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Wednesday, September 29, 2010

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

Gary Guenther
Analyst in Public Finance

Expensing is the most accelerated form of depreciation for tax purposes. Section 179 of the Internal Revenue Code (IRC) allows a taxpayer to expense (or deduct as a current expense rather than a capital expense) up to $250,00 of the total cost of new and used qualified depreciable assets it buys and places in service in 2010, within certain limits. The allowance begins to phase out, dollar for dollar, when a taxpayer’s total spending on qualified assets surpasses $800,000 in 2010 which means that the taxpayer may expense no amount of qualified investments when total spending exceeds $1,050,000.

Firms unable to take advantage of the Section 179 expensing allowance in 2010 can recover the cost of qualified assets over a longer periods, 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 examines the current status, legislative history, and economic effects of the allowance and discusses initiatives in the second session of the 111
th Congress to modify it. The report will be updated as legislative activity warrants.

There appears to be broad bipartisan support in the current Congress for using the allowance as a tool to stimulate the economy. Several bills to extend the current enhanced allowance (which was first enacted as part of the Economic Stimulus Act of 2008, P.L. 110-185) were introduced before the passage of the American Recovery and Reinvestment Act of 2009 (ARRA, P.L. 111-5). ARRA extended that allowance through 2009, and the Hiring Incentives to Restore Employment Act of 2010 (P.L. 111-147) further extended it through 2010. Congress is now considering several proposals to further enhance and extend the current allowance, including H.R. 5297. On September 14, the Senate approved a motion to invoke cloture on S.Amdt. 4954 to the Housepassed version of H.R. 5297, paving the way for the amendment’s passage; the amendment would increase the expensing allowance to $500,000 and the phaseout threshold to $2 million in 2010 and 2011. President Obama recently proposed allowing companies of all sizes to expense the entire cost of any qualified investments they make through the end of 2011.

Available evidence indicates that the Section 179 allowance has a minor effect on the level, composition, and allocation among industries 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 the 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 has the potential to restrain economic growth by encouraging a greater flow of capital into investments that may produce lower pre-tax returns than investments not favored by the Section 179 allowance. At the same time, the allowance has the advantage of simplifying tax accounting for small firms able to claim it.

At the same time, the allowance has had limited usefulness as a tool for economic stimulus in the past decade. Small business owners have come to expect temporary enhancements of the allowance to be extended indefinitely, lessening its incentive effect. The design of the allowance limits this effect to smaller companies. And available evidence suggests that an increase in the allowance is more likely to impart a significant stimulus to small business investment during an economic expansion than during a recession.

Date of Report: September 15, 2010
Number of Pages: 19
Order Number: RL31852
Price: $29.95

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