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Key Findings
- Cost recovery refers to how businesses deduct their investments over time.
- The Tax Cuts and Jobs Act of 2017 reintroduced 100 percent bonus depreciation for short-lived investments, such as machinery and equipment, allowing full cost recovery for qualifying investments. Bonus depreciation will begin phasing down at the beginning of 2023.
- In 2018, the first full year of 100 percent bonus depreciation, corporations made $1.23 trillion of new investments in depreciable property, nearly 84 percent of which will be deductible over time, in real terms.
- If not for bonus depreciation, we estimate corporations would only have been able to deduct just under 76 percent of the value of investments made in 2018 over time.
- The extent of cost recovery varies by industrial sector and by asset, reflecting the numerous depreciation schedules to which different industries and assets are subject.
- If bonus depreciation is allowed to phase out, then the tax bias against capital investments will increase, discouraging firms from making otherwise profitable investments.
Table of Contents
Introduction
Capital investment is an important driver of long-run economic growth. New capital investments raise worker productivity, which grows wages and the economy at large.[1]
The tax treatment of investment directly affects long-run economic growth. Ideally, investment costs would be fully and immediately deductible—just like operating costs—so the tax system does not discourage capital investment. Unfortunately, under current law, many capital investments cannot be fully deducted.
Instead, the tax system partially relies on the accounting principle of matching deductions for expenses with the revenues they generate, meaning companies must spread deductions out over several years—or even decades, in some cases. Spreading deductions out over time creates a tax penalty on investment. Inflation and the time value of money, which are the opportunity costs of taking a deduction later rather than today, mean companies cannot deduct the full cost of investment. The resulting distortion has economy-wide costs—reducing investment, growth, and wages—and industry-specific costs—creating a bias against industries more reliant on physical capital.[2]
To grow the U.S. workforce and increase productivity, businesses must invest in new equipment and technology, expand facilities and locations, and hire and train workers. Penalties on capital investment hurt workers, as lower investment means slower productivity growth and slower wage growth. Conversely, better tax treatment of capital investment helps accelerate wage growth.[3] Establishing full expensing for all capital investments is one of the most potent policies for expanding broad economic growth across the board.[4]
The Tax Cuts and Jobs Act of 2017 (TCJA) moved the U.S. tax code closer to full expensing—at least temporarily. The law reintroduced 100 percent bonus depreciation for short-lived assets,[5] allowing companies to immediately deduct 100 percent of the cost of investments in assets with lives shorter than 20 years. The provision will begin to phase out after the end of 2022, allowing companies to deduct 80 percent of new investment costs in 2023, 60 percent in 2024, 40 percent in 2025, and 20 percent in 2026, after which it completely phases out.
IRS data from 2018, the first full year of the TCJA’s 100 percent bonus depreciation, illustrates how the policy boosts the real value of depreciation deductions for firms.
Data
The IRS data used in the paper includes investment in assets depreciated in the tax code made by corporations, including S corporations, RICs, and REITs. It does not include investment in intellectual property, some forms of software purchases, or land purchases. It also excludes investment by sole proprietorships and partnerships. For the rest of the paper, we will refer to the investment in depreciable assets as “investment.”
We will use the following acronyms throughout the paper: GDS stands for General Depreciation System, the most common set of rules firms use to depreciate property in the tax system. ADS stands for Alternative Depreciation System, an alternate approach available for some assets. For more information, see the IRS’s Form 946 guide on how to depreciate property.[6]
Corporations Could Deduct 84 Percent of New Investment in Depreciable Assets in 2018
U.S. corporations (including S corporations, RICs, and REITs) reported $1.23 trillion of investment in 2018.[7] Because of 100 percent bonus depreciation, more than 48 percent of corporate investment could be immediately deducted in 2018. In combination with Section 179 expensing, nearly 51 percent of new corporate investment was immediately deducted in 2018.
The remaining investment, however, was not immediately deducted and instead must be spread out over time. Over time, in present value terms, corporations will be able to claim $1.03 trillion of depreciation deductions compared to $1.23 trillion in investment costs—just under 84 percent of investments made in 2018.
| Depreciation Schedule | Amount of New Investment Subject to Schedule, 2018 (Billions) | Present Value of Deductions in Dollars (Billions) | Present Value of Deductions as Percentage of Investment Cost |
|---|---|---|---|
| Section 179 | $34.0 | $34.0 | 100.0% |
| 100 Percent Bonus | $594.5 | $594.5 | 100.0% |
| GDS 3-year | $15.9 | $15.1 | 95.4% |
| GDS 5-year | $107.5 | $98.7 | 91.7% |
| GDS 7-year | $81.1 | $71.6 | 88.3% |
| GDS 10-year | $6.7 | $5.6 | 83.5% |
| GDS 15-year | $50.1 | $36.6 | 73.1% |
| GDS 20-year | $42.0 | $27.8 | 66.4% |
| GDS 25-year | $1.7 | $1.0 | 57.5% |
| Residential rental property | $16.5 | $9.0 | 54.6% |
| Nonresidential real property | $141.1 | $62.5 | 44.3% |
| 50-year property | $0.004 | $0.002 | 37.1% |
| Other ADS | $52.0 | $33.2 | 63.8% |
| ADS 12-year | $9.0 | $6.8 | 75.5% |
| ADS 30-year | $20.6 | $10.8 | 52.2% |
| ADS 40-year | $62.3 | $27.2 | 43.6% |
| Total | $1,234.9 | $1,034.3 | 83.8% |
|
Source: IRS Corporate Complete Report Table 13 and author calculations. Note: The calculations assume an inflation rate of 2 percent and a real discount rate of 3 percent. The value of deductions for Other ADS is imputed, see Appendix for details. Higher inflation further reduces the present value of deductions; see Garrett Watson and Huaqun Li, “Permanent 100 Percent Bonus Depreciation Even More Important When Inflation Is Elevated,” Tax Foundation, Oct. 27, 2022, https://taxfoundation.org/permanent-bonus-depreciation-inflation/. |
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Bonus Depreciation Improved Cost Recovery by More Than 10 Percent in 2018
If not for 100 percent bonus depreciation of short-lived investments, U.S. corporations would deduct an even smaller fraction of their investments over time. Table 2 shows an estimate of the percentage of investment businesses would be able to deduct if bonus depreciation were not part of the tax code.
Without 100 percent bonus depreciation, businesses would only be able to claim $941 billion in depreciation deductions in real terms—76 percent of investments made in 2018. In 2018, bonus depreciation resulted in a 7.6 percentage point improvement in the ability of corporations to deduct the real value of their investments.
| Depreciation Schedule | Amount of New Investment Subject to Schedule, 2018 (Billions) | Present Value of Deductions in Dollars (Billions) | Present Value of Deductions as Percentage of Investment Cost |
|---|---|---|---|
| Section 179 | $34.0 | $34.0 | 100.0% |
| 100 Percent Bonus | $0.0 | $0.0 | 100.0% |
| GDS 3-year | $47.0 | $44.8 | 95.4% |
| GDS 5-year | $318.4 | $292.1 | 91.7% |
| GDS 7-year | $240.0 | $212.0 | 88.3% |
| GDS 10-year | $19.8 | $16.5 | 83.5% |
| GDS 15-year | $148.3 | $108.4 | 73.1% |
| GDS 20-year | $124.2 | $82.4 | 66.4% |
| GDS 25-year | $1.7 | $1.0 | 57.5% |
| Residential rental property | $16.5 | $9.0 | 54.6% |
| Nonresidential real property | $141.1 | $62.5 | 44.3% |
| 50-year property | $0.0 | $0.0 | 37.1% |
| Other ADS | $52.0 | $33.2 | 63.8% |
| ADS 12-year | $9.0 | $6.8 | 75.5% |
| ADS 30-year | $20.6 | $10.8 | 52.2% |
| ADS 40-year | $62.3 | $27.2 | 43.6% |
| Total | $1,234.9 | $940.6 | 76.2% |
|
Source: IRS Corporate Complete Report Table 13 and author calculations. Note: The calculations assume an inflation rate of 2 percent and a real discount rate of 3 percent. The value of deductions for Other ADS is imputed, see Appendix for details. Numbers may not add up due to rounding. |
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The Importance of Bonus Depreciation Varies by Industry
100 percent bonus depreciation is only available for investments with asset lives shorter than 20 years. For the most part, investment in equipment and machinery is eligible, while investment in structures is not. Some sectors, like manufacturing, tend to invest much more in equipment than structures, while sectors like educational services and health care invest much more in structures.[8]
The table below shows industries’ percentage point increase of recoverable investment costs due to 100 percent bonus depreciation. Information, management of companies, and finance and insurance see the largest increases.
| NAICS Sector | Amount of New Investment in Industry (Billions) | Cost Recovery of Investment (Billions) | Estimated Cost Recovery of New Investment Assuming No Bonus Depreciation (Billions) | Impact of bonus depreciation |
|---|---|---|---|---|
| Agriculture, Forestry, Fishing, and Hunting | $13.4 | $12.2 | $11.4 | 6.4% |
| Mining | $37.4 | $34.2 | $30.9 | 8.9% |
| Utilities | $120.1 | $93.8 | $90.2 | 2.9% |
| Construction | $38.0 | $34.8 | $31.9 | 7.6% |
| Manufacturing | $280.5 | $246.3 | $222.1 | 8.6% |
| Wholesale Trade | $99.2 | $89.8 | $80.0 | 9.9% |
| Retail Trade | $86.2 | $74.3 | $65.8 | 9.9% |
| Transportation and Warehousing | $68.2 | $63.2 | $56.9 | 9.3% |
| Information | $86.6 | $79.0 | $69.3 | 11.1% |
| Finance and Insurance | $53.5 | $46.8 | $41.4 | 10.1% |
| Real Estate and Rental and Leasing | $201.0 | $132.9 | $125.4 | 3.8% |
| Professional, Scientific, and Technical Services | $25.8 | $22.4 | $20.4 | 7.8% |
| Management of Companies | $44.3 | $39.5 | $34.6 | 10.9% |
| Administrative and Support and Waste Management and Remediation Services | $14.4 | $13.2 | $12.0 | 8.6% |
| Educational Services | $1.3 | $1.1 | $1.0 | 5.7% |
| Health Care and Social Assistance | $18.9 | $15.3 | $14.1 | 6.5% |
| Arts, Entertainment, and Recreation | $8.0 | $6.2 | $5.5 | 9.9% |
| Accommodation and Food Services | $28.1 | $20.9 | $18.5 | 8.6% |
| Other Services | $9.1 | $7.7 | $7.1 | 5.9% |
| Total | $1,233.9 | $1,033.6 | $938.4 | 7.7% |
|
Source: IRS Corporate Complete Report Table 13 and author calculations. Note: The calculations assume an inflation rate of 2 percent and a real discount rate of 3 percent. The value of deductions for Other ADS is imputed, see Appendix for details. Total values may not be equal to those found in Table 1 and Table 2 since the IRS has deleted certain data to avoid disclosure of information for specific corporations. |
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The results need some interpretation. The effects of bonus depreciation by industry as presented here partly reflect the share of short-lived asset investment within an industry, as opposed to the overall level of investment and corresponding reduction in tax liability.
As an example, the real estate, rental, and leasing industry sees only a 3.8 percentage point increase due to bonus depreciation. Its benefit is comparatively low because it makes a lot of investments in long-lived assets that are not eligible for bonus depreciation. However, it could still benefit significantly from bonus depreciation being made permanent.
Under our analysis of permanent bonus depreciation’s impact, real estate, rental, and leasing would see one of the largest reductions in tax liabilities as a share of income.[9] The apparent conflict reflects that the industry is capital-intensive across asset classes.
The wholesale trade industry provides a reverse case. The wholesale trade industry saw a larger, 9.9 percent improvement in the share of recoverable costs, but a relatively low change in tax liability.[10] This is because the wholesale trade industry is comparatively less capital-intensive, but its investment is heavily concentrated in short-lived assets eligible for bonus depreciation.
Conclusion
100 percent bonus depreciation moved the tax code closer to the neutral tax treatment of capital investment by allowing firms to deduct a larger portion of the real value of their investments.
100 percent bonus depreciation improves the ability of firms to recover their investment costs, increasing neutrality compared to other costs businesses face. But because it does not apply to all investment costs, bonus depreciation does not improve neutrality between types of investment, leaving lawmakers with the opportunity for further reforms. Extending full expensing to all assets or enacting neutral cost recovery for structures is necessary to eliminate the remaining tax bias against capital investment.
Appendix: Data and Methodology
Data
The primary data is from the IRS Statistics of Income Division, which issues an annual summary of all depreciation and amortization claimed on Form 4562 in each tax year.[11] Because Form 4562 is required of every corporation that claims a depreciation deduction, the IRS dataset covers all new investment reported on the tax returns of corporations in 2018.
A particularly useful feature of the IRS depreciation data is that it breaks down capital expenditures by the depreciation schedule to which they are subject. Based on the data, the table below displays all the major schedules under current federal law and the amount of new investment subject to each schedule.
| Depreciation Schedule | Line Number, Form 4562 | Amount of New Investment Subject to Schedule, 2018 | Percentage of New Investment Subject to Schedule, 2018 |
|---|---|---|---|
| Section 179 | 12 | $33,952,442 | 2.7% |
| 100 Percent Bonus | 14 | $594,498,214 | 48.1% |
| GDS 3-year | 19a | $15,871,199 | 1.3% |
| GDS 5-year | 19b | $107,533,069 | 8.7% |
| GDS 7-year | 19c | $81,067,451 | 6.6% |
| GDS 10-year | 19d | $6,687,441 | 0.5% |
| GDS 15-year | 19e | $50,099,119 | 4.1% |
| GDS 20-year | 19f | $41,953,738 | 3.4% |
| GDS 25-year | 19g | $1,717,224 | 0.1% |
| Residential rental property | 19h | $16,451,408 | 1.3% |
| Nonresidential real property | 19i | $141,142,091 | 11.4% |
| 50-year property | margin | $4,077 | 0.0% |
| Other ADS | 20a | $52,021,925 | 4.2% |
| ADS 12-year | 20b | $8,962,770 | 0.7% |
| ADS 30-year | 20c | $20,632,181 | 1.7% |
| ADS 40-year | 20d | $62,330,067 | 5.0% |
| Total | $1,234,924,416 | ||
|
Source: SOI Tax Stats – Corporation Income Tax Returns Complete Report (Publication 16), Table 13, and author calculations. |
In total, corporations reported $1.23 trillion in capital expenditures in 2018. Most of the new investment, $628 billion, was immediately deducted through Section 179 and 100 percent bonus depreciation. Another $463 billion was subject to MACRS GDS schedules, while $144 billion was subject to ADS schedules.
We exclude three categories from our analysis: depreciation deductions for property subject to the section 168(f)(1) election reported on line 15, investments subject to alternate depreciation schedules, such as ACRS reported on line 16, and depreciation deductions for listed property reported on line 21. The three categories are not usable for our analysis because the IRS statistics record the value of deductions taken but not the value of the investment made and do not distinguish between investments in the current year versus previous years.
The capital expenditure totals reported on Form 4562 differ significantly from the corporate investment data measured by the Bureau of Economic Analysis. According to the BEA’s Fixed Assets Accounts tables, corporate fixed asset investment in 2018 totaled $2.2 trillion compared to $1.2 trillion derived from Form 4562. One explanation for the discrepancy could be that the BEA data may include investments that businesses do not report or do not categorize as capital expenses on their tax returns.
Methodology
According to the data shown above, corporations spent $1.2 trillion on capital expenditures in 2018. In nominal terms, corporations will be able to deduct almost the entire $1.2 trillion over the 50 years following 2018. Converting the nominal figure to present value terms requires a two-step calculation.
First, we calculate the present value of the stream of deductions provided under each depreciation schedule. We use a combined discount rate of 2 percent inflation plus a 3 percent real rate of return. The resulting discount rate is lower than the rate many corporations use, meaning our estimates are likely conservative.[12]
For each major depreciation schedule, we use the depreciation tables provided in Appendix A of IRS Publication 946, selecting the half-year convention or month 7 convention.[13] The only exception is the “Other ADS” category, for which we use a heuristic: Other ADS deductions are 90 percent as valuable as deductions taken under GDS. We calculate the weighted-average present value of GDS deductions and multiply by 90 percent to arrive at the imputed present value of deductions for Other ADS investments.
After calculating the present values of deductions under each depreciation schedule, we average the values weighted by the amount of investment under each schedule in 2018. The result is an economy-wide measure of the percentage of all capital expenditures corporations were able to deduct in present value terms in 2018.
We also estimate the economy-wide percentage of capital expenditures corporations would be able to deduct if bonus depreciation were not part of the tax code. We assume all capital expenditures subject to bonus depreciation in 2018 would instead be proportionally spread out among the MACRS schedules for 20-year asset lives or shorter, according to the shares of investment across the short-lived schedules in 2018.
In addition, we calculate an economy-wide measure of the percentage of capital expenditures corporations were able to deduct by NAICS industrial sector and the industry-level percentages of capital expenditures corporations would be able to deduct if bonus depreciation were not part of the tax code.
[1] Michael T. Owyang and Hannah Shell, “How Capital Deepening Affects Labor Productivity,” Federal Reserve Bank of St. Louis, Apr. 19, 2018, https://www.stlouisfed.org/on-the-economy/2018/april/capital-deepening-affects-labor-productivity#.
[2] Erica York, Alex Muresianu, and Alex Durante, “Tariffs, Trade, and Industrial Policy: How the U.S. Tax Code Disadvantages Manufacturing,” Tax Foundation, Mar. 17, 2022, https://taxfoundation.org/us-manufacturing-tax-industrial-policy/.
[3] Eric Ohrn, “The Effect of Tax Incentives on Manufacturing: Evidence from State Accelerated Depreciation Policies,” Journal of Public Economics 180 (December 2019), https://www.sciencedirect.com/science/article/abs/pii/S0047272719301458; see also Clemens Fuest, Andreas Peichl, and Sebastian Siegloch, “Do Higher Corporate Taxes Reduce Wages? Micro Evidence from Germany,” American Economic Review 108:2 (February 2018): 393–418, https://www.doi.org/10.1257/aer.20130570.
[4] Erica York, William McBride, Garrett Watson, Alex Muresianu, Alex Durante, and Daniel Bunn, “10 Tax Reforms for Growth and Opportunity,” Tax Foundation, Feb. 22, 2022, https://taxfoundation.org/economic-growth-opportunity-tax-reforms/.
[5] Erica York and Alex Muresianu, “The TCJA’s Expensing Provision Alleviates the Tax Code’s Bias Against Certain Investments,” Sep. 5, 2018, https://taxfoundation.org/tcja-expensing-provision-benefits/.
[6] Internal Revenue Service, “How to Depreciate Property,” Publication 946, https://www.irs.gov/pub/irs-pdf/p946.pdf.
[7] REITs are Real Estate Investment Trusts, and RICs are Regulated Investment Corporations.
[8] U.S. Census Bureau, “2022 Capital Spending Report: U.S. Capital Spending Patterns 2011-2020,” Annual Capital Expenditures Survey, Apr. 5, 2022, https://www.census.gov/library/publications/2021/econ/2021-csr.html.
[9] Erica York, Huaqun Li, Daniel Bunn, Garrett Watson, and Cody Kallen, “The Economic, Revenue, and Distributional Effects of Permanent 100 Percent Bonus Depreciation,” Tax Foundation, Aug. 30, 2022, https://taxfoundation.org/permanent-100-percent-bonus-depreciation-effects/.
[10] Ibid.
[11] “SOI Tax Stats – Corporation Income Tax Returns Complete Report (Publication 16),” Table 13, https://www.irs.gov/statistics/soi-tax-stats-corporation-income-tax-returns-complete-report-publication-16.
[12] See Jagannathan, Ravi, David A. Matsa, Iwan Meier, and Vefa Tarhan. “Why Do Firms Use High Discount Rates?” Journal of Financial Economics, forthcoming, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2412250.
[13] Internal Revenue Service, “Publication 946: How to Depreciate Property,” https://www.irs.gov/publications/p946.