Guest Post: Why The New Obama Capital Investment Write Off Will Do Little
Submitted by Mark Mansfield of Mark's Market Analysis
Why the New Obama Capital Investment Write Off Will Do Little
I am strongly thinking that Barack Obama has never taken an accounting class in his life and therefore believes that he is giving business some wonderful incentive they never had before. But that is quite simply not the case. Business capital investment is already tax beneficial and written off, it is just written off over time through depreciation. The Obama write-off would simply be an acceleration of depreciation to the first year.
Under what scenarios would this be beneficial to business?
The Obama write-off of capital investment spend in year 1 would be beneficial two those companies which believe that interest rates will go up in the future, will have either a flat or decreasing rate of future taxation, and use traditional capital budgeting methods to assess projects. The rising interest rate scenario means that future cash flows will not be worth as much as cashflows today or in the near term because of the effect of discounting. Given the effect of discounting, your project NPV would be higher under a flat or increasing interest rate regime, all other things being equal.
Additionally if you believe your taxes will either stay the same or go down, you wouldn’t have any reason to forestall taking the write-off. I believe that given the level of current interest rates, that it would be fair to say rates will go up in the future and thus some companies may choose to take the “instant write-off” offered by Obama. However given that we are only talking about the time value of a tax benefit, likely a small total component of the capital budgeting equation, I have a hard time believing this will be a significant motivating factor that will cause businesses to approve projects they would otherwise toss out.
Under what scenarios would this not be beneficial for business?
If you instead belief that deflation will take hold or that your tax rate will go up in the future, you wouldn’t be too eager to jump on the year 1 instant write-off idea. Deflation would mean that dollars are worth more tomorrow than they are today, therefore you would wish to forestall a benefit from the current time to the future. Probably not a huge part of the analysis for business, but theoretically it is relevant. A much more important consideration to businesses in evaluating this opportunity is taxation. Do you have a low tax rate today or a low effective tax rate? The first question is a political one. You may believe that under Obama or just as a result of the large deficits that we must conquer, that future tax rates will be higher. You may not be thinking of future legislation, but you may just anticipate that your income will go up in the future and thus you will be in a higher tax bracket or have other cause for a higher effective rate in the future. In either case, you would want to “save the tax benefit” of depreciation for a later time when it is more beneficial to you. This would be most acutely true if you paid no taxes today at all as a result of negative income, but you thought you would become income positive over the next few years. You would want the benefit of depreciation in those years, not today.
And what of “small business?”
Small businesses in most cases do not likely perform any sort of complex capital budgeting analysis, but rather make decisions more intuitively. I am certain small business owners would appreciate the tax argument as I have made it. But for small businesses, the crucial issue is not the tax deductibility of capital equipment, but rather the availability of credit to buy that equipment in the first place as well as the end demand that would necessitate it. You may well have demand for your product and thus demand for capital equipment to build that product, but if you do not have credit, you cannot buy that equipment. Similarly, if demand is still weak, and I have many reasons to believe it is, than you are not going to buy that equipment no matter what write down you are going to get.
Businesses make decisions about capital investment based on demand, profitability, and credit availability. Under the current taxation regime, capital equipment is already fully written down over time. All the new Obama plan does is accelerate that write-down to the current year. The cost savings that will result will be purely the product of discounting. Additionally firms which believe their taxes will go up, will want to forestall the benefit of equipment depreciation to later years so as to better match up with their anticipated tax liability. For a company paying no tax at all today due to negative earnings, Obama’s plan will not be beneficial. Altogether, I have no reason to believe that Obama’s Capital Investment Write-off Plan will do much to spur businesses to purchase durable goods.