With critical economic support running out at the end of the month and COVID-19 cases rising in nearly every state, Congress has no choice but to revisit measures designed to provide immediate relief to businesses and households. At the same time, it has to address the long-term need for a robust and sustainable economic recovery.
The best and most cost-effective way to accomplish that — far better than a capital-gains tax cut or a payroll-tax holiday, to name two frequently floated ideas — is to pass a law allowing for full-cost recovery for private investment. It might sound arcane, but the effects are profound.
Here’s how it works: Businesses pay taxes on their profits, defined as revenue minus costs. Revenue is mostly straightforward, but costs are more complex. The IRS allows businesses to count the full cost of expenditures on payroll and supplies in the year they are purchased. Investment expenditures, however, usually have to be deducted over period of up to 39 years, according to depreciation or amortization schedules.
A tax deduction of a dollar 39 years from now isn’t worth nearly as much as a deduction of a dollar today. That’s partly because of inflation, and partly because the wait increases the amount a business has to borrow to finance a given investment. Full-cost recovery would allow businesses to either deduct the full amount of the investment expenditures immediately or, in the case of real estate, index those deductions to compensate for inflation and interest costs.
Models show that adopting full-cost recovery for all assets would boost long-run GDP by 5%, raise wages by 4.3% and add more than 1 million permanent new jobs. The question is whether these estimates are realistic.
It’s hard to say with certainty because the IRS has never allowed full-cost recovery across the board. But it has temporarily allowed so-called “bonus cost recovery” for certain assets, and studies show that expenditures on eligible investment rose by as much as 16.9% during those periods. Just as important, this effect was more pronounced in small firms than in large ones.
The change would also add an average $39 billion a year to the deficit over the next 10 years. This is small in comparison to the costs of the CARES Act, yet some lawmakers have already expressed reluctance to approve another large relief package because they don’t want to add to the debt. Yet it’s important to realize that efforts to restrain the growing debt are likely to backfire if they end up weakening the economy, reducing revenue and increasing the aid required to keep businesses and households afloat.
The White House has expressed interest in full-cost recovery but is also considering several alternatives, including a temporary capital-gains tax cut and a payroll-tax holiday. These measures would provide little bang for the buck in comparison to full-cost recovery. Together they would add more than $500 billion to the deficit while providing negligible long-term growth.
In the current economic environment, a capital-gains tax cut is like pushing on a string. Interest rates are near record lows, and stock prices are rising because the global economy is awash in savings and desperate for a (relatively) safe place to put its money. Despite the ravages of the virus, that place remains the U.S. economy.
A payroll-tax holiday, which would put money in consumers’ pockets and reduce the costs of hiring to businesses, makes more sense. But suspending the payroll tax is hugely expensive. So most proposals would offer only a brief holiday through the end of the year, effectively imposing a tax increase on workers and employers in 2021 that would undo all of the short-term job gains.
Increasing economic growth has to be a priority if the U.S. is going to recover from the pandemic and replace the jobs permanently lost during this crisis. None of the proposals now under consideration, however, is as productive or cost-effective as full-cost recovery. If Congress wants to grow the economy without exploding the deficit, then full-cost recovery should be in the next coronavirus relief bill.
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. He wrote this for Bloomberg Opinion.