The BBB (Big Beautiful Bill, also US debt’s future credit rating) is going to the Senate. It includes a plan to abolish deprecation.
How so?
The alternative to depreciation is “full business expensing”.
Quite simply – when calculating taxable profits for a tax year – businesses take revenue and subtract all costs, including the costs of any investments in physical assets.
Made $100M in revenue, but spent $100M to buy a machine? Your business pays no corporate tax for that year.
How does that differ from depreciation?
Made $100M in revenue, but spent $100 to buy a machine? Your business can only offset $10 per year for the next ten years. So, this year, you’ll pay corporate tax on $100 – $10 = $90 of revenue.
Doesn’t that net out to the same thing? No, because of the time value of money.
Deprecating Depreciation is a Good Thing: Reason 1
It is more valuable to have $100 today than $10 per year for each of the next ten years. Here’s the problem with depreciation: Businesses incur costs today, but the associated tax credits are spread out over time – without any adjustment for time value of money. This increases the tax cost to businesses of making capital investments, particularly during periods when rates of return on capital (think interest rates) are high.
Deprecating Depreciation is a Good Thing: Reason 2
Calculating depreciation involves a lot of paperwork. Assets are “depreciated” over a “useful life”. This requires regulating what the useful life of each asset should be – often a subjective matter.
With full business expensing, it’s much simpler. You subtract all costs, including physical assets, and pay taxes on remaining profits. [Side note: but what if the asset later has re-sale value? then it counts as revenue when you sell it!]
How did we get depreciation in the first place?
I did a quick check with o3 – interesting! – and the crux seems to be that governments were concerned about more spiky revenue. Their concern was asset purchases would initially offset revenue, leaving little tax.
However, ditching depreciation probably makes long run government revenue less spiky! Companies tend to invest more in boom times, when revenue is higher. With full expensing, tax revenues would be dampened in boom times. Conversely, when revenues are lower in the economy, companies invest less. With full expensing, less investment means fewer tax offsets, which is a relative boost tax revenue. So, full expensing probably smooths government revenue over time.
Granted, there is a one-off effect when a government moves from depreciation to full-expensing. Tax revenue dips in those immediate years. This makes it hard for governments to drop depreciation.
The international picture
The UK has already moved to full expensing. With the US moving to full expensing, this will put pressure on other countries to follow their lead. Why? There is an economic incentive for companies to shift their capital spending not just to lower tax regions but also regions with full upfront expensing (or, at least, they should factor in both).
That gap between 15% corporate tax in Ireland and 21% might practically get even narrower.
[Side note: Yes, if you move to full expensing that is a wealth transfer to business from government AND a reduction in tax in real terms. The technocratic solution is to increase the corporate tax rate a little. Now you have less paperwork, the same government revenue (possibly more), you smooth government revenue, and you get rid of the relative disincentive for businesses to invest.]