Bonus Depreciation: Is It Worth It?
Earlier this year, the Congressional Research Service (CRS) released the Section 179 and Bonus Depreciation Expensing Allowances: Current Law, Legislative Proposals in the 112th Congress, and Economic Effects report written by Gary Guenther, Analyst in Public Finance. Included with a historical analysis of the effects of increased limitation on Section 179 and the advent of bonus depreciation, the report also gives a preview of initiatives by the current Congress to modify Section 179 and bonus.
As we are currently subject to a Congress polarized by self-interest, the business community has difficulty planning for any anticipated changes in Sec 179 and bonus. With that thought in mind, while reviewing the CRS report’s list of House and Senate bill proposals, an extension of bonus depreciation may come back onto the scene. And I am sure it will include the word retroactive.
- H.R. 158 would remove all limits on the Section 179 allowance, converting it to a permanent 100% bonus depreciation allowance.
- H.R 1792 would make automated fire sprinkler systems permanently eligible for expensing under Section 179.
- S.727 would permanently grant qualified small companies an unlimited expensing allowance for qualified property under Section 179. Companies that qualify could not have more than $1 million average annual gross receipts in the three previous years.
- S.3302 would permanently extend the Section 179 allowance to $500,000 and the phase-out at $2,000,000 with eligible computer software a permanent part of Section 179.
- In the House and Senate there are eight bills that extend the 100% bonus depreciation through 2012, 2013 or 2014.
- The Obama administration supports the extension of 100% bonus through 2012.
The intent of these allowances is to spur the economy, and Congress must feel that bonus and Section 179 are hitting the target because they keep extending and moving limitations. However, the CRS Report leans the opposite way. From the condensed version of the report’s analysis that follows, a few of my own comments, and knowing what your business uses to weigh asset investment, maybe you should decide if Section 179 and bonus are making a difference.
According to the CRS report, public finance economists and analysts evaluate the effect of tax policy on the basis of three criteria: efficiency, equity and simplicity.
When the allocation of goods and services yields the greatest possible economic surplus, this is considered an efficient allocation. Therefore, if expensing lowers the cost of capital by reducing the tax burden, this would be efficient.
For example when an asset is fully expensed; the government becomes a partner in the investment. If the business owner’s tax rate is 35%, the government becomes a 35% partner in the asset. Because the asset is fully expensed the government assumes 35% of the cost of the asset, since the entire asset is expensed in the first year. As the recovery years fade, 35% of the income (assuming there is no change in tax rate) earned from the asset belongs to the government. The business owner gets 65% of the returns from the asset and bears only 65% of the cost. For each dollar spent on the asset, the owner earns the same rate of return after taxes as he does before taxes. Full expensing produces a marginal effective tax rate of 0%. I don’t think this qualifies as a reduction in the tax burden, more along the lines of break even.
There is an argument that full expensing allows a greater investment than would have otherwise occurred versus the argument that investment in these assets would have occurred anyhow. Because the purchase of assets is driven more by future expectations of growth in sales and profits rather than purely as a tax benefit, the accelerated expensing probably does not encourage the investment expansion, only the timing.
Douglas Holtz-Eaking, a former Director of the Congressional Budget Office, asserts that these allowances are a tax on growth of small business. Since the large firms are not the consumers of the Section 179 deduction, smaller firms may be limiting their growth by selecting investments that allow them to take advantage of the Section 179 deduction while postponing or limiting other investments they may have made otherwise.
On the measurement of efficiency, the allowances haven’t reduced the tax burden and may have persuaded small business to base investment decisions on tax rather than growth. It doesn’t look like accelerated expensing gets high marks on the efficiency test.
Equity is concerned with fairly dividing up the tax burden. Horizontally, the tax burden is similar for those with similar income, and vertically, the tax burden varies according to differing incomes.
Applying Section 179 has not reduced the federal taxes paid on the income earned by fully expensed assets over their useful life. The expensing just lets business owners take a larger share of depreciation earlier than would be allowed under MACRS. The CRS report points out that Section 179 may lower the tax burden on small business when compared to other sources of income; yet it has no effect on these same business owners for the amount of taxes paid on the income from these assets over their lives.
The conclusion: the allowance has no discernible effect on the distribution of after-tax incomes.
Simplicity is the final component of the analysis criteria. Writing off the entire cost of an asset in the first year is definitely simpler than tracking depreciation over the IRS recovery periods. However, understanding and applying the complex compliance rules of the allowances negates any simplicity. Everyone that works in tax could have saved the analyst a lot of time evaluating this one.
In a 2001 study, written for the Office of Advocacy at the Small Business Administration, it was estimated the cost per employee for tax compliance is $665 for all firms, $1,202 for firms with less than 20 employees, $625 for firms with 20 to 499 employees and $562 for firms with 500 or more employees. If you are small, your tax compliance could cost you over $20,000 a year and if you are large, the cost could start at $200,000. The large may benefit from scale, but everyone loses on simplicity.
The conclusion is that Section 179 and bonus depreciation score low marks for efficiency, equity and simplicity.
Other studies in the CRS report also point out lackluster results.
- Enhancing the Section 179 limits is less likely to stimulate a lackluster recessive economy, since business investment is more likely driven by sales and economic outlooks rather than by temporary tax incentives. According to the CRS report, the total value of Section 179 property placed in service from 1999 to 2003 represented 0.4% of cumulative gross domestic product. This was only 5% of total investment in equipment and software in that time period. That is a very small portion of GDP and of total asset investment.
- Two studies by the Office of Tax Analysis at the Treasury Department found that in 2002-2004 only 54% to 61% of C Corps and 65% to 70% of S Corps took advantage of the bonus deduction. The low rates of usage were attributed to corporations with large stocks of accumulated NOLs and the fact that many states decoupled from bonus. Another study in the same time period indicated that no more than 10% of companies used the allowances as an important consideration in determining the timing or amount of investment they would incur. The study deducts that many of the investments made in that time period would have been made with or without the benefit of bonus depreciation.
- Although Section 179 and bonus may not have spurred greater amounts of investment, a study by Christopher House and Matthew Shapiro estimated that the accelerated depreciation programs created 100,000 to 200,000 jobs in 2002 and 2003. Job creation is always a good thing. But, does this seem like a worthy return?
Since many of us have work days that revolve around rules, regulations and planning for past, present and future fixed assets, I find it interesting that 10 years and counting of bonus depreciation may not have had as significant of an impact on the economy as intended. With bonus in effect for more than a decade, I would like to have had the analysis contain more recent information. Possibly over time the results would be more positive.
What do you think? Were any of your investment choices made because of the increased limits on Section 179 or the effective dates of bonus depreciation? Or were your investment decisions weighted heavily on other factors, and bonus wasn’t a consideration? Or maybe you have a better idea for economic stimulation?