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Econometric Advisors' blog

The Tax Reform Act: The expensing of investment

Jan 19, 2018, 16:31 PM by Bill Wheaton

For years, many economists have advocated for “expensing” investments—depreciating and deducting their full value in the year they are put into operation. The new Tax Reform Act provides for a new and novel way to depreciate new capital investment—plant, equipment and buildings. Purchase of existing assets will still follow a more traditional, long-term depreciation schedule.

Expensing new investment will likely have a significant impact. It will encourage the replacement of older, less productive capital with newer capital. This will increase the rate of investment for the U.S. economy, which, per traditional macroeconomic thinking, would stimulate both short- and long-term rates of economic growth. In theory, expanding the capital stock should boost overall worker productivity (based on capital/labor ratios) as well. And wages rise with increases in productivity (also in theory). But in the current context, expensing raises two concerns.

  1. There is great intellectual debate and much concern among the populace about automation displacing and replacing workers rather than helping them. New plant and equipment, stimulated by expensing, will surely involve significant automation, employing robots and guided by artificial intelligence. This may hurt job creation rather than help it. Jobs that remain will no doubt be more productive (as such, warranting greater wages), but the impact of displaced workers might keep a lid on such wage gains.
  2. For real estate in particular, the expensing of new investment is a huge incentive to build new structures: shopping centers, industrial parks, offices. However, these property markets are not exactly crying out for more investment at present. In particular, retail space finds its demand waning as consumers shift to internet shopping. Industrial space demand has been healthy but a building boom is already underway in the sector. In the office sector, hoteling or co-working, which some believe will lower demand for aggregate space, is causing some discomfiture. Expensing could generate new building construction precisely when more space is not warranted by property fundamentals.

The last time something similar occurred was over 1982-1986, with the Reagan Economic Recovery Tax Act. Accelerated depreciation was applied to both new and existing assets, and it did encourage new investment. In real estate, this proved to be particularly troublesome for the apartment sector, which became so overbuilt (construction was twice today’s worrisome levels) that rents subsequently sagged for a decade.

Expensing should definitely encourage new investment, but the lesson is: be careful of what you stimulate with tax policy. It may not be what is needed, and it may have unintended consequences down the road.


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