This Change in Tax Law Could Help the Post-Pandemic Economy

(Bloomberg Opinion) -- The coronavirus has U.S. businesses grappling with enormous uncertainty, making them cautious about new investment. At the same time, without increases in private investment and capital spending, the overall economy won’t be able to make the structural changes required to prosper in a post-pandemic environment.

What’s needed are policies that both spur investment now and put the economy in a better position for long-term growth. One idea that should be part of the debate is to allow the permanent full expensing of all capital investments.

If you think of this change as a relatively minor detail, consider the big picture: The Federal Reserve currently has limited ability to use interest rates to stimulate investment. In a crisis such as this, typically the Fed would lower short-term interest rates to reduce the cost of borrowing. That would then set off a virtuous cycle: Capital expenditures would increase employment, which would increase spending, allowing more businesses to expand, and so on. That option isn’t available because short-term interest rates are already at zero.

What about the Fed’s quantitative-easing program, when it buys up public and corporate debt? That worked in the last crisis to help drive down long-term rates. This time, quantitative easing will likely have limited effects because even long-term interest rates are already extremely low.

Congress, meanwhile, has already passed four bills to provide immediate relief to businesses and workers, with plans for more. This assistance is absolutely necessary and will continue to be.

Changes to the tax code can also have a major impact. As part of the Tax Cuts and Jobs Act, Congress temporarily allowed full expensing for a few types of assets. But those provisions are set to expire in 2022.

Typically, a business writes off the value of its investments over time as they depreciate. For buildings and other structures, that can be as long as 39 years. Full expensing allows businesses to deduct the entire amount of their capital expenditures in the first year. That dramatically lowers the cost of investment and spurs growth in a manner similar to a rate cut by the Fed.

Yet allowing businesses to deduct their capital expenses immediately won’t matter much if businesses don’t have any cash to invest. In order to facilitate this, Congress should allow businesses to “cash out” any unused depreciation and expensing allowances to cover the cost of any investment they undertake. That is, they should be able to receive a refundable credit to cover capital expenditures, and in exchange they would lose an equal value of depreciation or expensing allowances they are carrying on the books.

In the short term, these two changes — full expensing of capital investments, and cashing out unused allowances — would be a huge cost to the federal budget. Over the long term, however, the cost would decline dramatically and potentially even reverse, because businesses would have no allowances to offset future income.

This trade-off — a big revenue loss now for a revenue gain in the future — makes full expensing difficult politically. The Congressional Budget Office evaluates tax policies based on their budget effects over only the next 10 years.

Now is an opportune moment to make such a move, however, because Congress understands correctly that immediate action is needed to alleviate the short-term economic and public health crisis. Once the economy is in a stronger position, and Congress is looking to reduce the deficit, revenues will rise more sharply since businesses will already have expensed their investments.

With the Fed unable to reduce interest rates, and its quantitative easing program already in operation, an increasing amount of the response to this crisis is going to have to come from Congress. Full expensing is one of the best policies it has available to stimulate private-sector investment.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Karl W. Smith, a former assistant professor of economics at the University of North Carolina and founder of the blog Modeled Behavior, is vice president for federal policy at the Tax Foundation.

©2020 Bloomberg L.P.

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