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Expensing Is Infrastructure, Too | Tax Foundation Analysis


The Biden administration has suggested several tax increases for his infrastructure plan. Public infrastructure can help increase economic growth, but by raising taxes on private investment, the net effect on growth may be negative. However, tax options like retaining expensing for private R&D investment or making 100 percent bonus depreciation for equipment permanent would be complementary to the goals of infrastructure spending.

Manufacturing

The American Jobs Act proposes spending $300 billion on several programs to boost American manufacturing, including $50 billion to support semiconductor production through passage of the CHIPS Act, $52 billion in capital to domestic manufacturers (primarily expanding existing capital access programs), $46 billion in clean energy technology improvement, and several other targeted investments.

However, these public subsidies would come on top of a tax code that penalizes manufacturing. In theory, the corporate income tax should be a tax on profits, or revenues minus costs. Labor and administrative costs can be deducted immediately, but capital investments usually must be deducted over many years. Due to inflation and the time value of money, that means companies cannot deduct the full, real cost of many investments.

This creates a bias against manufacturers, because investment in physical capital is a much larger portion of their costs than it is for, say, a fast food restaurant or a commercial bank. The Tax Cuts and Jobs Act (TCJA) introduced 100 percent bonus depreciation for spending on equipment, allowing companies to deduct their investment immediately. However, that provision is temporary, and will start phasing out at the end of 2022. Making this provision permanent would help generate investment in manufacturing, helping grow productivity and wages over the long run.

Economic and Revenue Effects of Making 100 Percent Bonus Depreciation Permanent
Gross Domestic Product (GDP) +0.5%
Gross National Product (GNP) +0.4%
Wage Rate +0.4%
Capital Stock +0.9%
Full-Time Equivalent Jobs +86,000
Static 10-Year Revenue -$213.4 billion
Dynamic 10-Year Revenue -$110.2 billion

Source: Tax Foundation, Options for Reforming America’s Tax Code 2.0.

Research and Development

Biden’s infrastructure plan includes $180 billion for R&D, in addition to R&D proposals included under the umbrella of manufacturing support. R&D is crucial to driving long-term economic growth and innovation. However, at the end of this year, the tax code will start working against private R&D.

Under current law, companies can deduct the full cost of spending on research and development. However, after the end of 2021, firms will have to spread the cost of their investment in R&D over five years. This would effectively be a tax increase on firms for whom research and development is a central part of their business model. Canceling this upcoming amortization would raise long-run GDP by 0.1 percent and create 20,000 full-time equivalent jobs.

Economic and Revenue Effects of Canceling R&D Amortization
GDP +0.1%
GNP +0.1%
Wage Rate +0.1%
Capital Stock +0.2%
Full-Time Equivalent Jobs +20,000
Static 10-Year Revenue -$131.3 billion
Dynamic 10-Year Revenue -$107.9 billion

Source: Tax Foundation, Options for Reforming America’s Tax Code 2.0.

Housing

The Biden plan proposes to produce, preserve, and retrofit two million new housing units, at a price tag of $213 billion. But the existing tax code disadvantages investment in housing, particularly multifamily housing.

The Tax Reform Act of 1986 required companies to spread the cost of investment in residential structures over 27.5 years, and removed accelerated depreciation provisions that let builders deduct a larger share of their investment sooner. This change significantly raised the cost of investment, particularly in multifamily housing relative to owner-occupied housing. After 1986, multifamily housing construction collapsed, from 500,000 new units in 1986 to only 140,000 by 1991. Construction levels have not reached those heights since.

One solution to this problem would be to implement neutral cost recovery for structures, or NCRS, which would allow companies to adjust their deductions by inflation and the time value of money each year. In real economic terms, this would be equivalent to allowing companies to fully deduct investments in structures the year they’re made. This change would lower the cost of capital and stimulate investment, increasing long-run GDP by 1.2 percent according to Tax Foundation estimates.

Lowering the cost of capital can only go so far in places where housing markets are heavily constrained by zoning regulations. However, the infrastructure package also includes a grant program to incentivize states and localities to repeal regulations to allow for the expansion of the housing stock. Neutral cost recovery, paired with federal grants to encourage zoning reforms, could be a  potent combination to expand housing supply, lower rents, and create jobs. 

Economic and Revenue Effects of Neutral Cost Recovery for Structures
GDP +1.2%
GNP +1.0%
Wage Rate +1.0%
Capital Stock +2.3%
Full-Time Equivalent Jobs +231,000
Static 10-Year Revenue -$10.35 billion
Dynamic 10-Year Revenue +$300.98 billion

Source: Tax Foundation, Options for Reforming America’s Tax Code 2.0.

Energy Efficiency

Climate change is a central issue of the Biden plan, from manufacturing to housing to R&D.  Moving towards immediate expensing for capital investment can accelerate the transition to a greener economy.

For instance, the plan heavily emphasizes “mobilizing private investment” towards upgrading existing power generation infrastructure. Making investment fully and immediately deductible would make replacing existing equipment cheaper, relatively speaking, than keeping old, less energy-efficient equipment in operation.

The current system, in which operating costs are deducted immediately while many capital investments are not, creates a bias in favor of older, less efficient equipment (with higher operating costs, but lower capital costs) and against new equipment (lower operating costs, but with a big upfront investment). As a result, improving the tax treatment of investment, whether structures or equipment and machinery, would encourage greater investment in newer, more efficient infrastructure.

Economic and Revenue Effects of Full Expensing for All Capital Investment
GDP +2.3%
GNP +1.9%
Wage Rate +1.9%
Capital Stock +4.3%
Full-Time Equivalent Jobs +442,000
Static 10-Year Revenue -$1,707 billion
Dynamic 10-Year Revenue -$1,167 billion

Source: Tax Foundation, Options for Reforming America’s Tax Code 2.0.

In the context of the American Jobs Act, each of these reforms moving toward immediate tax deductions for investment—except for the combined option that uses immediate expensing rather than neutral cost recovery for investment in structures—are small in terms of revenue impact. But they would work in tandem with the Biden plan’s objectives.  Unlike the current tax components of the plan, which would raise taxes on domestic production, enacting full expensing would encourage private investment in infrastructure that would complement the Biden plan’s public infrastructure spending.

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