Capital Equipment Expensing: Incremental Tax Reform for a Transition Realization-Based Income Tax

Abstract:     
Cost recovery, under the current, underlying MACRS regime, is financially insufficient to completely restore the amount invested in equipment by taxpayers (capital or not). Although, selectively overriding this cost recovery regime, none of the current partial or limited expensing deduction provisions under sections 168(k) and/or 179, bear any relationship to the amounts of tax capital concurrently created and actually invested in expensed equipment by taxpayers. This frequently creates one of two tax base structural problems depending on the specific characteristics of a given equipment purchase: (1) the ability to recover pre-tax earnings tax-free, on one hand, or (2) the inability to recover actual invested tax capital tax-free on the other hand.

At this preliminary stage of development, I basically propose matching the amount of investment in equipment made during a taxable year against the amount of tax capital created and available at the end of that taxable year. More specifically, I propose to aggregate all investment in equipment made by a taxpayer during a taxable year, and compare it to the total amount of tax capital created from that taxpayer's net business income as of the end of that taxable year. The amount of tax capital created and available at the end of a taxable year would be determined by using the simple formula in Equation 4.113.

To the extent aggregate investment in section 179 property equals, but does not exceed, the tax capital creation threshold for that year at that time, all equipment investment for the year would be allowed as an immediate deduction under section 179. To the extent tax capital is created in excess of equipment investment for that year, it would be carried over to following years, to be matched against the aggregate equipment investment that occurs in those following years. Similarly, to the extent aggregate equipment investment in a given year is made in excess of tax capital created during that year, excess nonexpenseable amounts of equipment investment would be carried over to following years to be tested for deductibility against current and any cumulative tax capital created or available in those following years.

Overall, CEE is a tax-sustaining, economic capital-generating engine. It produces more tax capital for every dollar of revenue lost than any existing equipment expensing or cost recovery method. And, since we have not moved to full expensing yet, it is the best engine for both revenue sustenance and capital formation that we can have during this transition period of unknown duration today. Furthermore, studies have shown that investment in equipment, in particular, is directly related to job creation, which makes this sector of the economy a proven job-creation source. Therefore, optimizing capital formation and reinvestment on an ongoing tax-sensitive basis through CEE should increase investment in equipment, as well as create more jobs associated with those equipment investments.

CEE has tremendous efficacy as a transition sub-tax base structure for an important sector of our economy. How long this specialized sub-tax base would endure is open to question since the federal government is engaged in an ongoing major tax reform process. Nonetheless, CEE can create a stable transitional platform, from which a wide variety of subsequent tax reform options can be more easily and efficiently pursued in the near or distant future. Finally, CEE can likely be implemented without the immediate serious administrative and fiscal problems that would likely be caused by other transition platforms.

Accepted Paper Series