Accounting for Behavioral Considerations in Business Tax Reform: The Case of Expensing

56 Pages Posted: 25 Jan 2017 Last revised: 5 Feb 2017

Date Written: January 24, 2017


One of the fundamental questions in business tax reform is whether to allow firms to immediately expense investments or require economic cost recovery. The conventional view is that expensing would generate stronger growth effects holding revenues constant. This view is rooted in traditional models of corporate finance that assume firms look at the net present value of expected tax payments when incorporating taxes into investment decisions. But this traditional view ignores the possibility that firms focus on more salient measures of taxes as well. If so, they may respond less to expensing than this theory suggests because expensing does not lower their financial accounting tax liability and, all else equal, requires a higher statutory rate.

This paper considers whether firms undervalue expensing due to a focus on these non-economic tax metrics and, if so, what this implies about business tax reform if the goal is to increase US investment. It develops a framework for what cost recovery rules are optimal, and then uses new and existing data to parameterize this framework, holding constant long-run revenues and the relative tax treatment of debt and equity. While the empirical evidence is still nascent, it tentatively concludes that applying economic cost recovery to public and very large companies in order to pay for a lower statutory tax rate would generate more US investment and growth than expensing — reducing the relevant tax rate on such companies by more than two percentage points estimated conservatively, and possibly by much more. This estimate is sensitive to the underlying empirical parameters and could easily change. But it does cast doubt on the conventional view that expensing would generate much more US investment and growth than the alternatives. It also contrasts with estimates by non-partisan Congressional staff that expensing as part of a business cash-flow tax would generate modestly higher growth, and with far more dramatic positive growth estimates by some prominent think tanks.

Keywords: tax reform, business income taxation, corporate income taxation, cash-flow tax, behavioral corporate finance, behavioral economics, accounting

JEL Classification: D21, D22, G02, G38, H20, H21, H25, H32, K22, K34, M41, M48

Suggested Citation

Batchelder, Lily L., Accounting for Behavioral Considerations in Business Tax Reform: The Case of Expensing (January 24, 2017). Available at SSRN: or

Lily L. Batchelder (Contact Author)

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States
212-992-8156 (Phone)


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