Section 179 and Bonus Depreciation
Expensing Allowances:
Current Law, Legislative Proposals in the
113th Congress, and Economic Effects
Gary Guenther
Analyst in Public Finance
February 1, 2013
Congressional Research Service
7-5700
www.crs.gov
RL31852
CRS Report for Congress
Pr
epared for Members and Committees of Congress

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Section 179 and Bonus Depreciation Expensing Allowances

Summary
Expensing is the most accelerated form of depreciation for tax purposes. Section 179 of the
Internal Revenue Code (IRC) allows a taxpayer to expense (or deduct as a current expense rather
than a capital expense) up to $500,000 of the total cost of new and used qualified depreciable
assets it buys and places in service in 2013, 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 and 168. While the Section 179 expensing
allowance is not targeted at firms that are relatively small in employment, asset, or receipt size,
the rules governing its use generally confine its benefits to such firms.
In addition, Section 168(k), which provides a so-called bonus depreciation allowance, generally
allows taxpayers to expense half the cost of qualified assets bought and placed in service in 2013.
Taxpayers taking the allowance have the option of monetizing any unused alternative minimum
tax credits left over from tax years before 2006, within certain limits, and writing off the cost of
the assets that qualify for the allowance over longer periods.
This report examines the current status, legislative history, and economic effects of the two
expensing allowances. It also discusses initiatives in the 113th Congress to modify them. The
report will be updated as legislative activity warrants.
Both expensing allowances have enjoyed broad bipartisan support in recent Congresses. A bill
enacted late in the 112th Congress (American Taxpayer Relief Act of 2012, P.L. 112-240)
increased the maximum Section 179 expensing allowance to $500,000 and the phaseout threshold
to $2 million for qualified assets acquired and placed in service in 2012 and 2013. The act also
extended through 2013 the 50% bonus depreciation allowance that was available in 2012.
Since 2002, the allowances have served as two of several tax incentives for stimulating the U.S.
economy. This raises the question of their effectiveness. Though there are 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 two allowances applied to mostly the
same property. Basically, the studies concluded that accelerated depreciation in general is a
relatively ineffective tool for stimulating the economy.
Available evidence, as incomplete as it is, indicates that the expensing allowances probably have
had no more than a minor effect on the level, composition, and allocation among industries of
business investment; the distribution of the federal tax burden among income groups; and the cost
of tax compliance for smaller firms. On the one hand, an expensing allowance has the potential to
spur 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. It also has the advantage of
simplifying tax accounting for depreciation for firms that take the expensing allowance. On the
other hand, an expensing allowance could interfere with the allocation of economic resources by
diverting capital flows away from investments with more productive outcomes and speeding up
the timing of qualified investments.
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Section 179 and Bonus Depreciation Expensing Allowances

Contents
Introduction ...................................................................................................................................... 1
Current Expensing Allowances ........................................................................................................ 1
Section 179 ................................................................................................................................ 1
Maximum Expensing Allowance ........................................................................................ 1
Qualified Property ............................................................................................................... 1
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
Legislative Initiatives to Modify the Two Expensing Allowances .................................................. 8
112th Congress ........................................................................................................................... 8
Section 179 Expensing Allowance ...................................................................................... 8
Bonus Depreciation Allowance ......................................................................................... 10
113th Congress ......................................................................................................................... 11
Economic Effects of the Section 179 and Bonus Depreciation Allowances .................................. 11
The Allowances as Tools for Economic Stimulus ................................................................... 12
Efficiency Effects .................................................................................................................... 15
Equity Effects .......................................................................................................................... 17
Tax Administration .................................................................................................................. 18

Tables
Table 1. Maximum Expensing Allowance and Investment Limitation from 1987 to 2014 ............. 3

Contacts
Author Contact Information........................................................................................................... 19

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Section 179 and Bonus Depreciation Expensing Allowances

Introduction
Under current tax law, firms may expense (or deduct as a current rather than a capital expense) up
to $500,000 of the total cost of new and used qualified assets they purchase and place in service
in 2013 under Section 179 of the federal tax code. They also have the option under Section 168(k)
of expensing half of the cost of qualified assets they buy and place in service the same year. Many
assets qualify for both allowances.
Expensing is the most accelerated form of depreciation. As a result, it has the potential to
stimulate business investment by reducing the cost of capital for favored investments and
increasing the cash flow of firms making such investments. This explains why economists view
the two allowances as a significant investment tax subsidy.
The 112th Congress passed one measure that altered the two allowances. Under the American
Taxpayer Relief Act of 2012 (ATRA, P.L. 112-240), the Section 179 allowance was increased to
$500,000 and the phaseout threshold to $2 million for qualified assets acquired and placed in
service in 2012 and 2013. In addition, the act extended the 50% bonus depreciation allowance
that was available in 2012 through 2013. No bills have been introduced in the 113th Congress to
modify either allowance.
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. It also identifies legislative initiatives in the 113th Congress to modify either
allowance.
Current Expensing Allowances
Section 179
Under Section 179 of the Internal Revenue Code (IRC), firms in all lines of business and all sizes
have the option, within certain limits, of expensing part or all of the cost of new and used
qualified property (or assets) 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 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 $500,000 for qualified assets bought and
placed in service in 2013. Assuming no change in current law, the allowance drops to $25,000 in
2014 and thereafter.
Qualified Property
Current law defines property that qualifies for the allowance as new and used tangible property—
as specified in IRC Section 1245(a)(3)—that is depreciable under IRC Section 168 (which holds
the MACRS) and acquired for use in the active conduct of a trade or business. With a few
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exceptions, this property consists of machines 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 and lodging facilities) do not qualify for the allowance. But an
exception is made for the 2010 to 2013 tax years: taxpayers may expense up to $250,000 of the
cost of qualified leasehold improvements, qualified retail improvement property, and qualified
restaurant improvement property incurred in each tax year during that period. Research and bulk
storage facilities do qualify for the allowance, as do single-purpose 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 depreciable in three years and placed in service from 2003
to 2013 may be expensed under Section 179.
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 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 a tax year exceeds what is often referred to as a phaseout threshold. The threshold
is set at $2 million in 2013 and is scheduled to fall to $200,000 in 2014 and thereafter. (See Table
1 for the amounts in tax years before 2013.) As a result, a taxpayer may claim no Section 179
expensing allowance in 2013 when the total cost of qualified property it acquires and places in
service that year reaches $2.5 million or more.
The income limitation bars a taxpayer from claiming an allowance greater than its taxable income
(including wages and salaries) from the active conduct of a trade or business. It is determined
after the application of the investment limitation. This means that if a firm has $25,000 in taxable
income from a business but may claim a Section 179 allowance no larger than $20,000 under the
investment limitation, it could expense up to $20,000 of the cost of qualified property and recover
the remainder under the MACRS, if applicable. Though taxpayers cannot carry forward any
allowance that is denied because of the investment limitation, they may carry forward indefinitely
any allowance that is denied because of the income limitation.
Claiming the Allowance
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 has been suspended for the tax years
from 2002 to 2013. During this time, a taxpayer may revoke any portion of an election to expense
qualified property without the IRS’s consent, regardless of whether the election was made on an
original or amended return (IRS regulation 1.179-5). A revocation is made by submitting an
amended tax return for the tax year in question. 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.
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Table 1. Maximum Expensing Allowance and Investment Limitation
from 1987 to 2014
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 and 2011
$500,000
$2,000,000
2012 $500,000
$2,000,000
2013 $500,000
$2,000,000
2014 and thereafter
$25,000
$200,000
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 have had in recent years the option of
claiming an additional first-year (or bonus) depreciation allowance that entered the tax code
(§68(k)) in 2002 and is scheduled to last through 2013, under current law. The allowance speeds
up the depreciation of qualified property, increasing the present value of the tax savings from
depreciation. As such, it is intended to stimulate more business investment in the short run than
otherwise would occur.
The initial bonus depreciation allowance was a 30% first-year depreciation deduction included in
the Job Creation and Worker Assistance Act of 2002 (P.L. 107-147). It applied to 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. This property had to
be acquired between September 12, 2001, and December 31, 2004, and placed in service before
January 1, 2005. Taxpayers claiming the allowance had to be the original user of the property.
They could apply it against the regular income tax and the AMT with no adjustments.
Under current law, a 50% bonus depreciation allowance is available for the same property
acquired and placed in service in 2013. It is scheduled to expire on December 31, 2013.
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C corporations have the option under Section 168(k)(4) to claim a portion of their unused
alternative minimum tax (AMT) credits from tax years before 2006, in lieu of any bonus
depreciation allowance they could take in 2013. The accelerated credit is refundable and limited
to a corporation’s bonus depreciation amount for the tax year. This amount cannot exceed what is
known as the “maximum increase amount,” which is the lower of 6% of the sum of the
corporation’s unused AMT credits from tax years before 2006 or $30 million. In 2008, 2009, and
2010, corporations were allowed to claim both unused AMT and research credits from tax years
before 2006, in lieu of any bonus depreciation allowance it could take.
Interaction with Other Depreciation Allowances, Including the
Section 179 Allowance
In the case of assets that are eligible for both expensing allowances, a taxpayer is required to
recover their cost in a prescribed order. The expensing allowance must be taken first, lowering the
taxpayer’s basis in the asset by that amount. If there still is a basis, the taxpayer then may apply
the bonus depreciation allowance to that amount, further reducing her basis in the property.
Finally, the taxpayer is allowed to claim a depreciation allowance under the MACRS for any
remaining basis, using the double declining balance method.
A simple example can show how this procedure is supposed to work. Assume that the only
investment a company makes in 2013 is the acquisition of 10 new machine tools at a total cost of
$700,000. Such a purchase qualifies for both the expensing and bonus depreciation allowances
for that year. It would recover that cost as follows:
• First, the company takes 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 claims a bonus depreciation allowance of $100,000 ($200,000 x 0.5),
further lowering its basis to $100,000 ($200,000 - $100,000).
• Next, the company takes 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 with the double-declining-
balance method, it is permitted claim an additional depreciation allowance equal
to 20% of $100,000, or $20,000, using the half-year convention.
• The company recovers 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.
• Thus, the company writes off nearly 89% of the cost of the machine tools in the
year they were bought and placed in service: 2013.
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Legislative History of the Two
Expensing Allowances
Section 179
The Section 179 expensing allowance originated as a special first-year depreciation allowance
that Congress included in the Small Business Tax Revision Act of 1958 (P.L. 85-866). Its purpose
was the same as the current allowance: 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 (or $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 special 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 gradually increasing the allowance to $10,000 by 1986. In spite of the substantial
increase in the allowance, few firms took advantage of it. Some attributed the tepid response to
the limitations on the use of an investment tax credit that ERTA established. A business taxpayer
could claim the 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 alone reportedly outweighed the tax savings from combining the
credit with the allowance.
In an effort to stop the growth 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. Use of the allowance
rose markedly following the repeal of the investment tax credit by the Tax Reform Act of 1986.
With the backing of Congress, the allowance rose to $10,000 in 1990, as scheduled, and remained
at that level until the passage of 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 (EZ). The benefits included an enhanced expensing allowance for qualified assets placed in
service in an EZ.1 To be designated as an EZ, an area had to meet a variety of eligibility criteria
relating to population, poverty rate, and geographic size.
With the enactment of the Small Business Job Protection Act of 1996 (P.L. 104-188), the regular
allowance again moved upward but with a difference: scheduled annual (with one exception)
increases over six years. Specifically, the act raised the maximum allowance 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 so-called renewal
communities (RCs) to the list of special areas and granted them the same tax benefits available to

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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businesses in EZs, including the enhanced expensing 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) to encourage new business investment in the section of lower
Manhattan in New York City that bore the brunt of the aerial attacks on the World Trade Center.
The act designated this area as the New York “Liberty Zone.” Among the tax benefits offered to
firms operating in the zone was the same enhanced expensing allowance for qualified investments
in EZs and RCs.
After the enactment of the Small Business Jobs Protection Act, no change was made in the
allowance until the passage of JGTRRA. Under the act, the allowance rose four-fold to $100,000
(as of May 6, 2003), was to stay 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 economic recovery 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 what was known as a Gulf Opportunity
Zone (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 that for the regular allowance. And the enhanced GOZ allowance applied to more assets than
the regular allowance.
The Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) extended the changes
in the allowance under JGTRRA through 2009.
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 for 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 an accelerating economic downturn,
Congress increased the allowance to $250,000 and the phaseout threshold to $800,000 in 2008
only, 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.
During the 111th Congress, 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) extended it through 2010.
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Under the Small Business Jobs Act of 2010 (P.L. 111-240), the maximum amount a taxpayer can
expense was increased to $500,000, and the phaseout threshold was raised to $2 million, for tax
years beginning in 2010 and 2011.
The Tax Relief, Unemployment Compensation Reauthorization, and Job Creation Act of 2010
(P.L. 111-312) raised the maximum expensing allowance to $125,000 and the phaseout threshold
to $500,000 for the 2012 tax year, indexed those amounts for inflation, set the maximum
allowance at $25,000 and the phaseout threshold at $200,000 for the 2013 tax year and each tax
year thereafter, and extended through 2012 the eligibility of purchases of off-the-shelf computer
software for the allowance.
Facing a number of key policy issues, including continuing weakness in job creation and
economic growth, the 112th Congress passed the American Taxpayer Tax Relief Act of 2012 in
early 2013. Among other things, the act retroactively increased the maximum expensing
allowance to $500,000 and the phaseout threshold to $2 million for the 2012 and 2013 tax years.
It also made purchases of off-the-shelf software eligible for the allowance in 2013 and extended
through 2013 a $250,000 expensing allowance for leasehold property improvements that first
became available in 2010.
Bonus Depreciation Allowance
The Job Creation and Worker Assistance Act of 2002 (P.L. 107-147) created the initial 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 no later than December 31, 2004. A one-
year extension of the placed-in-service deadline was available for certain property with a
MACRS recovery period of 10 or more years and for transportation equipment.
Under the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27), the allowance
became 50% for the same qualified property acquired after May 5, 2003, and placed in service
before January 1, 2006. A one-year extension of that deadline was available for the same qualified
property.
Congress passed the Economic Stimulus Act of 2008 in response to the financial crisis that
emerged with devastating effects in the late summer and early fall of that year. Included in the act
was a reinstatement of the 50% bonus depreciation allowance that had 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 a measure (the Housing Assistance Tax Act of 2008) intended to
ease the impact of the financial crisis on the domestic housing market. It included a provision that
gave corporations the option of trading any bonus depreciation allowance they could claim for
eligible property acquired between April 1 and December 31, 2008, for a refundable tax credit
equal to the lesser of $30 million or 6% of the sum of any research and AMT credits that could be
carried forward from tax years before 2006. Corporations choosing the option were required to
depreciate the property that qualified for the allowance under the MACRS using the straight-line
method; no AMT adjustment for depreciation was required.
The American Recovery and Reinvestment Act of 2009 (P.L. 111-5) extended the deadlines by
one year, to the end of 2009, for both the 50% bonus depreciation allowance and for the option of
monetizing a portion of unused research and AMT credits from tax years before 2006.
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Congress extended the 50% allowance so that it and the option to exchange it for an accelerated
research and AMT credit applied to qualified property acquired and placed in service in 2010 by
passing the Small Business Jobs Act of 2010 (P.L. 111-240).
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 it 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 included an extension of the 50% bonus depreciation
allowance through the end of 2013. ATRA also extended through 2013 the option to claim a
refundable credit for unused AMT credits from tax years before 2006 instead of the bonus
depreciation allowance to qualified property acquired and placed in service in 2013.
Legislative Initiatives to Modify the Two
Expensing Allowances
There was strong bipartisan support in the 112th Congress for retaining or enhancing the Section
179 and bonus depreciation allowances. It found expression in the provisions in ATRA enhancing
the Section 179 allowance for 2012 and 2013 and extending a 50% bonus depreciation allowance
through 2013.
But the outlook in the 113th Congress for similar treatment of both allowances is difficult to
discern at the moment. Sharp disagreements between and among Democratic and Republican
leaders in the House and Senate over what steps to take to lower or eliminate future budget
deficits and federal debt cast a shadow of uncertainty on the status of the allowances beyond
2013.
112th Congress
Section 179 Expensing Allowance
Several bills were introduced in the House and Senate to extend an enhanced allowance beyond
2011. Each bill is briefly described below.
House Bills
H.R. 15 would have raised the maximum allowance to $250,000 and the phaseout threshold to
$800,000 for 2013 only. It would also have extended through 2013 the period during which
purchases of qualified computer software would be eligible for Section 179 expensing.
H.R. 8, which the House passed on August 1, 2012, would have increased the maximum
allowance to $100,000 and the phaseout threshold to $400,00 in the 2013 tax year, index both
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amounts for inflation, and allow purchases of off-the-shelf computer software to qualify for the
allowance through the 2014 tax year.
H.R. 158 would have removed all limits on the Section 179 expensing allowance, effectively
converting it into a permanent 100% bonus depreciation allowance.
H.R. 206 would have permanently set the maximum allowance at $125,000, and the phaseout
threshold at $500,000, starting in the 2012 tax year. It would also have permanently indexed those
amounts for inflation beginning in the 2013 tax year, permanently extended the rule allowing off-
the-shelf computer software eligibility for the expensing allowance, and permanently allowed
taxpayers to revoke claims for the allowance without the permission of the IRS.
H.R. 1773 would have permanently set the maximum allowance at $250,000, and the phaseout
threshold at $800,000, for tax years beginning in 2012.
H.R. 1792 would have made automated fire sprinkler systems permanently eligible for expensing
under Section 179.
H.R. 3302 would have permanently extended the allowance at $500,000 and the phaseout
threshold at $2 million and permanently added off-the-shelf computer software to the list of
property eligible for expensing under Section 179.
H.R. 3476 would have extended the 2012 expensing allowance and dollar limitation through
2014 and the inflation adjustment for both amounts through 2015; it would also have extended
the eligibility of off-the-shelf computer software for Section 179 expensing through 2016.
H.R. 6240 would have raised the expensing allowance to $500,000 and the phaseout threshold to
$2 million phaseout in 2012 and allowed purchases of off-the-shelf software to qualify for the
allowance through tax years beginning in 2013, among other things.
Senate Bills
S. 12 would have permanently extended the $500,000 maximum allowance and the $2 million
phaseout threshold for tax years beginning in 2011. It would also have permanently extended the
rules allowing off-the-shelf computer software to qualify for Section 179 expensing and taxpayers
to revoke an election of Section 179 expensing for any property without the permission of the
IRS.
S. 727 would have permanently granted qualified small companies an unlimited expensing
allowance for qualified property, under Section 179. A company would have qualified for this
treatment if its average annual gross receipts had not exceeded $1 million in the three previous
tax years.
S. 1801 would have extended the 2011 expensing allowance and dollar limitation through 2012,
the inflation adjustment for both amounts through 2013, and the eligibility of computer software
for the allowance through 2014.
S. 1866 would have made the same changes in the Section 179 allowance as H.R. 3476.
S. 1873 would have made the same changes in the allowance as S. 1801.
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S. 2050 would have extended through 2012 the expensing allowance that was available in 2011.
S. 3401 would have extended through 2012 the $500,000 allowance from the 2010 and 2011 tax
years. It would also have extended through 2012 the $2 million phaseout threshold from 2010 and
2011. Starting in 2013 and for each subsequent tax year, the maximum allowance would have
been set at $25,000 and the phaseout threshold at $200,000. In addition, the bill would have
extended the eligibility of computer software and certain leasehold property for the expensing
allowance through the 2013 tax year.
S. 3412 would have made the same changes in the Section 179 allowance as H.R. 15.
S. 3417 would have raised the maximum allowance to $500,000, and the phaseout threshold to $2
million, in 2012 and 2013. It would also have extended the eligibility of off-the-shelf computer
software through 2013 and allowed taxpayers to expense up to $250,000 in qualified leasehold
over the same period.
S. 3442 would have increased the allowance to $500,000 and the phaseout threshold to $2 million
for the 2013 tax year. Starting in 2014 and for each subsequent tax year, the maximum allowance
would have been set at $25,000 and the phaseout threshold at $200,000. The bill would also have
extended the eligibility of computer software and certain leasehold property for the expensing
allowance through the 2013 tax year.
S. 3521 (as reported by the Senate Finance Committee on August 2, 2012 and incorporated into
ATRA) would have raised the maximum allowance to $500,000 and the phaseout threshold to $2
million in 2012 and 2013. It would also have permitted taxpayers to expense up to $250,000 of
the cost of qualified leasehold property improvements made in those years.
President’s Budget Request for FY2013
President Obama’s budget request for FY2013 did not include an extension of an enhanced
version of the Section 179 allowance beyond 2012.
Bonus Depreciation Allowance
Several bills to extend the current 100% bonus depreciation allowance were introduced in the
House and Senate. Each is briefly described below.
House Bills
H.R. 12 would have extended the 100% allowance through 2012 and allowed firms to claim a
50% allowance for qualified property acquired and placed in service in 2013.
H.R. 660 would have extended through 2013 both the 100% allowance and the option to
monetize unused AMT credits from tax years before 2006.
H.R. 3476 would have extended through 2014 both the 100% allowance and the option to
exchange unused AMT credits from tax years before 2006 for any bonus depreciation allowance
that could be claimed in the current tax year.
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H.R. 3630 (as passed by the House) would have extended through 2012 both the 100% bonus
depreciation allowance and the option to claim a refundable credit for unused AMT credits
instead of a bonus depreciation allowance. In addition, it would have changed the limit on the
refundable credit a corporate taxpayer may take in a tax year to make it equal to the lesser of 50%
of a taxpayer’s AMT credit for the first tax year after 2011 or the current-year ATM credit taking
into account “only the adjusted minimum tax for taxable years ending before January 1, 2012
(determined by treating credits as allowed on a first-in, first-out basis).”
H.R. 4196 would have extended the 100% allowance through 2012.
H.R. 6240 would have extended the 100% expensing allowance and the option to use qualified
AMT credits in lieu of the allowance through 2012 and established a 50% allowance for 2013.
Senate Bills
S. 1801 would have extended through 2012 both the 100% bonus depreciation allowance and the
option to monetize unused AMT credits from tax years starting before 2006.
S. 1866 would have made the same changes in the allowance as H.R. 3476.
S. 1873 would have made the same changes as S. 1801.
S. 2237 would have reinstated the 100% allowance for qualified property acquired and placed in
service in 2012 and allowed a 50% allowance for 2013.
S. 2240 would have made the same changes in the allowance as H.R. 3630.
President’s Budget Request for FY2013
The Obama Administration called for an extension of the 100% bonus depreciation allowance
through 2012.
113th Congress
No legislation modifying either allowance has been introduced in the House or Senate.
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 raises after-tax rates
of return on investments in qualified property and simplifies tax accounting.
But in the minds of many public finance economists and other 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 affect the allocation of capital within the economy, the distribution
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of the federal tax burden among income classes, and the cost of tax compliance for smaller firms
in ways that might lead to inefficient or less equitable outcomes. These effects correspond to three
traditional criteria for evaluating tax policy: efficiency, equity, and simplicity. Each is discussed
below, following 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, six 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, and ATRA. Since 2002, seven bills have been enacted to extend or enhance the bonus
depreciation allowance. Each one was intended, in part, to spark an increase in small business
investment, as part of a broader government-financed effort to stimulate the economy. It was
reasonable to expect that these measures would have such an effect, since expensing lowers the
user cost of capital for investment in qualified property and expands the short-term cash flow of
companies that claim it.
The user cost of capital plays a significant role in a firm’s investment decisions. This cost
represents 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 Treasury bond) and its direct
costs, such as depreciation, the actual cost of the asset, and income taxes.2 In effect, the user cost
of capital establishes 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 a firm can profitably undertake, and the lower its desired capital stock. In theory, when a
shift in tax policy decreases the user cost of capital, many firms would respond by increasing 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.3 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

2 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.
3 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.
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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 -0.50.4 An elasticity of that
size means that a 10% decline in the user cost of capital should result in a 5% rise in business
spending on equipment, all other things being equal.
Cash flow can also affect the investment behavior of firms.5 A firm’s owners or senior managers
may prefer to finance new investment from retained earnings in order to limit their exposure to
external debt and the risk of default it entails. Or retained earnings may be the only feasible
option for financing new investment for firms that have limited or no access to debt and equity
markets because the owners know more about their services and products and potential for
growth than investors and lenders, including banks. For firms in this position, the cost of internal
funds is lower than the cost of external funds, which means they would be better off financing
new investments out of retained earnings. Expensing can increase a 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 the firm
places them into service.
Still, the impact of increases in cash flow on business investment remains uncertain. Some studies
have found a significant positive correlation between changes in a firm’s net worth and its
investment spending.6 This correlation was strongest for firms with very limited access to debt
and equity markets. Yet it would be a mistake to interpret these findings as conclusive proof that
firms with relatively high cash flows invest more than firms with relatively low or negative cash
flows. After all, a strong correlation between two factors does not necessarily mean that one is a
main cause of the other. It may be the case 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.7 The relationship between cash flow and
business investment is complicated, and further research is needed to clarify it.
These considerations suggest that an enhanced Section 179 or generous bonus depreciation
allowance has the potential to boost small business investment in the short run. They also raise
the question of how effective expensing has been as a 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 be likely to have no more than a modest effect on the economy
during a downturn or period of stagnant growth. The design of each sharply limits their potential
to affect economic activity. Neither allowance has affected investments in inventory, structures,
and land. And among qualified assets, each provides a greater tax benefit for investment in

4 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.
5 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.
6 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.
7 Harvey S. Rosen and Ted Gayer, Public Finance, 8th edition (New York: McGraw-Hill Irwin: 2008), p. 448.
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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).8
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. Companies may be able to
accelerate some planned investments to take advantage of an enhancement in an expensing
allowance, but little new investment would be likely to occur while the sales and profit outlook
for most companies remains bleak, the availability of a relatively generous but temporary
expensing allowance notwithstanding.
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
ranged from 54% to 61% for C corporations and from 65% to 70% for S corporations.9 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.10 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

8 See http://www.irs.gov/uac/SOI-Tax-Stats-Corporation-Depreciation-Data.
9 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.
10 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.
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a cumulative increase in GDP between 0.07% and 0.14%, and in overall employment between
100,000 and 200,000, in 2002 and 2003.11
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.12 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.13
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.

11 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.
12 Binyamin Applebaum, “Tax Break Increases Deficit, but May Have a Silver Lining,” New York Times, February 3,
2012.
13 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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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
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%.
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.14 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.15 But it can also be argued that much of this investment would have taken place

14 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.
15 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
(continued...)
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in any event.16 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.17 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.18
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 tax-
favored 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
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).19 Douglas Holtz-Eakin, a former director of the Congressional Budget Office, has
labeled this incentive effect a “tax on growth by small firms.”20
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

(...continued)
Economy, by Jane G. Gravelle.
16 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.
17 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.
18 Various data on business claims for the expensing allowance were obtained via e-mail from the Statistics of Income
Division at IRS on March 21, 2006.
19 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.
20 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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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.
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
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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
than 20 employees, $625 for firms with 20 to 499 employees, and $562 for firms with 500 or
more employees.21 This finding underscores a well-established truth about the costs to firms of
tax compliance: namely, these costs are22 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


21 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.
22 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.
Congressional Research Service
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