Is it Time to Rationalize Depreciation Policy?

Is it Time to Rationalize Depreciation Policy?C. Eugene Steuerle"Economic Perspective" column reprinted withpermission.Copyright 2001 TAX ANALYSTSThe nonpartisan Urban Institute publishes studies, reports,and books on timely topics worthy of public consideration.The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees,or its funders.© TAX ANALYSTS. Reprinted with permission.[1] Depreciation policy seems to be back on the table for the first time since the mid-1980s. Technology,electronics, and related companies are claiming that the depreciation lives for some of their equipment aretoo long. Thomas Neubig and Stephen Rhody suggest that these are among a variety of distortions that havenow arisen from using old depreciation class lives (Tax Notes, May 29, 2000, pp. 1267-1273). Real estatefirms grumble about the lives granted for real estate. (See also Tax Notes, July 23, 2001, p. 461.) At theNational Tax Association Spring Symposium this year, Jane Gravelle suggested that structures indeed may befavored relative to equipment. In the energy bill recently passed by the House of Representatives, the lives ofseveral types of property were shortened as an incentive for energy exploration and production. [2] What are the best depreciation policies for the nation? Will they treat businesses on an equal basis beforethe law? [3] To answer those questions, we often rely on the Treasury Department to articulate a coherent approachto this policy based on principles. Its 2000 Report to the Congress on Depreciation Recovery Periods andMethods helps but does not fully articulate how policy should proceed or how the new administration viewsthe issues. If Treasury doesn't set up the rules under which policy development is to take place, the policy islikely to evolve in dribs and drabs, lack coherence, and discriminate significantly against some businesses inthe process of favoring others, and effectively reduce national income. [4] Since World War II depreciation policy has been reconsidered several times. Accelerated depreciation,investment credits, and then the accelerated cost recovery system (ACRS) in 1981 all tended to reduce thecost of capital by accelerating when deductions would be taken or, in the case of the investment credit, bygranting an immediate credit rather than deduction. Although many argued that these changes werenecessary to encourage business investment, the entire period up to the adoption of ACRS was also one ofcontinually higher inflation rates. Because the cost of property is deducted only over time, higher rates ofinflation effectively reduce the real value of the deductions -- denying the full write-off of the real value ofpurchases made -- and thus providing partial justification for greater acceleration. [5] Then in 1986, in exchange for lower rates of tax on capital at both the corporate and individual levels,Treasury proposed a form of depreciation that was close to economic depreciation -- the attempt to allowdeductions that approximate the real economic loss associated with owning such property. Treasury alsoproposed that such allowances be indexed for inflation so that the real -- not the nominal value -- of suchproperty could be depreciated. Congress did not wholly accept the Treasury position, but it did make the livesof property conform more to what were then thought to be the actual periods of time over which property wasused. However, it did not allow for inflation adjustments, partly out of concern over whether theseadjustments could practically be made for capital gains and interest as well. [6] With perhaps the major exception of structures (Congress increased the period over which structurescould be deducted primarily as a revenue raising measure in 1993), the 1986 compromise has held up.Indeed, corporate policy as a whole has remained relatively stable since 1986, with some small exceptionssuch as the corporate tax rate being raised by 1 percentage point (as a revenue raising measure) in 1993. [7] At the same time, one important mechanism for making future adjustments -- in effect, testing the claimsmade by technology firms and holders of real estate today -- was abandoned. The Office of DepreciationAnalysis, created as a result of the 1986 legislation, went out of business a few years later. Some businesseslobbied against it, almost surely because they feared that the lives of some of their assets would be declaredtoo short. At the same time, the office had trouble gathering the necessary data it needed from manyDocument date: August 17, 2001Released online: August 17, 2001 businesses. [8] One consequence of its abandonment, however, has been the lack of detailed examination of realdepreciation rates on assets in any consistent manner for some period of time. Not surprisingly, such analysisis needed. The world continues to change. Not only are updates needed for tax purposes, but for nationalincome accounting as well. Not comm