Tuesday, September 07, 2010

A Small Step in the Right Direction

The Obama administration is now proposing that businesses be allowed to expense investment expenditures.  That is, for purposes of calculating taxable income, businesses would be able to fully and immediately deduct the cost of equipment, rather than having to gradually deduct the cost via depreciation allowances.

This is a good idea.  People are feeling poorer and more uncertain about the future.  The rational response is greater saving.  The trick to restoring aggregate demand and full employment is to channel that saving into investment.  Normally, the Fed can help by lowering interest rates.  But with interest rates at the zero lower bound, that option is not available.  Tax incentives for investment can help achieve what monetary policy would if it could.

However, the impact will be relatively modest. Notice that expensing merely accelerates deductions. Thus, the value to the firm depends on interest rates. With interest rates near zero, the impetus to investment is small. Put another way, this policy can be seen as giving firms a zero-interest loan if they invest in equipment. But with interest rates near zero anyway, the value of the loan is not that great.

One can imagine more aggressive policies along similar lines, such as an investment tax credit together with expensing.  But let's not make the best the enemy of the good.  This policy proposal is a step in the right direction.  I hope Congress passes it quickly and in a bipartisan fashion.