Is full expensing the right path for tax reform?

by on August 30, 2017 at 12:27 am in Economics, Law | Permalink

That is the topic of my latest Bloomberg column, here is one excerpt:

Since 2008, the federal government has extended “bonus expensing,” which allows for a 50 percent deduction for many investments and covers about two-thirds of all investment. There are already various expensing provisions for investing in equipment, advertising, and research and development, and many forms of accelerated depreciation. By one estimate, corporations in 2012 were able to deduct more than 87 percent of the value of their investments, over time. So moving to “full expensing” may not be a complete economic game changer.

If nothing else, full expensing would benefit businesses by accelerating when the relevant deductions could be taken (right away, rather than over a multiyear period), and for that reason it would boost investment. But that in turn benefits some kinds of businesses more than others. What about businesses that invest a lot today, but earn back the cash slowly and turn a profit only years later? Without a big tax bill, they won’t get a significant tax reduction now, which would blunt the benefits of full expensing. That’s OK, but again it means not to expect a miracle from tax reform.

And near the end:

But so often the devil is in the details, and the simple idea of applying economic logic to the tax code can be harder to pull off than it might seem at first.

Do read the whole thing.

1 Thanatos Savehn August 30, 2017 at 2:09 am

“… economic logic”? Seriously? “Most economists think one thing. I (Tyler) am an economist. Therefore, I mostly think …”

Economics encounters deduction only when it maps its predictions. Yet logic, such as it is among the financial high weeds, often produces thinking of the “if 2 + 2 = 7 then 2 * (2 + 2) = 24.5” variety. That it is not tethered to objectivity makes its unmoored assertions akin to gluten-free diets for the kinda/sorta autistics. Yuck. Try harder.

2 A clockwork orange August 30, 2017 at 2:31 am

The day began in a sort-of huff, an hour west of the Western Reserve, when after being rebuffed by mouthless lips, he was rebuked by a mug broken in three parts. The prior evening, the innkeeper had placed a bookmark in La Chute and set the book down next to a placard.

3 GBFM August 30, 2017 at 1:51 pm

I want my shtick back, copyright infringer!

4 Chocolate Seller August 30, 2017 at 3:39 am

You discuss “…one pure version of full expensing…”, where the government fronts money to companies who have tax credit. Really?? Wouldn’t it just be practical to carry forward the tax credit to next year and offset against tax liability on future profits? Wouldn’t this reduce (any) risk of crony capitalism involved with Govt fronting of money to private companies?

Carry forward of tax credit with full expensing is a big incentive, IMHO. Even for “…businesses that invest a lot today, but earn back the cash slowly and turn a profit only years later”

5 mulp August 30, 2017 at 5:24 am

Tax rate reductions has led to tax credits for hiring more workers because with low tax rates, hiring more workers hits profits much harder. Ie, a 20% rate means a new worker costs profits 60% more than when the tax rate is 50%. The 35% rate increased the cost to profits of hiring workers 50%, and similarly increased the addition to profits of firing workers relative to the old 50% rate.

Cutting the number of workers was a stated goal of Milton Friedman in arguing for lower corporate tax rates circa 1970.

6 mulp August 30, 2017 at 5:16 am

Expensing investments merely delays taxes on profits if profits are to be had.

If the economy is efficient, profits will be zero.

Drawing the distinction between returns to investment aka rewards to not consuming aka saving.

Savers earn interest aka dividends based on risk. In the 60s, completely safe investments, demand deposits providing cash to banks to lend returned 4-5% and utility bonds 8%, with stocks paying 4% dividends with prices and dividends increasing over time, but with high risk. Preferred shares earned a fixed rate with share price not increasing.

So, the issue is how should interest and dividends be taxed. Well, interest was expensed, but taxed as ordinary income to the saver/investor just like for savings in a bank. But dividends were taxed as “profit” whether paid as dividends or reinvested as retained earnings. Except for LLCs or S corps where they pass through to the owner.

But selling interest in the firm is not income and is not taxed. Paying workers with this cash to build a factory is not an expense until production is sold. Production “consumes” the factory with the expense called depreciation. In steady state, consumption of capital like factories and machines are offset with equal investment, paying workers to repair, rebuild, replace that which is consumed.

If normal return on invested capital were treated like interest on debt, then in steady state and an efficient market with zero profit, expensing investment when workers are paid or when the asset is consumed as depreciation will be identical.

For a startup or growing firm, expensing paying workers to build capital assets results in expenses higher than revenues and thus carry forward losses. Amazon and Tesla depreciate real capital assets and expense intangible investments aka R&D for the most part, and thus lose money while rapidly growing revenue and owned capital assets.

Amazon warehouses and data centers cost say $10 billion but have book value SS of $5 billion whIle producing as if they were new at $8 billion. Ie, a 1gig drive bought 3 years ago is still working fine but is depreciated to 25% while the same original cost buys a 2 gig today thus making the value of the 3 year old drive today twice the booked value, ie residual book value. But this is true because Amazon is growing rapidly.

A firm that is not growing ends up with it computer capital assets falling in book value at a rate equal to the increase in technology productivity.

The ONLY time expensing makes a difference is when market inefficiency results in high profits, like when oil exceended $80 a barrel and ExxonMobil had $50 billion in actual profit from scarcity. With expensing capital investment, ExxonMobil would likely drastically increased its drill baby drill, pipelines, refineries, or maybe build wind, solar, and battery farms to take market share from coal faster than natural gas alone. For ExxonMobil drill baby drill kills it’s profits from scarcity, so instead ExxonMobil buys oil leases and books the reserves without producing them to maintain scarcity, and keep others from drilling those leases.

Today, tax law favors ExxonMobil paying taxes on profits and using 5% buying leases it sits on, but with expensing, dodging taxes will increase actual productive assets. Creating lots more jobs when profits are high.

7 rayward August 30, 2017 at 6:26 am

Full expensing is the least bad tax reform; rate cuts the most bad tax reform. Corporations should be encouraged to invest in productive capital; it’s what increases productivity and economic growth. Cutting tax rates just encourages corporations to distribute dividends to shareholders and to re-purchase their stock, neither of which increases productivity or economic growth. Cowen’s version of tax reform is so simple even members of Congress can understand it. But understanding it won’t motivate Congress to adopt it, because Congress is always looking to support the special interests that fund their election campaigns, and full expensing has the unfortunate feature of treating all taxpayers alike while rate cuts mostly benefit a select few.

8 dave schutz August 30, 2017 at 6:26 am

Seems to me this will encourage McDonald’s to buy more robots and fire more minimum wagers, faster. I’m not sure this is something we want to encourage.

9 JWatts August 30, 2017 at 11:18 am

“Seems to me this will encourage McDonald’s to buy more robots and fire more minimum wagers, faster. I’m not sure this is something we want to encourage.”

We already incentivize McDonald’s to automate to a much greater degree with the national minimum wage.

10 Just Another MR Commentor August 30, 2017 at 11:23 am

You mean we don’t want to encourage productivity growth?

11 Evans_KY August 30, 2017 at 6:42 am

“All we need for that is an administration and a congressional process fully devoted to mastering detail and rendering objective assessments and communicating them transparently.” Badum-Ching! Anyone who expects miracles from tax reform is delusional. The Killdeer Syndrome afflicts so many.

My new term for the day is full expensing. I have long thought that all tax cuts for large businesses should be tied to their altruism. Job training, internships, capital investments. I consider this a very “America First” approach. The larger question in tax reform is what do we want to incentivize. Hoarding or new investment. I vote to raise their tax rates in tandem with implementation of expensing measures and closing loopholes. Vicious, I know. But then again this is all hypothetical and I expect more of the same. Killdeers swoop.

12 TMC August 30, 2017 at 12:54 pm

“tax cuts for large businesses should be tied to their altruism”

This kind of think got us into the tax mess. So many deduction and credits for things politicians value. Some contradictory. Businesses should be 1. law abiding, and 2. focused on profit. This way they will be efficient. All the other crap gets in the way of a good running business. If the owners or CEO wants to get into philanthropy, then do so on their own dime.

Businesses should have 0% tax rate. Taxes distorts its behavior. Pass the profits on to the owners who will pay taxes on it. A business will pay $4 on something stupid to save $5 in taxes. Very wasteful.

13 Ricardo August 31, 2017 at 2:13 am

Businesses are already free to pay 0% taxes by organizing as a partnership or S Corp. Some businesses owe taxes because they decide the benefits of operating as a traditional C Corp outweigh the tax costs. Even most “tax havens” tax corporations so there would be little benefit for America to cut its rate to zero.

14 Pat August 30, 2017 at 7:38 am

“(1)For full expensing to have a major positive effect, and outperform the “skinny” option of just slashing the corporate tax rate, it will have to bring more than just a marginal gain in expensing benefits. (2)It will have to stay relatively neutral across different classes of investment, and it will have to avoid becoming another form of crony capitalism.”

On (1), these things can be modelled.
On (2), you seem to be holding full expensing to a higher standard than the option to cut the rate while maintaining existing write-offs; why would the latter option perform any better on these crtieria?

15 Gideon Magnus August 30, 2017 at 7:41 am

Interesting topic.

I wrote about full expensing a few months ago at Forbes:

16 bob August 30, 2017 at 8:03 am

cut the corporate tax rate to zero, but all distributions to any individual taxed at individual rate (and not advantaged vs wage income) and tie to eliminating the treatment of corporations as people for political purposes. Health care costs are a more important issue for competitiveness (and for individuals).

17 celestus August 30, 2017 at 8:39 am

If I am a trucking company and I buy a truck in December 2017 for $100,000 and use it for 4 years, then logically I should attribute the cost of the truck to 2018, 2019, 2020, and 2021, so that the revenue I earn from operating the truck is matched with the expense of buying it (and, if I borrowed money to buy the truck, the interest and principal I pay on the debt). Also, if we do things your way it becomes a massive problem if I sell my trucking company. I might have $10 million in trucks that have been completely expensed, so I whine and complain that I am being double taxed: once on the $10 million and then again when I take the cash out of the company.

But more generally, wait what? Unemployment is 4%, real GDP per capita is at an all time high. On the other side of the ledger, the current estimates are that the average budget deficit over the next 10 years will be $1 trillion, assuming no recession, no new wars, no new health care programs, etc. Wouldn’t an economist prioritize the second issue?

18 Brian Donohue August 30, 2017 at 9:01 am

Like most economists, Tyler hasn’t said boo about the deficit over the past several years except to argue that the debt ceiling is nonsensical.

19 John Thacker August 30, 2017 at 9:45 am

Wouldn’t an economist prioritize the second issue?

The proposals so far have been deficit neutral under static analysis through base-broadening. I do fully expect Trump and others in the Administration to try to move to a simple cut rather than reform (and arguing for a “skinny” tax reform is more likely to move in that direction). However, Ryan and Brady so far have been sticking to their deficit neutral guns.

20 Vivian Darkbloom August 30, 2017 at 10:02 am

1. Expensing versus depreciating (or amortising) an asset is merely a question of timing. Over the life of an asset, the net deduction for depreciation, amortization (or loss on disposal or abandonment) is exactly the same. Tyler gets part of this right: “If nothing else, full expensing would benefit businesses by accelerating when the relevant deductions could be taken (right away, rather than over a multiyear period), and for that reason it would boost investment”. However, the last part of that sentence (“for that reason it would boost investment”) should be questioned. Over what time frame would this boost in investment would occur? For a few years; till the next election cycle; until this prediction is “under the fold” of this blog; indefinitely? Unfortunately, economists are always making these type of predictions without specifying the time frame involved. My take is that expensing, because it is merely a timing change, would not make a significant difference in overall investment over the indefinite term (that is, if we assume such changes are intended to be permanent, which I’m sure this one is). At most, it front loads a bit of growth at the expense of later growth. At worst, it would exacerbate the boom/bust tendency of the economy and associated tax revenues.

2. Your dire prediction (“massive problem”) about double taxation and expensing is misplaced. In your example, the owner (and buyer) of the company would have two options a) a deal for the assets of the company (either a direct sale or a deemed sale via a tax election); or 2) a deal for the shares. Which option makes sense is often driven by the optimal tax consequences for both parties. In a share deal, the seller would not need to take cash out of the company (absent a holding company, he sells his shares directly) so when you write, he would be taxed again when he takes his cash out of the company, this is not normally relevant when the “sells his company” as you put it. Double taxation of corporate profits and distributions to shareholders is a feature of our current tax system. Expensing does not change that.

3. Whether you have a sale of shares or an actual or deemed sale of assets, the buyer, assuming he is an intelligent one, will carefully analyze all the tax attributes of the target, includiing all the “tax assets” and “tax liabilities”. This includes depreciation, amortisation, potential tax on built-in gains, NOL’s, etc. It is simple economics of these transactions that if the existing owner has previously expensed an asset (such that future depreciation deductions are not available to the purchaser) that purchaser will simply pay less. Your truck owner has already had the benefit of his immediate write-off and, if not used in the current year, a loss is carried forward for use in a later year (e.g., either to offset future gain on the sale of those trucks with zero basis or as a tax asset to be purchased by the buyer). If your truck owner is complaining, it is likely from ignorance. It is possible that as a result of expensing, the prevalance of share transactions would increase relative to asset transactions; however, I hardly consider this to be a “massive problem”.

4. All that said, I agree that our deficit should come down. The expensing proposal is likely, unfortunately, merely an another example of short-term, opportunistic thinking. The deficit and the debt will always be tomorrow’s problem–until it isn’t.

21 JWatts August 30, 2017 at 11:25 am

I think you left out the most obvious benefit of full expensing. It’s far simpler to administrate.

22 Vivian Darkbloom August 30, 2017 at 11:34 am

Maybe, but I seriously doubt maintaining depreciation schedules is a major administrative problem. And, the difference between tax and book will become even greater.

As you may have detected, I’m not strongly for or against expensing. I just feel the need to correct some muddled thinking over something I happen to know a bit about.

Expensing, due to up-front tax write-offs, will somewhat increase the NPV of an investment in a tangible (and intangible?) asset. Part of me thinks this is not the time to further accelerate (via tax policy) the growing preference for machines over man.

23 john August 30, 2017 at 11:50 am

“If nothing else, full expensing would benefit businesses by accelerating when the relevant deductions could be taken (right away, rather than over a multiyear period), and for that reason it would boost investment”.

Which seems to suggest that cheap money is good if it boost investment. But that then begs the question of viabilityof the investments and the potential for malinvestments induced by the investment incentives.

24 Vivian Darkbloom August 30, 2017 at 12:03 pm

Yes and no. I doubt companies will go out and make bad investment choices simply because of earlier tax write-offs. But, it does change the calculus to some extent, just like outright subsidies do (e.g., tax subsidies for solar and electric cars), albeit not to the same degree.

I wonder, also, if this changes somewhat the equation between debt and equity. Would I be more likely to go out and borrow to pay for that equipment? The tax write-off is immediate; but the loan (with interest) is repaid over the term of the loan. For this reason, I think combining expensing with refundable tax (rather than carry forwards) would be an invitation for some big problems. Moral hazard, writ big.

25 celestus August 30, 2017 at 12:06 pm

Yes, the sellers are complaining from ignorance, but that doesn’t matter. They still refuse to sell unless it’s a stock deal at an appropriate price for an asset deal, and the reason is that the taxes from an asset deal are too high.

This is not a dire prediction about the overall U.S. economy, just a statement that this one operation becomes impossible.

26 Viking August 30, 2017 at 2:03 pm

If we are talking about fairness, it might make sense that expensing follows the cash flow impact, if one pays cash for an asset, allow expensing, if asset is financed, allow amortization up to the outlays, but not beyond the initial cash value.

The fairness angle gets tricky when inflation comes into play, if there is a big discrepancy between present value of money, and the average discounted value.

The second issue is with depreciation recapture. If you can move to expensing, then the recapture after 20 years might be a great deal, if the tax benefit of expensing something is $10K, but the asset doesn’t really depreciate (like high quality land improvements), then exchanging $10K liquidity today for $10K liquidity in 20 years is like getting a free loan for 20 years. This is a moot point if the asset really depreciated.

27 John Thacker August 30, 2017 at 9:44 am

Terrible column, terrible reasoning. It’s true that “There are already various expensing provisions for investing in equipment, advertising, and research and development, and many forms of accelerated depreciation…So moving to “full expensing” may not be a complete economic game changer.” However, that fact completely vitiates the terrible argument in your piece that full expensing would somehow be “crony capitalism.” If you’re worried about cronyism, then then the various complicated and heavily lobbied-for different expensing and depreciation schedules are obviously a much worse target. If you think that the product of all that lobbying is somehow fine-tuned for the complexities of reality (and there a case that can be made), then you aren’t worried about cronyism as a major issue.

“What about businesses that invest a lot today, but earn back the cash slowly and turn a profit only years later? Without a big tax bill, they won’t get a significant tax reduction now, which would blunt the benefits of full expensing.”
– The proposal includes interest on Net Operating Loss carryforwards, which would give them a significant tax reduction now, and is justified from the same economic principles. Add to that the massive decrease in necessary bookkeeping from such companies. (Also note that the supposed “skinny” alternative of a rate decrease wouldn’t help these companies at all for similar reasons, except that they wouldn’t get the simplicity or interest.)

If these are the best arguments against full expensing, then there are no persuasive arguments against it and we should do it now.

28 JWatts August 30, 2017 at 11:26 am

“If you’re worried about cronyism, then then the various complicated and heavily lobbied-for different expensing and depreciation schedules are obviously a much worse target.”

+ 100

Multiple depreciation schedules and the lobbying behind them are far worse cronyism.

29 john August 30, 2017 at 11:48 am

Seems to me they are all driven by the same mindest — get taxpayers to foot the bill for private investment by corporations.

At this stage of developement in capital makets and corporation the idea that corproate investments need any form of social support to encourage enough investment seem just wrongheaded.

30 Hazel Meade August 30, 2017 at 12:58 pm

Full expensing should be applied to individual tax returns too.
It’s silly that businesses get to expense rent, but individuals can’t.

31 Ricardo August 31, 2017 at 2:27 am

I’m sympathetic but one could argue that is what the standard deduction (among other deductions and exemptions) does. Instead of asking people to save receipts and carefully compute the amounts they spend on rent, commuting costs, dry cleaning, etc., we just allow people to take a flat deduction and be done with it.

32 byomtov August 30, 2017 at 2:46 pm

So it incentivizes capital expenditures. So what?

It seems to me that the is not an unalloyed good thing. Isn’t it possible that this could lead to serious misallocation of resources, as more investments suddenly exceed artificially lowered hurdle rates, or show (inflated) positive NPV.

33 lxm August 30, 2017 at 5:26 pm

I think it was Mitt Romney who said that corporations were people.

Well, I am a people, just like those corporations but the tax code treats me differently then them. Let’s say I make 20K/yr. Now lets say I am a corporation making 20K/yr. Well what’s the difference?

The 20K/yr I report is gross income. The 20K/yr income a corporation makes is after deductions for basic expenses, like gas, food and rent.

Please, please, please treat me like a corporation like Romney said.

Don’t you folks understand how you are being screwed?

34 Careless August 30, 2017 at 9:20 pm

… you do realize that at $20k you’ll likely be getting money from the government, while the corporation A) will have its owner of the company (the “people” the corporation is) is making essentially no money (quite conceivably a loss), and B) will be paying taxes?

35 zztop August 30, 2017 at 9:46 pm

Key powerful proposal provision involving %100 tax expensing for capex would be one that allows such deductible expenses to contribute to net operating losses thereby serving as carryback offsets against prior year taxable income. Now that, unlike current 179 and bonus provisions, which cannot be used in carrybacks, would be something significant, and something to behold.

36 Cjones1 August 30, 2017 at 11:21 pm

A simple man is what I am and I heard the deductions for state taxes and/or mortgage interest may be curtailed or eliminated.
I am not sure how many billions will be saved by taking the Forgotten Folks’ tax breaks away, but knowing that advertising cost expensing provides a $250+ billion tax break allowing actors, athletes, newscasters, and other media folks to have multimillion salaries rubs me the wrong way. Let the media folks live off ticket sales or let businesses risk their own money on stupid commercials, but quit finding ways for us commoners to pay their taxes.

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