Since the start of the Covid-19 pandemic, Congress has spent an enormous amount of time and energy attempting to jumpstart the economy following the unprecedented events of Covid-19. From the passage of the $1.9 trillion American Rescue Plan (ARP) intended to encourage consumer spending to the more recent $1.2 trillion Infrastructure Investment and Jobs Act (IIJA) and $700 billion Inflation Reduction Act (IRA) designed to foster investment and job creation, Congress has spent liberally in an effort to generate economic growth.
This commitment to economic growth makes it all the more surprising to learn that Congress is set to allow an important tax provision called 100 percent bonus depreciation to sunset at the end of this year.
Described at length in Section 168(k) of the Internal Revenue Code, 100 percent bonus depreciation allows a business to write off the total cost of new and used assets in the same year rather than amortizing, or applying, the reduction in taxable income over a longer period of time. This opportunity saves the business money immediately on its ongoing capital expenditures and encourages future investment.
Assets and capital equipment are nondurable goods with multi-year lives. For instance, an office building typically has a useful life of 39 years, while a computer, due to its quick obsolescence, lasts on average only five years. Today, businesses are allowed to deduct 100 percent of most capital expenditures directly from sales, thereby reducing their tax exposure.
Unfortunately, the tax provision was only introduced on a temporary basis and will begin its sunset phase-out period at the end of 2022. The allowance of 100 percent bonus depreciation will drop by 20 percent annually until it reaches zero after 2026. In practice, businesses that maintain the same level of investment will increasingly be exposed to increasingly high levels of taxation. This disincentive to invest, in turn, will lead to fewer job opportunities and reduced economic output. That outcome does not bode well for the health of the economy, which economists are increasingly predicting is on the brink of recession.
Congress must not allow 100 percent bonus depreciation to be phased out. To do otherwise would do significant harm to current investment practices, which drive research and development and encourage capital spending. It would also undermine many of the goals that lawmakers have set for the country, such as to close the digital divide, revitalize domestic manufacturing and reduce carbon emissions.
Meeting each of these goals requires significant business investment. The loss of 100 percent expensing would stifle investment due to the tax burden to businesses resulting in less revenue available for capital purchases.
For example, closing the digital divide necessitates manufacturing the equipment necessary to build out network infrastructure, a process that includes everything from hiring new labor and acquiring parts for cell towers to creating the protective conduit tubing needed for laying fiber. This elaborate process requires billions of dollars in capital spending by the telecommunications industry. An inability to write off capital purchases immediately will discourage that type of spending.
Similarly, American manufacturers depend more than most on the ability to purchase large amounts of machinery and production equipment to build complex products like semiconductors, cars, tools and medical equipment. A national tax environment that incentivizes capital formation plays an important role in these manufacturers’ operations and profitability.
Lawmakers claim to care about such concerns, and routinely urge the creation of high-paying manufacturing jobs here in the U.S.. As recently as August, Congress passed the CHIPS and Science Act, which provides $280 billion in new funding for research and the manufacture of semiconductors. Yet Congress appears to be oblivious to the fact that the coming sunset of 100 percent bonus depreciation will undercut these efforts.
Even Congress’s goal of reducing carbon emissions will be difficult to achieve without adequate collaboration between the government and business community. Reducing carbon emissions requires constructing new energy infrastructure with green technology. This undertaking will require billions of dollars in new spending on everything from mineral extraction equipment, needed for mining natural resources like lithium, cobalt and manganese for electric vehicles batteries, to the machinery needed to manufacture solar panels, wind turbines and renewable energy storage systems. Such an ambitious project will require a substantial increase in capital spending that may not be possible without the right incentive structure.
Extending 100 percent bonus depreciation would help preserve that incentive structure by freeing up cash flow for thousands of businesses through a reduction in taxes. It would also create a positive spillover effect that not only benefits the businesses that utilize the tax allowance for capital purchases, but also the businesses responsible for those sales.
This chain of events is perhaps best illustrated by a simple example. A farmer who has an old tractor may decide, after considering the benefits of the expensing provision, to purchase a new John Deere tractor from Deere & Company for $10,000 during the window of time allotted to write off his purchase. Now the farmer owns a new tractor and Deere & Company has made $10,000 in sales that can then be used to pay their sales team, who will then in turn use their earnings to purchase other goods and services. The entire business cycle is remarkably simple, yet hugely beneficial to the overall economy. The expensing provision helps makes this cycle possible.
While Congress has previously had little luck making 100 percent bonus depreciation a permanent feature of the U.S. tax code, it could propose legislation that would extend the provision for several more years. For example, extending the tax provision through 2026 would provide businesses four more years of optimal investment opportunity. This extension would give them plenty of time to make additional financial investments while planning for the future and riding out these current tumultuous times.
Congress should think long and hard about granting such an extension if it cares at all about achieving the goals it has set for the nation. A failure to act now would negatively impact the health of an economy that is already trending towards decreased spending and investment.