A new measure to allow companies to write-off capital investments is among the several stimulus proposals President Obama is expected to unveil on Wednesday. It would cost the government $200 billion in tax revenue initially, but would only result in a net loss of around $30 billion, according to the New York Times. The plan intends to get firms to buy more equipment in the near-term to help spur the economy. Is the idea a good one?
How It Works
First, how will it work? The measure is actually similar to one enacted during the Bush administration. It allowed firms to immediately depreciate 50% of certain capital investments, through 2009. Obama's plan is more aggressive. It would allow 100% write-offs through 2011, retroactive to its announcement this week.
The logistics boil down to favorable accounting treatment. If a company buys some piece of equipment, usually it depreciates that equipment over some amount of time. For example, imagine if UPS depreciated its delivery trucks over five years. That allows the company to spread the vehicles' cost over that time period, while it uses them, instead of declaring it all at once. Then, the profit it makes is more evenly associated with the toll (or expense) its deliveries take on its trucks.
So why allow companies to write equipment cost all off at once? If companies increase their costs, then their taxes decline. For example, imagine if a company has profit in 2011 of $1,000 before taxes and depreciation of capital expenses for that year, at a tax rate of 35%. And let's say it purchased $500 worth of equipment that it would have depreciated at $50 per year over 10 years. Then, its profit would be reduced to $950 for 2011, and its taxes would be $333. If it can declare the entire cost of that equipment in 2011, however, its profits would be reduced to $500, so its taxes would also be reduced --- to $175. Of course, investors wouldn't mind the decline in profits, because they would understand that the change is only accounting, and it allowed the firm to escape paying higher taxes.
The sort of nice feature of this program is that it won't really cost the government much. Ultimately, most companies will pay approximately the same amount in taxes they would have anyway. They will just pay more in future years, when they would have realized the cost of equipment through their depreciation accounting.
This program will result in a loss to the government for two main reasons. First, if companies go bankrupt or declare losses in future years, then those future taxes expected may never be paid. Second, the tax receipts the government won't obtain from these companies in 2010-2011 will require more debt, which will require the government to pay more interest over the time between now and when the capital investment would have been fully depreciated.
Will It Help?
This program's success depends on whether businesses will feel encouraged enough to to buy more equipment now to take advantage of the favorable accounting treatment. Certainly, some firms will bite. Since we know that many businesses are sitting on cash, this may provide a good reason to put that money to work now on capital investment.
But uncertainty will still be an issue. Many companies aren't sitting on cash only because there aren't many good investment options, but also because they want to ensure they have a cushion to fall on if the economy's troubles return. Moreover, if they're unconvinced demand is coming back for some time, then companies might not see the point to buying now only to pay more later. There's a reason why depreciation makes sense in accounting: it helps to match up profits and costs. Why bother declaring a bigger expense now only to pay more money in taxes in the future?
Certainly, such capital investment would help the economy if it works. Since consumers aren't spending, business spending could instead lead the way to job growth. But again, the government might worry about the problem of pulling forward demand. All those companies that purchase capital equipment now might not do so over the next five to ten years. Of course, the administration probably sees lackluster future growth a small price to pay if it means lowering the excruciatingly high unemployment rate more quickly.
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