Cost Recovery Advances the Nation’s Economy
July 17, 2017
The CRANE coalition is pleased to present these comments and recommendations on federal tax reform.   CRANE (Cost Recovery Advances the Nation’s Economy) is a coalition of trade associations and companies with the mission of preserving and enhancing accelerated depreciation in federal tax reform.

Accelerated Depreciation in Tax Reform
The treatment of capital cost recovery constitutes a fundamental fault line in tax reform.  When former House Ways and Means Committee chair Dave Camp crafted his comprehensive tax reform plan in the years leading up to its release as H.R. 1 in 2014, he essentially baked into the plan, early on, the elimination of the modified accelerated cost recovery system – MACRS.1Based on the 10-year budget projections accompanying the plan, the elimination of MACRS served as the largest single business-related budget offset for the tax cuts included in the plan.  In the Senate at the time, Finance Committee chair Max Baucus was similarly contemplating cutbacks in MACRS.   


The inclusion of the repeal of MACRS in H.R. 1 – a bill meant to promote faster economic growth -- essentially disregarded the findings of a 2007 study by Treasury Department under President George W. Bush that enhancements in cost recovery mechanisms in the tax code would be a more effective growth stimulus than other forms of tax reform.3   The bill also disregarded a 2011 paper by three economists with the Congressional Joint Committee on Taxation reaching that same conclusion.

In addition to the elimination of MACRS, H.R. 1 rejected an extension of bonus depreciation – a cost recovery measure that had been in effect most of the 15 years preceding the introduction of H.R. 1.   The aggregate result of the loss of both MACRS and bonus depreciation would have been a remarkably abrupt slowdown in depreciation for business equipment and machinery.   Deductions for the first two years of ownership of typical equipment and machinery would have dropped from 70 percent or higher to 20 percent or lower — an unmistakable signal from the federal government that domestic investment in equipment and machinery was no longer a priority.   If H.R. 1 had become law, tax advisors across the country would have warned business clients about the sharply downgraded economics of domestic investment.  

In wake of H.R. 1, the CRANE Coalition came into being and commissioned two studies by former economists with the Joint Committee on taxation regarding the budgetary and economic implications of the repeal of MACRS.  As described in more detail later in these comments, the first study demonstrated that the repeal of MACRS fails as a budget offset for permanent tax reform since the revenue generated by the repeal does not persist.  The 20-year revenue pattern for the repeal of MACRS shows an early spurt of revenue, followed by sharply declining rates of increase thereafter.   Reliance on cutbacks in MACRS as an offset for permanent tax reform is a prescription for revenue shortfalls in the longer term.

The second study calculated the effect of the repeal of MACRS on the cost of capital for domestic investment.  The study showed that capital-intensive industries could incur increases of more than 10 percent in the cost of capital.   Of course, taking into account the elimination of bonus depreciation would only have exacerbated the effective increase in the cost of capital.   That study is further described later in these comments, as well.    

A rethinking of the approach of H.R. 1 on Capitol Hill began in 2015 when the Senate Finance Committee created working groups of committee members to study options for tax reform.  No longer was the repeal of MACRS baked into concept of tax reform.  On the contrary, the report issued by the business tax working group that year explicitly identified both the budgetary and economic shortcomings of the repeal of MACRS as a budget offset for tax reform.          

The following year, 2016, the rethinking of H.R. 1 continued, with the release by House GOP leaders of a tax reform “blueprint” calling for full, first-year expensing of capital costs.  In other words, the blueprint made a 180-degree turn from H.R. 1 -- from the elimination of MACRS and the expiration of bonus depreciation, to full expensing.   The blueprint accompanied expensing with the elimination of the business interest deduction.        

This year, two thinktanks in Washington have published papers reinforcing the shift in thinking and harkening back to the Bush Treasury study.  The groups concluded that, other things being equal, enhancements in cost recovery are more effective at stimulating investment and economic growth than other forms of tax reform.  

Crane Recommendations
CRANE strongly urges the Finance Committee to preserve and enhance MACRS in tax reform for the same reason that this committee originally adopted accelerated depreciation in 1954:  to boost domestic investment and growth.  An historical perspective on accelerated depreciation follows in the next section.  In a tax reform measure meant to boost growth, Congress would be moving in precisely the wrong direction by curtailing MACRS.   Further, CRANE recommends that Congress extend bonus depreciation at the 50 percent level.

It is critical for lawmakers to be aware that the current system of accelerated depreciation-- MACRS and bonus depreciation – has developed over decades.  According to economists, those features of the tax code introduce elements of consumption taxation into the tax system.  Economic models indicate that consumption-based taxation generates less drag on economic growth than income-based taxation, but a sudden shift to consumption-based taxation has never proven to be politically feasible because of resulting shifts in the distribution of the tax burden among taxpayers.   By contrast, the gradual evolution of MACRS and bonus depreciation have been accompanied by such features of the tax system as the earned income tax credit – features that have allowed lawmakers to preserve a desired level of progressivity and sense of fairness in the system.  For Congress to curtail MACRS and bonus depreciation would be to move away from consumption-based taxation – a fundamental economic mistake.  Once embedded in the tax system, that mistake could take decades for lawmakers to correct.        

Full expensing of capital expenditures, as proposed in the House GOP blueprint, would complete the evolution of accelerated depreciation in the tax code.  CRANE members understand that the shift to full expensing would invite proposals for the curtailment of the deduction for interest on debt-financed capital expenditures (as indeed the blueprint proposes), as well as for restrictions on operating loss carrybacks and possibly other longstanding features of the tax system.  Further, concerns of lawmakers about the effect of full expensing on the distribution of the tax burden could lead to unpredictable proposals to undo such an effect.   Bonus depreciation, by contrast, is inapplicable to long-lived assets, as well as to used assets.  It enhances the role of MACRS in stimulating business expenditures on new equipment and machinery in manufacturing, transportation, communications, refining, energy production, agriculture, and other basic industries.   Bonus depreciation and MACRS have evolved in a manner consistent with lawmakers‘ desired degree of progressivity in the tax system and have not required Congressional consideration of cutbacks in the interest deduction or other basic features of the system.       

Abrupt shifts in longstanding features of the tax system, as an accompaniment to the adoption of expensing, would entail widely varying and unpredictable consequences for the cost of capital for different companies and different industries, both within CRANE and within the larger business community.   CRANE members would welcome the continued evolution of the tax system toward expensing in a way that would avoid such abrupts shifts and that would ensure an ample transition period for implementation of the new system. 

The Historical Perspective:  Accelerated Depreciation ConstitutesLong-term and Fundamental U.S. Tax Policy
Accelerated depreciation has been a permanent feature of federal tax policy since 1954, when Congress inaugurated a new tax code that was to last until its replacement 32 years later by the Internal Revenue Code of 1986.  The Internal Revenue Code of 1954 authorized the use of the double declining balance method and sum of the years’ digits method of depreciation for assets with a useful life of more than three years.      

The roots of accelerated depreciation actually go back even further than 1954.  Congress had previously deployed accelerated depreciation to boost domestic investment on a selective basis:  In 1940, Congress provided a temporary five-year depreciation period for assets considered important for war preparation.   A similar temporary provision was enacted later for the Korean War.   Altogether, accelerated depreciation has at least a 75-year history in the tax law.  

In adopting accelerated depreciation on a permanent basis in 1954, the Senate Finance Committee explained that the provision would boost investment and economic growth:        

More liberal depreciation allowances are anticipated to have far-reaching economic effects….The acceleration in the speed of the tax-free recovery of costs is of critical importance in the decision of management to incur risk. The faster tax write-off would increase available working capital and materially aid growing businesses in the financing of their expansion. For all segments of the American economy, liberalized depreciation policies should assist modernization and expansion of industrial capacity, with resulting economic growth, increased production, and a higher standard of living.

Over the decades from 1954 to the present, Congress has never looked back.  Accelerated depreciation has become ever more deeply embedded in federal tax policy.  In 1958 and again in 1962, Congress liberalized the rules in a number of ways, such as by enacting section 179, which then, as today, was meant to provide rapid write-offs for smaller businesses.   During the 1960s and 1970s, the administrative rules and regulations under which taxpayers determined the depreciable lives for assets moved steadily toward shorter lives.  The asset depreciation range (ADR) system prescribed by the Treasury Department in 1971 explicitly allowed taxpayers to select depreciable lives shorter than the Treasury’s calculation of industry average.   

In the 1980s, Congress further embedded accelerated depreciation in the tax law by enacting the accelerated cost recovery system (ACRS) and its revised version, the modified accelerated cost recovery system (MACRS).   As the rules settled out in 1986, most types of equipment were depreciable over either five years or seven years.  Depreciation periods longer than five years applied to real property, public utility property, some transportation property, and certain other long-lived assets, but those periods were shorter than the periods applicable in the 1970s.  Accelerated methods of depreciation (such as the double declining balance method) continued to apply to most types of assets other than real property.   The accelerated depreciation rules adopted in the 1980s have persisted to the present day.  

During the last two decades, accelerated depreciation has become even more central to the U.S. tax system as Congress has provided an add-on system of bonus depreciation during most of those years.  Bonus depreciation has allowed taxpayers to deduct in the first year a prescribed portion of the cost of assets, ranging from 30 percent to 100 percent, depending on the particular year.   The regular depreciation allowance (computed with respect to portion of the cost basis, if any, remaining after the bonus depreciation deduction) has remained applicable.  Most depreciable assets other than public utility property and other such long-lived assets are eligible for bonus depreciation.   Since 2008, 50percent bonus depreciation has applied every year, except for a single year in which 100 percent bonus depreciation applied.     

The Repeal of Accelerated Depreciation Fails as a Revenue Offset for Tax Reform
From a short-term budget perspective, cutbacks in accelerated depreciation have obvious surface appeal as an offset for the revenue cost of reductions in tax rates or other features of a tax reform measure.   As described previously, Camp’s 2014 tax reform plan relied on the repeal of MACRS as the key revenue offset for reduced tax rates and other tax reforms.  Even with its effective date deferred until 2017, and even with the inclusion of an inflation adjustment that would slightly accelerate deductions, the provision was estimated by the staff of the Joint Committee on Taxation (JCT) to raise $269 billion over the first decade.

Despite its surface appeal, reliance on the repeal of accelerated depreciation as a revenue offset for permanent tax reform is seriously misplaced since the revenue increase from the change declines precipitously over time.   To develop a clear picture of the revenue pattern, CRANE retained the services of two former JCT economists in the consulting firm Quantria Strategies.   We asked the economists to develop graphs that would illustrate the 20-year revenue and budget consequences of the repeal of accelerated depreciation, both as in the Camp measure (i.e., with the inflation feature and deferred effective date) and on a stand-alone basis (i.e., simply an immediate shift to the straight-line depreciation method and the asset lives from the 1970s).    Using standard JCT estimating techniques and assumptions, Quantria developed the following graph [contact CRANE for original document] that depicts the revenue pattern in the two cases: 

The graph shows clearly the extent to which the repeal of accelerated depreciation represents a front-loaded revenue increase.   For the first half-decade after their effective dates, both the Camp provision and the stand-alone provision raise substantial and increasing revenue.  But thereafter the amount of the revenue gain starts a yearly decline that continues through the second decade.  In short, the substantial early revenue increases from the repeal of accelerated depreciation simply do not persist.   

The consequence of relying on the repeal of accelerated depreciation to keep a tax reform measure revenue-neutral during the first decade is obvious:  The measure would generate a large and growing budget deficit after the first decade.  Quantria developed the additional graph below to demonstrate the point.  The graph shows the long-term, year-by-year budget shortfall resulting from relying on the repeal of accelerated depreciation as part of a package of offsets adopted to keep a permanent tax reform measure budget neutral in the first decade.  Like the first graph, this graph shows the result for a tax reform measure that includes the Camp MACRS provision and a measure that includes an immediate, straight repeal of MACRS.   For purposes of the exercise, the revenue-losing components of the tax reform measure are assumed to be rate reductions, expanded business deductions or exemptions, or other such provisions whose cost will grow over time with the economy.  
The graph illustrates clearly the peril of relying on the repeal of accelerated depreciation as part of a package of provisions designed to maintain the revenue neutrality of a permanent tax reform measure during the first decade.  The net effect is the addition of hundreds of billions to the national debt in the second decade, under either the Camp provision or a plain repeal of MACRS.   

The deficit increases resulting from enactment of a tax reform measure that relies on the repeal of accelerated depreciation as a major budget offset would occur just at the time when the Congressional Budget Office forecasts rapidly rising budget deficits from the aging of the baby boom generation.   If the country’s fiscal policies will be thrown into turmoil at that time as things stand now, an under-funded tax reform measure will add fuel to the fire, forcing policymakers to confront politically painful austerity measures.   The result could be skyrocketing, and ultimately unsustainable, increases in the national debt.  

Another possible consequence of the future budget deficits that would be created by relying on the repeal of accelerated depreciation to offset the cost of tax reform is the possible reversal of the tax reform measure down the road.  Critics in the future could readily point to the tax reform measure as a contributor to ballooning long-term budget deficits and seek to reverse the measure’s revenue-losing provisions – i.e., the reduced tax rates or other new tax benefits.  This is not a theoretical concern. 

Exactly that process occurred in the years following the tax reform act of 1986, as the top individual tax rate rose from 28 percent to 39.6 percent in two steps within seven years after 1986.  The net result in the present case could be the loss of both accelerated depreciation and the positive tax reforms for which accelerated depreciation was a tradeoff!   

Cuts in Accelerated Depreciation Have No Place in a TaxReform Measure Meant to Promote Economic Growth
The principal perceived benefit of reforming the country’s tax laws is to boost economic growth and the country’s standard of living.  To repeal accelerated deduction in the pursuit of tax reform would be to shift policy in exactly the opposite direction.   Congress enacted accelerated depreciation in 1954 to boost investment and economic growth, expanded it in the 1980s to boost investment and economic growth, and supplemented it over the last two decades with bonus depreciation, again to boost investment and economic growth.     

CRANE commissioned Quantria to produce a second paper explaining the adverse consequences of the repeal of accelerated depreciation, both for individual businesses and for the economy as a whole.   The Quantria economists calculated the effect of MACRS repeal on the cost of capital for domestic investment and determined that, economy-wide, the cost of capital would rise by more than eight percent, with increases of more than 10 percent for capital intensive-industries such as manufacturing.   The study went on to explain, “Even if coupled with proposals to lessen the impact of MACRS repeal, such as reducing the corporate tax rate, most studies show that the long-term effects would result in slower economic growth.”   

Further, the Quantria study did not take into account the effective elimination of bonus depreciation, as assumed in Camp’s H.R. 1.    The increase in the cost of capital would have been even greater with bonus depreciation taken into consideration.   
Repeal of Accelerated Depreciation:  the View from the Firm

As described previously, the elimination of both MACRS and bonus depreciation would represent nearly a 180-degree shift in U.S. tax policy and could result in far-reaching dislocations in the economy.   The shift back to pre-1981 and pre-1954 depreciation rules could dramatically alter the economics of buying, selling, making, or using depreciable plant and equipment.   Such a change could have the effect of a severe shock to the tax system, with unpredictable results.  Clearly, buyers and users of capital equipment, such as manufacturers, could feel the shock.  Anyone making or selling capital equipment could feel the same shock.  

For the broad array of capital-intensive companies across the country that have made investment decisions in recent years based on both accelerated depreciation and bonus depreciation, the shift to the rules of the past would necessitate a wholesale recalculation of the costs and benefits of domestic investment.  

It is sometimes argued that, for public companies, the repeal of accelerated depreciation should not matter since the change would not affect tax liability or earnings reported to shareholders in the short term.   That view is akin to arguing that cash does not matter to shareholders – or to the economy – and that what does matter is financial engineering.   For any company, the loss of MACRS and bonus depreciation would mean diminished cash flow.  Whether the company weathers the reduced cash flow by tapping cash reserves or by seeking fresh capital from outside, the result is the same:  reduced investment capital throughout the economy.    

If the first goal of tax reform should be to do no harm, the repeal of accelerated depreciation would violate that goal.  Federal tax policy has long evolved gradually, without abrupt changes that unduly disrupt investment and business patterns.  The repeal of MACRS and the loss of bonus depreciation would break faith with that practice by utterly changing the economics of investment in plant and equipment and sowing the seeds for reduced economic growth in the future.  

In summary, the CRANE coalition strongly urges the Finance Committee to preserve and enhance accelerated depreciation.   In particular, we urge the committee to further extend bonus depreciation at the 50 percent level.    We urge the committee to avoid making the mistake of reversing the long evolution of the tax system toward robust cost recovery.   Revenue gained from the repeal of accelerated depreciation does not persist and would lead to increases in the federal budget deficit just at the time of rising entitlement costs of the baby boom generation.   Additionally, the repeal of accelerated depreciation would tilt the tax system away from favoring investment to favoring consumption, with adverse consequences for future economic growth.  In conjunction with the loss of bonus depreciation, the repeal of accelerated depreciation would represent an abrupt turnaround in federal tax policy that could have the effect of a shock for individual businesses and the broader economy, forcing firms to reconsider the costs and benefits of domestic investment in plant and equipment.