The Shaky Future of Bonus Depreciation

by Tom Yamachika, President, Tax Foundation Hawaii

At about this time of year over the last few years, Congress debates the future of the “tax extenders” bill, which deals with fifty or so tax provisions that are set to expire. Typically, they get renewed for a year or two and are then looked at again making them one of Congress’s most frequent tax policy discussions. One of the provisions in the bill is “bonus depreciation.” For some reason the Congress has liked this provision but our legislature and Tax Department haven’t, so bonus depreciation is not allowed for Hawaii income tax.

What is depreciation? Many businesses need to buy assets that last more than a year. An architecture firm, for example, may buy a laptop computer that helps draft blueprints. It pays for the computer all at once, but the firm is required to deduct the expense of the computer over time, in theory to match the cost of the equipment against the revenue earned.

“50% bonus depreciation” is a system where half of the equipment cost can be deducted in the first year it is placed in service, and the rest of the cost can be deducted over time. The federal government allowed bonus depreciation at various times since 2001. In a few of those years it also allowed 100% bonus depreciation, with all of the qualifying equipment cost deducted in the first year. The State of Hawaii, however, has never gone along with bonus depreciation, often stating that it would be too expensive to adopt.

Is bonus depreciation a good thing? The economists seem to think so. According to a study by the national Tax Foundation, extending 50% bonus depreciation on a permanent basis at the national level would boost the long-term level of gross domestic product (GDP) by about 1 per cent, the amount invested in private business stocks would increase by a little more than 3 per cent, wages would rise by about 1 per cent as a result of the capital deepening, and the economy would add about 214,000 jobs over the next ten years. The study also concludes that although there would be a revenue loss because of the tax changes ($336 billion over 10 years), the additional wages and jobs would bring in additional income and payroll taxes that would blunt the revenue loss (to $74 billion over 10 years). The Joint Committee on Taxation staff also predicts higher investment and higher GDP as a result of letting bonus depreciation continue, but predicts a smaller effect on the economy.

Two policy questions come to mind.

First, should we be doing tax extenders legislation every year? Can’t we make up our mind about what’s good for our country? Businesses like predictability – as in knowing what the rules are and that they aren’t going to change all the time. Businesses need to decide whether to invest in that equipment, or software, that is supposed to last a while. Once the investment is made it’s tough to find out that all or some of the tax incentives on which it is based are not forthcoming. And when the incentives are enacted but late, you need to ask how they, or any other economic stimulus, can be effective if enacted after most or all of the year has already passed.

Second, why are we so fixated on having state depreciation rules so different from the federal ones? One of the purposes behind Hawaii’s tax code is “to conform the income tax law of the State as closely as may be with the Internal Revenue Code in order to simplify the filing of returns and minimize the taxpayer’s burdens in complying with the income tax law.” With the rules as they are now, each asset has a different amount of depreciation allowed for state and federal tax. Each asset has a different cost basis for state and federal tax, so if the asset is sold, there will be a different amount of gain for state and federal tax. Is that really what we want?

How we handle bonus depreciation, both at the state and federal levels, is an indicator of how harshly or kindly we are willing to treat businesses.