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Tuesday, November 8, 2011

Small Business Expensing Allowance: Current Law, Legislative Proposals in the 112th Congress, 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 taxpayers to expense (or deduct as a current expense rather than a capital expense) up to $500,000 of the total cost of new and used qualified depreciable assets they buy and place in service in 2011, within certain limits. The allowance begins to phase out, dollar for dollar, when a taxpayer’s total spending on qualified assets surpasses $2,000,000. This means that the taxpayer may expense none of the cost of qualified investments when total expenditures exceeds $2,500,000 in 2011.

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

This report examines the current status, legislative history, and salient economic effects of the allowance. It also discusses initiatives in the 112th Congress to modify it. The report will be updated as legislative activity warrants.

Broad bipartisan support for the allowance has been a mainstay of congressional consideration of small business tax issues in recent years. There is no evidence in the 112th Congress that this support has waned. A handful of bills have been introduced in the House and Senate to permanently extend a more generous allowance than is allowed under current law. For example, H.R. 1773 would permanently set the maximum allowance at $250,000 and the phaseout threshold at $800,000, beginning in the 2012 tax year; and S. 727 would permanently allow qualified small firms to claim an unlimited Section 179 allowance.

Going back to 2003, the allowance has served as one of several tax incentives for stimulating the U.S. economy. This raises the question of how effective the Section 179 allowance has been in promoting economic growth. Though no studies have been done that address the economic effects of the enhanced Section 179 allowances that were enacted in the previous eight years, several studies have been done on the economic effects from 2002 to 2004 of the 30% and 50% bonus depreciation allowances that were then available. The allowances covered most of the property that was eligible for the Section 179 allowance. Basically, the studies found that accelerated depreciation in general is an ineffective tool for stimulating the economy. Take-up rates for the allowances were lower than expected, and, of the firms that claimed them, only 10% said that the allowances played a decisive role in determining the timing and size of qualified investments.

Available evidence, as incomplete as it is, indicates that the Section 179 allowance probably has no more than 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 in favored assets by reducing the user cost of capital and increasing the cash flow of firms that use those 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 larger after-tax returns than investments not favored by the Section 179 allowance that may lead to more productive outcomes. At the same time, the allowance has the advantage of simplifying tax accounting for depreciation for firms that take it.

Date of Report: November 1, 2011
Number of Pages: 19
Order Number: RL31852
Price: $29.95

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