Study Looks At US Tax Treatment of Capital Assets
02 May 2013
Posted by: Author: Leroy Baker
Source: Leroy Baker (Tax-News.com, New York)
With the United States Congress debating major reforms of corporate and individual income taxes, with one of the objectives being to reduce tax rates to promote economic growth, a paper produced by the Tax Foundation (TF) looks at the tax treatment of the cost of plant, equipment and buildings as an important part of such a pro-growth tax system.
The paper points out that, in the early days of the corporate income tax, businesses were allowed to report the costs of their assets to any schedule they chose. Later, efforts were made to set rational guidelines for such reporting based on the expected lives of the assets, with accountants choosing their methods for financial statements, and Congress and the Internal Revenue Service choosing others for tax purposes.
The TF notes that those methods "focus on fundamentally unknowable asset lives instead of on the relatively clear issue of what is best for the economy," and that "economic growth, not budgetary convenience, should be the determining factor in crafting cost recovery in tax reform."
It believes that how capital assets are accounted for is a significant, but largely overlooked, tax reform issue. "How capital assets are accounted for in the tax code dramatically affects what is defined as taxable income and, thereby, directly influences the cost of capital," the TF confirms. "The higher the cost, the less capital is formed, and the slower the economy will grow. The lower the cost, the bigger the economy will be, and with it the number of jobs and the level of wages."
The main reason why tax authorities prefer depreciation to expensing is said to be because it appears to bring in more tax revenue sooner. The TF calls that "unfortunate, because money left in the private sector for saving and investment normally generates a pretax return, after inflation, of above 6%, which would provide an expansion of the economy."
It adds that "a more neutral tax base, combined with lower tax rates, would be a powerful engine for economic growth. Labor costs are expensed. Capital costs are not. Fixing the distortion in the tax base by moving toward expensing of capital outlays would redress some of the punitive treatment current law imposes on capital-intensive industries and the blue collar jobs they provide."
The TF concludes that "it would end the tax bias against long-lived assets such as plants, commercial buildings and multi-family housing in favor of short-lived assets. Lower corporate tax rates on the resulting, better-defined income would add a further boost to all types of innovation and expansion. The distortions in the tax base are as important as the level of the tax rates in determining the ability of businesses to create and employ capital and labor."