As the country continues to battle the health and economic crises brought on by the coronavirus pandemic, leaders and policymakers in Washington are considering a number of tax-related measures to hasten recovery and stimulate the economy in the wake of this generational crisis.
One such proposal would expand full and immediate expensing ability to include structures. The popular thinking is that this measure would incentivize companies to invest in U.S. facilities, including and especially those companies that historically have opted to offshore much of their manufacturing.
While the proposal is well-intentioned, if enacted it would have far more negative consequences, and far fewer benefits, than many people realize.
It is important to remember that the tax reforms of the 1980s tried this approach, accelerating depreciation to 15 years for real estate in an attempt to stimulate the economy. While thoughtfully considered, this measure resulted in massive overbuilding and the use of real estate as a tax shelter, a dynamic that contributed significantly to the savings and loan/real estate crisis of that time.
As a result, the depreciation schedule for structures was eventually lengthened to better reflect the true useful life of a structure or real estate. While measures were put in place to try to prevent entities using the construction of buildings as a tax shelter, there are ways to get around the rules. Expanding immediate expensing to include structures today would incite the same unintended consequences the U.S. experienced in the 1980s.
Some economists continue to claim that immediate expensing of structures, to include manufacturing plants, office buildings, and commercial real estate, would contribute substantially to the growth of gross domestic product and encourage companies to return to the United States. These assumptions are flawed, however, as they do not account for the tax consequences and restrictions unique to real estate, which prevent immediate expensing for structures and buildings from yielding the same economic benefits that may result if applied to other capital expenditures.
These models also do not reflect the very real dynamics of a post-COVID-19 business environment. In the last few days, some of our country’s largest employers including Facebook and Twitter have offered their employees extended teleworking flexibility well after a phased reopening of America begins. COVID-19 has shown that through technology, a large number of employees are capable of being highly productive working from home, providing an opportunity for companies to shed tremendous office space costs from their books, and leaving uncertainty about the future need for office space in the United States. We cannot afford a situation where office buildings are built for tax benefit rather than market need.
Most economists’ models demonstrating GDP growth from the inclusion of real estate in full and immediate expensing do not factor in basic real estate tax rules, such as recapture taxes, passive loss, basis, at-risk limitation rules, or other market drivers, as well as company valuations and shareholder requirements. They also often rely on European data that fails to effectively reflect U.S. economic realities. As a result, many of these models overstate both the increased investment that would result from immediate expensing, as well as the extent to which immediate expensing would incentivize U.S. companies to re-shore production lines and facilities currently located overseas.
Also of great concern is the possibility that providing immediate expensing for structures will greatly increase the incentive to utilize debt financing, which many economists believe is already too attractive.
Take, for example, an investor purchasing a $10 million building with $8 million in debt financing and just $2 million in equity. Under immediate expensing, that investor would receive a $10 million tax write-off despite having only expended roughly $2 million. This is a dangerous tax loophole that could hinder the U.S. recovery from the economic fallout of COVID-19.
Finally, there is the cost. The most recent estimate conducted by the Tax Foundation found that providing full and immediate expensing for structures would cost the U.S. Treasury nearly $1 trillion over the next 10 years. While many agree that repairing the damage COVID-19 has wrought to our economy will require significant and innovative government support, there are better ways to stimulate growth and encourage U.S. companies to re-shore their innovation and manufacturing capabilities that do not carry the same unintended consequences.
There are much stronger alternatives to immediate expensing that will bring companies and innovation back to the United States and support small businesses in the wake of COVID-19.