1950s Depreciation Class Lives for the 21st Century: Distortions in the Current System
7 Pages Posted: 20 Oct 2000 Last revised: 2 Dec 2016
Date Written: May 29, 2000
Recent research has shown that the tax treatment of depreciable assets can greatly affect the user cost of these assets and can have measurable impacts on investment levels. Most of this research accepts the current classification of assets into recovery periods. In large part, the current classification system was taken from guideline lives set by a Treasury study of corporation income tax returns from 1959, with few updates. No comprehensive study of depreciable lives has occurred in the past 40 years.
The use of this outdated classification system results in at least five undesirable outcomes. First, new assets may by "shoehorned" to fit within the existing classification system. Second, new assets could be assigned a default tax depreciation class life of seven years, regardless of the economic depreciation they display. Third, assets that were originally properly classified might have undergone technological or economic changes that change class life they should properly receive. Fourth, many assets are classified by industry rather than by type of asset. Fifth, if an asset is not clearly identifiable within the existing classification system, recovery periods for the same assets may vary across taxpayers.
We conclude that the current system for assigning depreciation lives does not fit the dynamic U.S. economy, and that it generates especially high effective tax rates for high-technology assets used in rapidly developing industries. One example of the type of industry that is adversely affected by the misclassification issue is the cellular telecommunications industry. This industry has made substantial and increasing investments in depreciable assets since 1986. Wireless assets do not have a separate depreciation class, as they were not contemplated in the 1986 legislation. As a result, cellular telecommunications assets are often assigned the default seven-year recovery period or are assigned recovery periods using asset categories designed for "wireline" telephone systems, despite the very different (and rapidly evolving) technologies cellular assets incorporate.
The problem of classifying new assets does not have a simple solution within the existing tax depreciation framework. Methods for adding new asset classes and regularly evaluating existing asset class lives and depreciation methods must be part of any solution designed to achieve tax neutrality, economic efficiency and economic growth for companies entering the 21st century. One approach would be the implementation of an "Advance Depreciation Agreement" for depreciation class lives and procedures similar to Advance Pricing Agreements used in section 482 transfer pricing.
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