Bring up bonus depreciation at a party, and you’ve guaranteed an early end for the festivities.
But it’s bonus depreciation that should have been put to bed long ago. Instead, the business tax benefit is taking center stage in one of the Maine Legislature’s most significant debates so far this year.
The debate is over a proposal from Gov. Paul LePage’s administration to conform Maine’s state tax laws with the federal code after Congress’ December 2015 passage of the Protecting Americans from Tax Hikes Act.
That piece of federal legislation extended the lives of a number of tax cut provisions that were due to expire at the end of 2015. Bonus depreciation was one of them. Congress voted to apply it retroactively to the 2015 tax year and extend its life through the end of 2019.
The federal tax code has long allowed businesses to claim a tax benefit as the value of business equipment — say, a machine on the assembly line — depreciates over time. Under normal circumstances, a business might claim its equipment has lost 10 percent of its value in a year and deduct that 10 percent from its taxable income each year.
Bonus depreciation accelerates that schedule, so the IRS now allows a business to deduct 50 percent of the equipment’s value from its taxable income in the equipment’s first year. So, if a business adds onto its facility to expand manufacturing capacity or buys a new truck, it can deduct half the value of that investment from its taxable income in Year 1 and claim smaller deductions in subsequent years as the equipment’s value continues to fall.
The LePage administration wants corporations, on their Maine tax returns, to be able to claim a bonus depreciation credit that’s worth 9 percent of the federal benefit. Business owners who claim business income on their individual tax returns would be able to claim 8 percent of the federal benefit for 2015 and 7 percent for 2016 through 2019.
The state would give up $23 million in revenue over the next two years to fund the tax breaks, according to Maine Revenue Services. Bonus depreciation is the largest part of the $38 million tax conformity package.
There are a number of reasons lawmakers should reject this state-level bonus depreciation with a questionable funding source.
When Congress first passed bonus depreciation in 2002, the intent was to provide a temporary economic stimulus — an incentive for businesses to make equipment investments at a time when the economy was slow. Indeed, that bonus depreciation provision — which allowed businesses to deduct 30 percent of an equipment’s value in the first year — lasted for three years.
But the fact that the tax conformity bill, LD 1564, is retroactive to last year removes the effect of bonus depreciation as an incentive to make an investment. Instead, it’s a reward for investments that businesses have already made. And the fact that bonus depreciation is now effectively permanent (the federal benefit has consistently been in effect since 2008, and a state-level benefit has been in effect since 2011) further removes the provision’s effectiveness as a temporary incentive.
But even as a temporary incentive, bonus depreciation’s effectiveness is minimal at best. According to a 2014 Congressional Research Service review of the policy, bonus depreciation influenced the timing of equipment investments at small firms, but most of the financial benefits flowed to the largest businesses. Leaders of those businesses say that bonus depreciation rarely factors into their decisionmaking.
“Overall, bonus depreciation did not appear to be very effective in providing short-term economic stimulus compared to alternatives,” the Congressional Research Service concluded.
If the policy’s effects are contained to the timing of investment decisions, that’s surely not a reason to make a marginally effective incentive permanent. Plus, Maine already has permanent state- and local-level tax benefits in place for business equipment: The Business Equipment Tax Exemption shields qualifying equipment from property taxes.
Instead of bonus depreciation, then, we’re confident Maine could find ways to spend $23 million over the next two years that could produce a more meaningful return on investment.