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Monday, March 22, 2010

Small Business Expensing Allowance: Current Status, Legislative Proposals, and Economic Effects

Gary Guenther
Analyst in Public Finance

Under Section 179 of the Internal Revenue Code (IRC), a business taxpayer is allowed to expense (or deduct as a current expense rather than a capital expense) up to $134,00 of the total cost of new and used qualified depreciable assets bought and placed in service in 2010, within certain limits. A more generous allowance ($250,000) was available in 2008 and 2009, as a countercyclical measure. Assuming no change in current law, the maximum allowance is set to drop to $25,000 in 2011 and thereafter, with no adjustment for inflation. The allowance begins to phase out, dollar for dollar, when a taxpayer's total spending on qualified assets surpasses $530,000 in 2010—which means that it may expense no amount when spending exceeds $664,000. This phaseout threshold, which was set at $800,000 in 2008 and 2009, is scheduled to fall to $200,000 in 2011 and thereafter, also with no adjustment for inflation. 

Firms unable to take advantage of the Section 179 expensing option may recover the cost of acquiring qualified assets over a longer period, using the appropriate depreciation schedules. While the expensing allowance is not targeted at firms that are relatively small in employment, asset, or receipt size, the rules governing its use confine most of its benefits to such firms. 

This report focuses on the current status, legislative history, and economic effects of what might be called the small business expensing allowance. It also discusses legislation being considered in the second session of the 111th Congress to modify the allowance.

There was bipartisan support in recent Congresses for enhancing the expensing allowance, and backing for the allowance has shown no sign of waning in the current Congress. Several bills to extend the current enhanced allowance were introduced before the passage of the American Recovery and Reinvestment Act of 2009 (ARRA; P.L. 111-5). ARRA extended through 2009 an enhancement of the allowance first enacted in 2008. Congress is now considering whether to extend that version or to make it more generous. On February 24, 2010, the Senate passed an amended version of H.R. 2847 (S.Amdt. 3310) that includes an extension of the 2009 allowance through 2010; a version of the Senate-passed bill approved by the House on March 4 included the same provision. President Obama has expressed support for such an extension. 

The Section 179 allowance appears to have a minor effect on the composition and allocation of business investment, the distribution of the federal tax burden among income groups, and the cost of tax compliance for smaller firms. These effects correspond to three traditional criteria for evaluating tax policy: efficiency, equity, and simplicity. On the one hand, the allowance has the potential to spur increased small business investment by reducing the user cost of capital and increasing the cash flow of firms that use qualified assets. On the other hand, it can harm economic welfare by discouraging a greater flow of capital into more productive investments. At the same time, the allowance appears to have no measurable impact on the distribution of the federal tax burden among income groups, but it simplifies tax accounting for firms claiming it. 

There are several reasons why it can be argued that the allowance has limited usefulness as a tool for economic stimulus. Business expectations about the duration of a temporary enhancement of the allowance can lessen its incentive effect. The design of the allowance limits its potential to affect economic activity. And a temporary increase in the allowance is likely to impart a greater stimulus to small business investment when it is least needed—during an economic expansion— than during a recession when it is most needed.

Date of Report: March 8, 2010
Number of Pages: 17
Order Number: RL31852
Price: $19.95

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