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BONUS DEPRECIATION: JOB KILLER?

September 13, 2004

Blogger Barry L. Ritholtz at "The Big Picture" has a theory that seems counterintuitive. He says "Bonus" depreciation provisions may have actually dampened hiring since they were enacted as an anti-recession measure.

This is counterintuitive because bonus depreciation was intended to jump-start a lagging economy by stimulating capital investment, causing factories to gear up to sell equipment. The Big Picture thinks it may have actually had an unintended side effect:

   The problem seems to be that a large 
   percentage of the capital purchases 
   have been made in the software sector: 
   Enterprise-wide applications make 
   companies more efficient, productive 
   and competitive. So efficient in fact 
   that it reduces (or even eliminates) 
   the need for additional hiring.

   Our channel checks confirmed that 
   suspicion: CIOs and CTOs, especially 
   at small and medium sized firms, have 
   been aggressively purchasing these 
   enterprise apps over the past 2 years. 
   Firms that design these ERPs market 
   them as "paying for themselves" in a 
   few years specifically, in labor 
   savings. The tax advantage of 
   accelerated depreciation provided 
   management with an incentive to install
   these apps sooner rather than later.

The Tax Update's old economy mindset has been that when the bonus depreciation expires at the end of the year, equipment vendors might be left with empty order books for the first few months 2005 because purchasers would pre-buy their anticipated needs in 2004, before bonus depreciation expires. This, we figured, would tend to dampen the economy for the first half of 2005.

The Big Picture thinks it may work otherwise:

   There is reason to hope that hiring 
   will begin to swing upward in 2005. 
   With the tax incentive to choose 
   equipment over labor removed, there 
   will be one less obstacle in the way 
   away of corporate hiring. And if that 
   were to occur, it would bode well for 
   further economic expansion.

We're accountants, not economists, but we've always thought increased capital investment is good for jobs, long-term. Maybe the expiration of bonus depreciation will indicate whether there is a short term "crowding out" of jobs when there are capital equipment purchase incentives. If so, it calls into question investment incentives like bonus depreciation, the defunct investment credit, and many state investment incentives. It would also be an argument against fine tuning the tax system for non-revenue purposes, as well as an illustration of the unintended consequences of well-intended laws.

On the bright side, the empty order books of equipment suppliers in the first half of 2005 -- which Mr. Ritholtz anticipates -- may not necessarily translate into a slow employment market.

PS: This post is one of many on this week's Carnival of the Capitalists. Check it out.

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