110-28), Congress further extended the changes in the allowance made by JGTRRA
through 2010, raised the maximum allowance to $125,000 and the phaseout threshold to
$500,000 during 2007 to 2010, and indexed both amounts for inflation in that period. The act also
extended through 2008 the special GOZ allowance.
In an effort to boost business investment in the midst of a severe economic downturn, Congress
increased the allowance to $250,000 and the phaseout threshold to $800,000 for qualified assestsassets
bought and placed in service in 2008 by passing the Economic Stimulus Act of 2008 (ESA, P.L.
110-185). Those amounts were supposed to reset at $125,000 and $500,000 in 2009 and 2010,
with adjustments for inflation.
Two laws enacted during the 111th Congress included provisions modifying the status of the
Section 179 expensing allowance. The American Recovery and Reinvestment Act of 2009 (P.L.
111-5) extended the enhanced allowance created by ESA through 2009, and the Hiring Incentives
to Restore Employment Act of 2010 (P.L. 111-147) further extended it through 2010.
Under the Small Business Jobs Act of 2010 (P.L. 111-240), the maximum expensing amount
increased to $500,000, and the phaseout threshold to $2 million, for tax years beginning in 2010
and 2011. Starting in 2012 and thereafter, the maximum allowance was scheduled to decrease to
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$25,000 and the phaseout threshold to $200,000. The act also expanded the definition of qualified
property to include certain real property: specifically, qualified leasehold improvement property,
qualified retail improvement property, and qualified restaurant property. For the 2010 and 2011
tax years, a taxpayer could elect to expense up to $250,000 of the annual cost of such property.
By passing the Tax Relief, Unemployment Compensation Reauthorization, and Job Creation Act
of 2010 (P.L. 111-312), Congress increased the maximum allowance to $125,000 and the
phaseout threshold to $500,000 for qualified assets acquired and placed in service in 2012,
indexed those amounts for inflation, set the maximum allowance at $25,000 and the phaseout
threshold at $200,000 for 2013 and thereafter, and extended the eligibility of off-the-shelf
computer software for the allowance through 2012.
The American Taxpayer Tax Relief Act of 2012 retroactively increased the maximum expensing
allowance to $500,000 and the phaseout threshold to $2 million for 2012 and 2013. It also made
off-the-shelf software eligible for the allowance in 2013 and extended through 2013 the
maximum annual $250,000 expensing allowance for qualified real property that first became
available in 2010.
Congress extended through 2014 the Section 179 expensing allowance from 2012 and 2013 by
passing the Tax Increase Prevention Act of 2014 (P.L. 213-295).
Bonus Depreciation Allowance
The Job Creation and Worker Assistance Act of 2002 (P.L. 107-147) created the bonus
depreciation allowance. It was equal to 30% of the adjusted basis of new qualified property
acquired after September 11, 2001, and placed in service by December 31, 2004. A one-year
extension of that deadline was available for property with MACRS recovery periods of 10 or
more years and lengthy production periods, as well as for transportation equipment.
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A year later Congress raised the allowance to 50% of the adjusted basis for qualified property
acquired after May 5, 2003 and placed in service before January 1, 2006 through the Jobs and
Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27). Once again, a one-year extension of
that deadline was available for certain property.
Congress passed the Economic Stimulus Act of 2008, in part, to address the economic effects of
the financial crisis that emerged in the late summer and early fall of that year. The act renewed the
50% bonus depreciation allowance that expired at the end of 2005. To claim the allowance, a
taxpayer had to acquire qualified property after December 31, 2007, and place it in service before
January 1, 2009.
Later in 2008, Congress passed the Housing Assistance Tax Act of 2008 (P.L. 110-289), which
was mainly intended to ease the impact of the financial crisis on the domestic housing market. It
included a provision that gave C corporations the option to trade bonus depreciation allowances
they could claim for property acquired between April 1 and December 31, 2008 for a refundable,
accelerated tax credit equal to the lesser of $30 million or 6% of the sum of any research and
AMT credits carried forward from tax years before 2006.
The American Recovery and Reinvestment Act of 2009 (P.L. 111-5) extended the 50% bonus
depreciation allowance and the option of monetizing a portion of unused research and AMT
credits from tax years before 2006 through 2009.
By passing the Small Business Jobs Act of 2010 (P.L. 111-240), Congress further extended the
50% allowance to qualified property acquired and placed in service in 2010.
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Under the Tax Relief, Unemployment Compensation Reauthorization, and Job Creation Act of
2010 (P.L. 111-312), the bonus depreciation allowance increased to 100% for qualified property
acquired after September 8, 2010, and placed in service before January 1, 2012. The act also
established a 50% allowance for property acquired and placed in service in 2012 and allowed
corporations to claim a refundable credit for unused AMT credits (but not unused research
credits) from tax years before 2006 in lieu of a bonus depreciation allowance for qualified
property they acquired between January 1, 2011 and December 31, 2012.
The American Taxpayer Relief Act of 2012 extended the 50% bonus depreciation allowance
through the end of 2013. ATRA also extended through 2013 the option to claim an accelerated,
refundable credit for AMT credits carried forward from tax years before 2006 instead of a bonus
depreciation allowance for qualified property acquired and placed in service in 2013.
The Tax Increase Prevention Act of 2014 (TIPA) extended through 2014 the bonus depreciation
allowance that was available in 2013.
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Legislation in the 113th and 114th Congresses to
Extend and Modify the Two Expensing Allowances
113th Congress
Section 179 Expensing Allowance
The House has passed two bills (H.R. 4457 on June 12, 2014, and H.R. 4 on September 18, 2014)
that would have permanently set the maximum expensing allowance under Section 179 at
$500,000 and the phaseout threshold at $2 million. Both amounts would have been indexed for
inflation, starting in 2015. And both bills would also have permanently expanded the property
eligible for the allowance to include qualified computer software; qualified leasehold
improvements for commercial, retail, and restaurant property; and air conditioning and heating
units. Neither bill was voted on in the Senate.
The Senate Finance Committee marked up on April 3, 2014 a bill (S. 2260, the Expiring
Provisions Improvement, Reform, and Efficiency Act) that would have extended through 2015 all
but two of the 57 individual and business tax preferences that expired at the end of 2013. Among
the benefits that would have been extended were the Section 179 expensing and the bonus
depreciation allowances that were available in 2013. If the bill had been enacted as it was marked
up by the committee, the Section 179 allowance would have been set at $500,000 and the
phaseout threshold at $2 million for qualified assets acquired and placed in service in 2014 and
2015. In addition, qualified real property (with an annual limit of $250,00000 per taxpayer) and offthe-shelf computer software would have qualified for the allowance during the same period. The
full Senate did not consider the bill.
In the waning days of the 113th Congress, the House and Senate agreed on a measure (H.R. 5571,
P.L. 113-295) that extended the Section 179 allowance from 2013 through 2014.
Bonus Depreciation Allowance
The House passed two bills (H.R. 4718 on July 11, 2014, and H.R. 4 on September 18, 2014) that
would have permanently extended the 50% bonus depreciation allowance from 2013 and
expanded the list of eligible property to include qualified leasehold and retail improvement
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property. In addition, the bills would have indexed for inflation the $8,000 increase in the firstyear depreciation allowance for luxury cars that qualified for bonus depreciation under Section
280F; expanded and permanently extended the option to exchange a bonus depreciation
allowance for unused AMT credits, which would become refundable for this purpose; and
allowed growers of fruit- and nut-bearing trees and vines to claim a first-year depreciation
allowance under Section 167(a) equal to 50% of the adjusted basis of any such trees and vines
they plant or graft in a tax year. The Senate did not consider either bill.
Under S. 2260, as marked up by the Senate Finance Committee, the 50% bonus depreciation
allowance from 2013 would have been extended through 2015. It would have made no other
changes in the allowance. The full Senate did not consider the measure.
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.
Near the end of the 113th Congress, the House and Senate agreed on a bill (H.R. 5571) to extend
through 2014 the 50% bonus depreciation allowance from 2013.
114th Congress
Section 179 Expensing Allowance
On February 13, 2015, the House passed a bill (H.R. 636) that would permanently set the
maximum allowance at $500,000 and the phaseout threshold at $2 million and index both
amounts for inflation starting in 2016. In addition, the bill would permanently add off-the-shelf
computer software, air conditioning and heating equipment, and qualified leasehold, restaurant,
and retail improvement property to the list of assets eligible for expensing under Section 179. It
would also remove the $250,000 limit on the expensing of this property that was in effect from
2010 to 2014. Under H.R. 636, a taxpayer would have the permanent right to revoke any election
made under Section 179 without the consent of the IRS. According to a revenue estimate by the
Joint Committee on Taxation, the measure would result in foregone revenue of $77.1 billion from
FY2015 to FY2025.2
Bonus Depreciation Allowance
The Senate Finance and House Ways and Means Committees have not considered a bill that
would extend the bonus depreciation allowance, which expired at the end of 2014. A significant
obstacle to an extension of the allowance is its likely revenue effects. According to an estimate by
the Joint Committee on Taxation, a permanent extension of the 50% allowance that was available
in 2014 and that was included in a bill (Division I of H.R. 4) passed by the House on September
18, 2014, would lead to forgone revenue of $244.7 billion from FY2015 to FY2024.3
The Senate Finance Committee favorably reported a measure (S. 1946) that would extend through
2016 the $500,000 expensing allowance and $2 million phaseout threshold that were available
from 2010 to 2014. Both amounts would be indexed for inflation. In addition, S. 1946 would
extend through 2016 the treatment of certain computer software and qualified leasehold,
restaurant, and retail improvement property (with an annual limit of $250,000) as eligible for the
allowance. The amount of revenue that would be forgone because of the extension is an estimated
$8.2 billion from FY2016 to FY2020 and $3.5 billion from FY2016 to FY2025.3
Bonus Depreciation Allowance
S. 1946, as reported by the Senate Finance Committee on July 23, would extend through 2016 the
50% bonus depreciation allowance and the option for monetizing unused AMT credits from tax
years before 2006 that were available in 2014. According to an estimate by the Joint Committee
on Taxation, the extensions would lower the amount of revenue collected by the federal
government by $22.2 billion from FY2016 to FY2020 and $3.6 billion from FY2016 to FY2025.4
2
U.S. Congress, Joint Committee on Taxation, Description of H.R. 636, The “America’s Small Business Tax Relief Act
of 2015,” JCX-12-15 (Washington: Feb. 3, 2015), p. 5.
3
U.S. Congress, Joint Committee on Taxation, Estimated Revenue Effects of the Chairman’s Modification to the
Chairman’s Mark of a Bill to Extend Certain Expired Provisions, JCX-104-15.
4
Ibid.
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President’s Budget Request for FY2016
President Obama’s FY2016 budget request includes an enhancement of the current Section 179
expensing allowance. The proposal would extend through 2015 the $500,000 maximum
allowance and $2 million phaseout threshold from 2014. Then, beginning in 2016, the maximum
allowance would permanently rise to $1 million, while the phaseout threshold would permanently
remain at $2 million. Both amounts would be indexed for inflation beginning in 2017, as would
the current $25, 000 limitation on the expensing of heavy-duty sport utility vehicles. The proposal
would also permanently add off-the-shelf computer software to the list of qualified assets but
remove improvements to leasehold and retail properties and restaurants. According to a revenue
estimate by the Treasury Department, the proposal would lead to foregone revenue of $71.0
billion from FY2015 to FY2025.4
2
U.S. Congress, Joint Committee on Taxation, Description of H.R. 636, The “America’s Small Business Tax Relief Act
of 2015,” JCX-12-15 (Washington: Feb. 3, 2015), p. 5.
3
U.S. Congress, Joint Committee on Taxation, Estimated Revenue Effects of Division I of H.R. 4 ,The “Jobs For
America Act,” JCX-105-14 (Washington: Sept. 17, 2014).
4
Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals
(Washington: Feb. 2015), p. 292.
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5
The President’s FY 2016 budget request does not call upon Congress to extend the bonus
depreciation allowance that expired at the end of 2014.
Economic Effects of the Section 179 and Bonus
Depreciation Allowances
Many lawmakers see the Section 179 expensing allowance as a useful and desirable policy tool
for promoting the growth of small firms and stimulating the economy. Many small business
owners view the allowance as a valuable and necessary tax benefit in that it increases cash flow
and after-tax rates of return on investments in qualified property and simplifies tax accounting.
But in the minds of some analysts, the allowance represents a source of inefficiency in the
allocation of resources within the U.S. economy. In their view, the allowance has the potential to
distort the allocation of capital among domestic investment opportunities, alter the distribution of
the federal tax burden among income classes, and reduce the cost of tax compliance for smaller
firms. These effects correspond to three traditional criteria for evaluating tax policy: efficiency,
equity, and simplicity. Each is discussed below. The discussion commences with a review of what
is known about the effectiveness of expensing allowances in general as a policy tool for economic
stimulus.
The Allowances as Tools for Economic Stimulus
Since 2003, seven bills have been enacted that included either a temporary enhancement of the
Section 179 expensing allowance and the phaseout threshold, or a temporary extension of an
already enhanced allowance: JGTRRA, the Economic Stimulus Act of 2008, ARRA, SBJA,
TRUCA, ATRA, and TIPA. Since 2002, eight bills have been enacted to extend or enhance the
bonus depreciation allowance. Each bill was intended, in part, to spark an increase in business
investment, as part of a broader government-financed effort to stimulate the economy. At the time
of their initial enactment in the early 2000s, it seemed reasonable to expect that these measures
would have such an effect, given that expensing lowers the user cost of capital for investment in
qualified property and expands the cash flow of companies that make such investments.
5
Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2016 Revenue Proposals
(Washington: Feb. 2015), p. 292.
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The user cost of capital plays a major role in business investment decisions. This cost combines
the opportunity cost of an investment (i.e., the highest pre-tax rate of return a company could earn
by investing the same amount in a low-risk asset like a U.S. Treasury bond) with its direct costs,
such as depreciation, the actual cost of the asset, and income taxes.56 In effect, the user cost of
capital sets the after-tax rate of return an investment must earn in order to be profitable—and thus
worth undertaking. In general, the higher the user cost of capital, the fewer projects companies
5
The user cost of capital is the real rate of return an investment project must earn to break even. In theory, a firm will
undertake an investment provided the after-tax rate of return exceeds the user cost of capital. Rosen has expressed this
cost in terms of a simple equation. Let C stand for the user cost of capital, a for the purchase price of an asset, r for the
after-tax rate of return, d for the economic rate of depreciation, t for the corporate tax rate, z for the present value of
depreciation deductions flowing from a $1 investment, and k for the investment tax credit rate. Then C = a x [(r +d) x
(1-(t x z)-k)]/(1-t). Under expensing, z is equal to one. By inserting assumed values for each variable in the equation,
one sees that C increases as z gets smaller. Thus, of all possible methods of depreciation, expensing yields the lowest
user cost of capital. For more details, see Harvey S. Rosen, Public Finance, 6th ed (New York: McGraw-Hill/Irwin,
2002), pp. 407-409.
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can profitably undertake, and the lower their desired capital stock. In theory, when a change in tax
law decreases the user cost of capital, many businesses can be expected to increase the amount of
capital they wish to own, boosting overall business investment in the short run.
How does expensing affect the user cost of capital? As the most accelerated form of depreciation,
expensing lowers the cost of capital by reducing the tax burden on the returns to an investment.
This reduction can be considerable.67 Allowing a firm to expense the cost of an asset is equivalent
to the U.S. Treasury providing the firm with a tax rebate equal to the firm’s marginal tax rate
multiplied by the cost of the asset. Several recent studies have shown that investment in
equipment is somewhat sensitive to changes in the user cost (or rental price) of capital. Estimates
of the price elasticity of demand for equipment (which is the percentage change in spending on
equipment divided by the percentage change in the user cost of capital) range from -0.25 to -0.66,
with some economists maintaining the elasticity is probably close to -0.50.78 An elasticity of that
magnitude means that a 10% decline in the user cost of capital should result in a 5% rise in
business spending on equipment in the short run, all other things being equal.
Cash flow can also affect the investment behavior of firms.8 9 A firm’s owners or senior managers
may prefer to finance new investments from retained earnings in order to limit the firm’s
exposure to external debt and the risk of default it carries. Or the owners may be forced to rely on
retained earnings to finance new investments their business has limited or no access to debt and
equity markets. Younger firms investing in the development of new technologies are especially
vulnerable to such financing difficulties. This is because the owners know more about their
services and products and potential for growth than investors and lenders, including banks. For
firms in this bind, the cost of internal funds is lower than the cost of external funds, which means
they are better off financing new investments out of retained earnings. Expensing can increase a
profitable firm’s cash flow in the short run because it allows the firm to deduct the full cost of
qualified assets in the tax year when they are placed in service, reducing its tax liability.
But what makes sense in theory is sometimes difficult to measure or verify in practice. The
impact of increases in cash flow on business investment (especially small business investment)
remains unclear. Some studies have found a significant positive correlation between changes in a
firm’s net worth and its investment spending.9 This correlation was strongest for firms with very
limited access to debt and equity markets. Yet these findings do not demonstrate that firms with
6
6
The user cost of capital is the real rate of return an investment project must earn to break even. In theory, a firm will
undertake an investment provided the after-tax rate of return exceeds the user cost of capital. Rosen has expressed this
cost in terms of a simple equation. Let C stand for the user cost of capital, a for the purchase price of an asset, r for the
after-tax rate of return, d for the economic rate of depreciation, t for the corporate tax rate, z for the present value of
depreciation deductions flowing from a $1 investment, and k for the investment tax credit rate. Then C = a x [(r +d) x
(1-(t x z)-k)]/(1-t). Under expensing, z is equal to one. By inserting assumed values for each variable in the equation,
one sees that C increases as z gets smaller. Thus, of all possible methods of depreciation, expensing yields the lowest
user cost of capital. For more details, see Harvey S. Rosen, Public Finance, 6th ed (New York: McGraw-Hill/Irwin,
2002), pp. 407-409.
7
In a 1995 study, Douglas Holtz-Eakin compared the cost of capital for an investment under two scenarios for cost
recovery. In one, the corporation making the investment used expensing to recover the cost of the investment; and in
the other, the cost was recovered under the schedules and methods permitted by the modified accelerated cost recovery
system. He further assumed that the interest rate was 9%, the inflation rate 3%, and the rate of economic depreciation
for the asset acquired through the investment 13.3%. Not only did expensing substantially reduce the cost of capital, its
benefit was proportional to the firm’s marginal tax rate. Specifically, Holtz-Eakin found that at a tax rate of 15%,
expensing lowered the cost of capital by 11%; at a tax rate of 25%, the reduction was 19%; and at a tax rate of 35%, the
cost of capital was 28% lower. See Douglas Holtz-Eakin, “Should Small Businesses Be Tax-Favored?” National Tax
Journal, September 1995, p. 389.
78
See Jonathan Gruber, Public Finance and Public Policy (New York: Worth Publishers, 2005), p. 675; and CRS
Report R41034, Business Investment and Employment Tax Incentives to Stimulate the Economy, by Thomas L.
Hungerford and Jane G. Gravelle.
89
In the realm of business finance, the term “cash flow” can take on different meanings. Here it denotes the difference
between a firm’s revenue and its payments for all the factors or inputs used to generate its output, including capital
equipment.
9
For a review of the recent literature on this topic, see R. Glenn Hubbard, “Capital Market Imperfections and
Investment,” Journal of Economic Literature, vol. 36, March 1998, pp. 193-225.
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services and products and potential for growth than investors and lenders, including banks. For
firms in this bind, the cost of internal funds is lower than the cost of external funds, which means
they are better off financing new investments out of retained earnings. Expensing can increase a
profitable firm’s cash flow in the short run because it allows the firm to deduct the full cost of
qualified assets in the tax year when they are placed in service, reducing its tax liability.
But what makes sense in theory is sometimes difficult to measure or verify in practice. The
impact of increases in cash flow on business investment (especially small business investment)
remains unclear. Some studies have found a significant positive correlation between changes in a
firm’s net worth and its investment spending.10 This correlation was strongest for firms with very
limited access to debt and equity markets. Yet these findings do not demonstrate that firms with
relatively high cash flows invest more than firms with relatively low or negative cash flows. A
strong correlation between two factors does not necessarily mean that one is a main cause of the
other. In this case, a plausible explanation for the correlation may be that firms with relatively
high cash flows invest more, on average, than firms with relatively low cash flows for reasons
that have little or nothing to do with the relative cost of internal and external funds.1011 The
relationship between cash flow and business investment is complicated, and additional research is
needed to shed more light on it.
Still, the financial effects among individual businesses of an enhanced Section 179 or generous
bonus depreciation allowance suggest that it has the potential to boost business investment above
what it otherwise would be. These effects raise the question of how effective expensing has been
as a policy tool for economic stimulus, both absolutely and relative to other policy options.
There are several reasons to believe that an enhanced Section 179 allowance or generous bonus
depreciation allowance would have no more than a modest impact on the economy during a
recession. First, the design of each allowance sharply limits their potential to affect economic
activity. Neither allowance applies to investments in inventory, structures, and land. And the
Section 179 allowance phases out once a company’s total investment in qualified assets in a tax
year crosses a certain threshold ($200,000 in 2015).
Second, among qualified assets, the tax benefit of each expensing allowance grows as the
depreciation life of qualified property increases. This means that investments in longer-lived
items (such as machine tools) generate a larger tax savings in present-value terms than do
investments in shorter-lived ones (such as business software). Consequently, spending on assets
eligible for the two expensing allowances tends to account for a relatively 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).1112
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. This is because business
investment in general is driven more by the short-to-medium-term outlook for sales and economic
10
For a review of the recent literature on this topic, see R. Glenn Hubbard, “Capital Market Imperfections and
Investment,” Journal of Economic Literature, vol. 36, March 1998, pp. 193-225.
11
Harvey S. Rosen and Ted Gayer, Public Finance, 8th edition (New York: McGraw-Hill Irwin: 2008), p. 448.
12
See http://www.irs.gov/uac/SOI-Tax-Stats-Corporation-Depreciation-Data.
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expansion than it is by temporary tax incentives. An increase in an expensing allowance when the
economy is contracting and many companies, large and small, have excess capacity may affect
the timing of planned qualifying investments, but is likely to have less of an effect on the total
amount of those investments. Companies may be able to accelerate some planned investments to
take advantage of a temporary expensing allowance, but little new investment would be likely to
materialize while the sales and profit outlook for most companies remains unpromising or bleak.
Three studies (two from 2006 and the other from 2007) provide additional support for the view
that temporary accelerated depreciation is largely ineffective as a policy tool for economic
stimulus. In one study, Matthew Knittel of the Office of Tax Analysis at the Treasury Department
found that take-up rates for the bonus depreciation allowances available from 2002 to 2004
10
11
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ranged from 54% to 61% for C corporations and from 65% to 70% for S corporations.1213 Knittel
attributed the surprisingly low rates to an increase in that period in the number of firms that had
relatively large stocks of accumulated net operating losses. He also pointed to the many states that
elected not to change their tax codes to include bonus depreciation allowances as another
contributing factor.
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.1314 This suggested that many of the investments in that period that
benefited from bonus depreciation would have been made without it.
Another study found that although the impact of bonus depreciation on gross domestic product
and employment may have been modest, it might have had a substantial impact on the
composition of business investment, boosting demand for qualified assets. The researchers,
Christopher House and Matthew Shapiro, estimated that bonus depreciation may have resulted in
a cumulative increase in GDP between 0.07% and 0.14%, and in overall employment between
100,000 and 200,000, in 2002 and 2003.1415
Furthermore, there is anecdotal evidence that the current bonus depreciation allowance has made
little or no difference in the investment plans of some companies, while accelerating the timing of
planned investments by other companies to take advantage of the tax savings.1516 These findings
hardly back the notion that temporary investment tax subsidies can serve as an effective tool for
stimulating the economy.
The forces constraining the stimulative potential of accelerated depreciation, particularly in a
weak economy, suggest that the two expensing allowances examined here would have relatively
little bang for the buck as a means of boosting economic activity. Other approaches may produce
better results, especially those that would quickly put more money in the hands of the
unemployed. A 2010 analysis by the Congressional Budget Office (CBO) lent some credence to
this notion. It estimated that increasing financial aid to the unemployed would increase GDP from
$0.70 to $1.90 for each $1.00 of budgetary cost from 2010 to 2015; by contrast, allowing full or
partial expensing of investment costs would raise GDP from $0.20 to $1.00 for each $1.00 of
budgetary cost.16
12
13
Matthew Knittel, Corporate Response to Accelerated Depreciation: Bonus Depreciation for Tax Years 2002-2004,
Department of the Treasury, Office of Tax Analysis, Working Paper 98 (Washington: May 2007),
http://www.treasury.gov/resource-center/tax-policy/tax-analysis/Documents/ota98.pdf.
1314
Darrel S. Cohen and Jason Cummins, A Retrospective Evaluation of the Effects of Temporary Partial Expensing,
Federal Reserve Board, Finance and Economics Discussion Series, Working Paper No. 2006-19 (Washington: April
2006), http://www.federalreserve.gov/pubs/feds/2006/200619/200619pap.pdf.
1415
Christopher House and Matthew D. Shapiro, Temporary Investment Tax Incentives: Theory with Evidence from
Bonus Depreciation, National Bureau of Economic Research, working paper no. 12514 (Cambridge, MA: September
2006), p. 2. http://www.nber.org/papers/w12514.
1516
Binyamin Applebaum, “Tax Break Increases Deficit, but May Have a Silver Lining,” New York Times, February 3,
2012.
16
Congressional Budget Office, Policies for Increasing Economic Growth and Employment in the Short Term,
Statement of Douglas W. Elmendorf, Director, before the Joint Economic Committee, February 9, 2010, table 1, p. 11.
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this notion. It estimated that increasing financial aid to the unemployed would increase GDP from
$0.70 to $1.90 for each $1.00 of budgetary cost from 2010 to 2015; by contrast, allowing full or
partial expensing of investment costs would raise GDP from $0.20 to $1.00 for each $1.00 of
budgetary cost.17
Efficiency Effects
Efficiency lies at the core of economic theory and analysis. In essence, it refers to the allocation
of resources in an economy and how that allocation simultaneously affects the welfare of
consumers and producers. When the allocation of resources yields the greatest possible economic
surplus—which is defined as the total value to consumers of the goods and services they purchase
minus the total cost to sellers of providing the goods and services—the allocation is said to be
efficient. But when the allocation is inefficient, some of the possible gains from exchanges among
buyers and sellers are not realized. For example, economists deem an allocation of resources
inefficient when most suppliers of a good fail to produce it at the lowest marginal cost permitted
by current technology. In this case, a shift in supply from high-cost producers to low-cost
producers, driven by consumers seeking greater value, would lower the economic cost of
providing the good, perhaps increasing the economic surplus.
Expensing is equivalent to exempting from taxation the normal returns on investment. As such, it
would be the preferred option for capital cost recovery under some kind of consumption tax, such
as a flat tax or a value-added tax. But under an income tax, expensing becomes a tax preference
or benefit because it allows the normal returns on investment to go untaxed. When this happens,
new opportunities for tax arbitrage open up. Expensing allows taxpayers to borrow funds to
purchase new depreciable assets, deduct the full cost of those assets in the year they are placed in
service, and deduct interest payments on the debt incurred to acquire the assets.
How does the expensing allowance affect the allocation of capital within an economy? In theory,
all taxes, except lump-sum taxes, generate inefficient economic outcomes, because they influence
the decisions of consumers and producers in ways that leave one group or the other, or both,
worse off. Non-lump-sum taxes have this effect because they distort the economic choices facing
individual and business taxpayers, leading them to allocate resources on the basis of how taxes
affect the costs and benefits of the goods and services they buy and sell, rather than according to
their actual costs and benefits. Such a distortion entails what economists call a deadweight loss: a
condition where the amount of revenue raised by a tax is less than the loss of economic welfare
associated with it.
The Section 179 and bonus depreciation expensing allowances have the potential to distort the
allocation of resources in an economy by driving a wedge between favored assets and all other
assets regarding their profitability. All other things being equal, expensing increases the after-tax
rates of return for favored assets compared with the after-tax rates of return for all other assets.
Thus, it could encourage inefficient levels of investment in favored assets, at least in the short
run, depriving more productive investments with lower after-tax rates of return of needed capital.
In general, how beneficial is expensing? One way to illustrate its potential tax benefit is to show
how expensing affects the marginal effective tax rate on the returns to an investment. This rate
encapsulates the tax provisions that affect the returns on an investment and is calculated by
subtracting the expected after-tax rate of return on a new investment from the expected pre-tax
17
Congressional Budget Office, Policies for Increasing Economic Growth and Employment in the Short Term,
Statement of Douglas W. Elmendorf, Director, before the Joint Economic Committee, February 9, 2010, table 1, p. 11.
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rate of return and dividing by the pre-tax rate of return. Under expensing, it can be shown that the
pre-tax and after-tax rates of return are the same for the investment, which means that full
expensing produces a marginal effective tax rate of 0%.
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This equivalence between pre- and after-tax rates of return reflects a critical aspect of expensing:
it reduces the total after-tax return and total cost for an investment by the same factor: an
investor’s marginal tax rate.1718 For example, if a small business owner’s income is taxed at a rate
of 35%, and the entire cost of a depreciable asset is expensed, the federal government effectively
becomes a partner in the investment with a 35% interest. Through the tax code, the federal
government assumes 35% of the cost of the asset by allowing its entire cost to be deducted in the
first year of use, but it shares in 35% of the income earned by the investment in subsequent years,
assuming no change in the owner’s tax rate. At the same time, expensing allows the small
business owner to receive 65% of the returns from the investment over its lifetime but to bear
only 65% of the cost. Such an outcome implies that for each dollar spent on the asset, the owner
earns the same rate of return after taxes as he does before taxes.
Is there evidence that the expensing allowance has contributed to shifts in the size and
composition of the domestic capital stock in recent decades? This question is difficult to answer,
largely because no studies have been done that assess the impact of the allowance on capital
formation over time. Given that the expensing allowance lowers the cost of capital and boosts the
cash flow of firms using it, and that investment in many of the assets eligible for the allowance
seems somewhat sensitive to changes in the cost of capital, one might be justified in concluding
that the allowance has caused domestic investment in those assets to be greater than it otherwise
would have been.1819 But it can also be argued that much of this investment would have taken place
in any event.1920 Most economists would agree that investment in the assets eligible for the
expensing allowance is driven more by expectations for future growth in sales and profits by
firms that use these assets, the nature of the assets, and conditions in debt and equity markets than
by tax considerations.2021 This view finds some support in available data on use of the expensing
allowance: although 22% of corporations filing federal tax returns claimed the allowance from
1999 through 2003, the total value of Section 179 property placed in service was equal to 5% of
gross domestic investment in equipment and computer software.2122
When seen through the lens of economic theory, the expensing allowance has efficiency effects
that may worsen the deadweight loss associated with the federal tax code. Under the reasonable
assumption that the amount of capital in the economy is fixed in the short run, a tax subsidy like
the allowance is likely to divert some capital away from relatively productive uses and into taxfavored ones. Standard economic theory holds that in an economy devoid of significant market
failures and dominated by competitive markets, a policy of neutral or uniform taxation of capital
income minimizes the efficiency losses associated with income taxation. But the expensing
1718
Raquel Meyer Alexander, “Expensing,” in The Encyclopedia of Taxation and Tax Policy, Joseph J. Cordes, Robert
D. Ebel, and Jane G. Gravelle, eds. (Washington: Urban Institute Press, 2005), p. 129.
1819
Two studies from the 1990s found that a 1% decline in the user cost of capital was associated with a rise in business
equipment spending of 0.25% to 0.66%. See CRS Report RL31134, Using Business Tax Cuts to Stimulate the
Economy, by Jane G. Gravelle.
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There is some anecdotal evidence to support this supposition. At a recent hearing held by the House Small Business
Subcommittee on Tax, Finance, and Exports, Leslie Shapiro of the Padgett Business Services Foundation stated that
expensing “may be an incentive in making decisions to buy new equipment, but it’s not the dominant force.” His firm
provides tax and accounting services to over 15,000 small business owners. See Heidi Glenn, “Small Business
Subcommittee Weighs Bush’s Expensing Boost,” Tax Notes, April 7, 2003, p. 17.
2021
See Roger W. Ferguson, Jr., “Factors Influencing Business Investment,” speech delivered on October 26, 2004,
available at http://www.federalreserve.gov/boarddocs/speeches/2004/20041026/default.htm.
2122
Various data on business claims for the expensing allowance were obtained via email from the Statistics of Income
Division at IRS on March 21, 2006.
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failures and dominated by competitive markets, a policy of neutral or uniform taxation of capital
income minimizes the efficiency losses associated with income taxation. But the expensing
allowance encourages investment in a specific set of assets by relatively small firms. As such, it
represents a departure from the norm of neutral taxation.
In addition, an expensing allowance, like any subsidy targeted at firms of a certain size, gives
smaller firms an incentive to limit their growth by restricting investments to take advantage of the
allowance. This unintended effect stems from the steady increase in the marginal effective tax
rates on the income earned by qualified assets in the allowance’s phaseout range ($500,000 to $2
million 2011).2223 Douglas Holtz-Eakin, a former director of the Congressional Budget Office, has
labeled this incentive effect a “tax on growth by small firms.”2324
Equity Effects
Equity is another basic concept in economic analysis. It generally refers to the distribution of
income among the individuals or households in a particular geographic area.
In the context of income taxation, equity usually denotes the distribution of after-tax household
incomes among individuals grouped by income. Economists who analyze the equity effects of
income taxes tend to focus on two kinds of equity: horizontal equity and vertical equity. A tax is
said to be horizontally equitable if it imposes similar burdens on individuals with similar incomes
or living standards. And a tax system is said to be vertically equitable if the burdens it imposes
vary according to an individual’s or household’s ability to pay. The principle of vertical equity
provides the basis for a progressive income tax system. Under such a system, an individual’s tax
liability, measured as a fraction of income, rises with income.
The current federal income tax system may lean more in the direction of vertical equity than
horizontal equity. Many individuals with similar incomes before taxes end up in the same tax
bracket. But because of the tax preferences (e.g., deductions, preferential rates, deferrals,
exclusions, exemptions, and credits) that have been enacted in recent decades, a substantial
number of individuals with similar before-tax incomes end up being taxed at different effective
rates. At the same time, the income received by those with relatively high pre-tax incomes is
generally taxed at higher rates than the incomes of those with relatively low pre-tax incomes.
How does the expensing allowance affect vertical and horizontal equity?
To answer this question, it is necessary to consider the tax benefits associated with the expensing
allowance, who receives them, and how they affect the recipients’ federal income tax burden. The
main tax benefit from the allowance is a reduction in the marginal effective tax rate on the
income earned by assets eligible for expensing. How much of a reduction depends critically on
the proportion of an asset’s cost that is expensed. As was noted earlier, if the entire cost is
expensed, then the marginal effective rate on the returns falls to zero.
22
Yet the allowance does not change the actual marginal rates at which this income is taxed.
Accelerated depreciation, such as the Section 179 expensing allowance, does not reduce the
federal taxes paid on the stream of income earned by an asset over its useful life. Rather, it allows
23
Jane Gravelle of CRS has estimated that, with a corporate tax rate of 28% and a rate of inflation of 3%, the marginal
effective tax rate on the income earned by assets eligible for the expensing allowance is 36% in the phase-out range for
the allowance. By contrast, under the same assumptions, the marginal effective tax rate on the income earned by
qualified assets is 0% for each dollar of investment in those assets up to $430,000.
2324
U.S. Congress, Senate Committee on Finance, Small Business Tax Incentives, hearings on S. 105, S. 161, S. 628, S.
692, S. 867, and H.R. 1215, 104th Cong., 1st sess., June 7, 1995 (Washington: GPO, 1995), pp. 11-12.
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Yet the allowance does not change the actual marginal rates at which this income is taxed.
Accelerated depreciation, such as the Section 179 expensing allowance, does not reduce the
federal taxes paid on the stream of income earned by an asset over its useful life. Rather, it allows
firms to take a larger share of depreciation deductions for an asset in its first year or two of use
than would be possible under the MACRS. This forward shift or acceleration in depreciation
allowances raises the present discounted value of the tax savings from depreciation.
Most of the assets eligible for the allowance are held by smaller firms. Therefore, any gains in
profits that can be attributed to the allowance end up in the hands of small business owners. Since
the tax benefits associated with capital income tend to concentrate in upper-income households, it
might be argued that the expensing allowance tilts the federal income tax away from vertical
equity. The allowance lowers the effective tax burden on small business income relative to other
sources of income. While this effect makes investment in qualified assets more attractive, it does
not change the fact that the allowance has no effect on the taxes paid by small business owners
over time on the income that can be attributed to the affected assets. Over the useful life of such
an asset, the amount of taxes paid on income from it is the same, regardless of whether its cost is
expensed or not. As a result, it seems fair to conclude that the allowance has no discernible effect
on the distribution of after-tax incomes.
Tax Administration
Yet another policy issue raised by the expensing allowance concerns its impact on the cost of tax
compliance for business taxpayers.
Most public finance economists would agree that one of the key elements of a desirable income
tax system is relatively low costs for administration and compliance. Research indicates that the
administrative cost of a tax system hinges on three factors: (1) the records that must be kept in
order to comply with tax laws, (2) the complexity of those laws, and (3) the types of income
subject to taxation.
Most public finance economists would also agree that the current federal income tax system fails
this test on all counts. In their view, the costs of collecting income taxes and enforcing
compliance with the tax laws are needlessly high, and the primary cause is the growing
complexity of the federal tax code. Many small business owners have long complained about the
costs imposed on them by the record keeping and filings required by the federal income tax.
The expensing allowance addresses this concern by simplifying tax accounting for depreciation.
Less time and paperwork are expended in writing off the entire cost of a depreciable asset in its
first year of use than in writing off that cost over a longer period using the appropriate
depreciation schedules. At the same time, it cannot be denied that the rules governing the use of
the allowance add a layer of complexity to the tasks of administering and complying with the tax
code.
Tax simplification is a long-standing policy objective for small business owners. A primary
motivation for pursuing this goal is the relatively high costs small firms evidently bear in
complying with federal tax laws. These costs were the main focus of a 2001 study prepared for
the Office of Advocacy at the Small Business Administration. The study estimated that the cost
per U.S. employee for tax compliance in 2000 was $665 for all firms, $1,202 for firms with fewer
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than 20 employees, $625 for firms with 20 to 499 employees, and $562 for firms with 500 or
more employees.2425 This finding underscores a well-established truth about the costs to firms of
tax compliance: namely, these costs are25
25
W. Mark Crain and Thomas D. Hopkins, The Impact of Regulatory Costs on Small Firms (Washington: Office of
Advocacy, Small Business Administration, 2001), p. 32.
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tax compliance: namely, these costs are26 regressive to firm size in that, “as a fraction of any of a
number of size indicators, the costs are lower for larger companies.”
Author Contact Information
Gary Guenther
Analyst in Public Finance
gguenther@crs.loc.gov, 7-7742
24
W. Mark Crain and Thomas D. Hopkins, The Impact of Regulatory Costs on Small Firms (Washington: Office of
Advocacy, Small Business Administration, 2001), p. 32.
25
26
Joel Slemrod, “Small Business and the Tax System,” in The Crisis in Tax Administration, Henry J. Aaron and Joel
Slemrod, eds. (Washington: Brookings Institution Press, 2004), p. 81.
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