Ask a thousand random people what the 2017 tax reform law did, and probably none of them would tell you about full expensing of business investments — instead, they’d likely cite individual or corporate income tax reductions. And yet, the ability to immediately deduct investment expenses was one of the most important, pro-growth provisions in the entirety of the Tax Cuts and Jobs Act (TCJA). Now, though, it’s in danger of being phased out, unless Congress passes legislation sponsored by Rep. John Larson (R-CT) and other House Republicans to extend it.
Economists and tax experts have long recognized the importance of incentivizing investment by allowing businesses to recoup some of the value of their investments through the tax code. Yet rather than allowing businesses to deduct the value of their investments immediately (known as “full expensing”), they were required to navigate complex amortization schedules that could spread out the timetable for recovering the value of an asset up to fifty years.
Not only was this system of asset depreciation a compliance nightmare, it also reduced the value of the tax deduction for businesses. Businesses value cash on hand more than cash down the road, as cash on hand can be used for other productive purposes now rather than later.
Requiring businesses to recoup the tax benefit over the course of many years in no way increases federal revenue over the long term, but it does reduce the benefit to those businesses. A 2012 report by the Tax Foundation’s Scott Greenberg found that a system of asset depreciation reduced the value of investments for businesses by just under 17 percent on average compared to a system of full expensing.
In recognition of this, the TCJA sought to transition to full expensing for capital investments, allowing businesses to bypass the system of asset depreciation entirely. Instead, they could immediately deduct the full value of capital investments the year they were made.
There was a catch, though — unfortunately, full expensing has the bad luck of looking costly under a ten-year budget window. The budget impact of all legislative proposals are “scored” by official government budget scorekeepers over a ten-year period, and this is generally the window at which Congress considers the impact legislation will have on the budget. As a result, the expensing provision was scheduled to expire in 2022 in order to make the 10-year budget math fit with Congress’s complicated budget reconciliation rules. This included research and development costs, which had been subject to expensing since the 1950s.
The thing is, full expensing reduces federal tax revenue by next to nothing in practice. Businesses receive the same tax benefit over the long run — the sole difference is whether they receive it simply over one year, or in a complicated manner over as many as fifty.
But looking at a ten-year budget window, any asset depreciation that would normally take place over more than ten years appears to “cost” the federal government revenue, since part of the tax benefit would have accrued to businesses outside the ten-year window. As a result, instituting full expensing for just five years between 2018 and 2022 was estimated to “cost” the federal government just under $120 billion in revenue.
In order to comply with budget reconciliation limitations on budget impact, Congress chose to phase out full expensing between 2023 and 2027, hoping to extend it later before that happened. Full expensing of R&D costs were scheduled to end in 2022. That made full expensing’s “price tag” on the final TCJA a far more manageable $86.3 billion.
That helped with making the TCJA’s budget math work, but reverting to asset depreciation makes no sense at all from a policy perspective. It’s more complicated, it reduces the incentive for businesses to invest (which is crucial to raising wages), and it increases federal revenue only in the short term.
The impact is even more severe for R&D investments, which businesses have been able to fully expense for decades, even prior to the passage of the TCJA. Allowing R&D investments to be subjected to the system of asset depreciation would not just be undoing a good policy fix (like with other capital investments) it would subject this kind of investment to an inferior system for essentially the first time.
Given the importance of research and development investments to economic growth, Congress must consider how to make full expensing of R&D costs permanent rather than allowing it to expire next year. At a time when the economy is trying to recover from a recession, Congress cannot afford to disincentivize investment. It especially can’t afford to do so simply because of a quirk in the budget scoring process.