In my last post, I suggested that temporary bonus depreciation rules, enacted pursuant to the Economic Stimulus Act of 2008, were likely to reduce job growth and depress wages through the end of this year, and perhaps beyond.
And yet we all know, in our heart of hearts, that investment in equipment is a good thing. This post will explain how both can be true – that is, how tax incentives to purchase equipment can both hurt wage-earners in the short run and help the economy in the long run. And it will explain why more is at stake than just bonus depreciation.
The simplest way to understand how investment incentives work is to focus on the real economy, by which I mean real investment and real consumption. Ignore cash flows. Money is merely an accounting system that makes the real economy possible. Focus instead on what is really being produced and used, and by whom.
In the real economy, additional equipment purchases are the equivalent of savings. Instead of eating all that our economy produces, we put some aside to generate future product. The more we save, the fast our economy grows.
In other words, if tax incentives to purchase equipment work and have no adverse side effects, our economy should grow faster in the long run. Hence our intuition that investment in equipment is a good thing.
But this raises two obvious questions: Who is not consuming? And who ends up owning the resulting wealth?
The answer to the first is simple: Under bonus depreciation, the unemployed workers and workers whose wages are depressed consume less, thus freeing up real capacity for equipment production. Tax incentives for business investment force wage-earners not to consume – in real economic terms, to save.
The answer to the second is equally clear: The newly purchased equipment ends up being owned by the owners of capital, not by the wage-earners who were forced to forego consumption. In other words, in addition to forcing wage-earners not to consume, tax incentives for business investment transfer the resulting savings to owners of capital. Robin Hood in reverse, if you will. (Some of these owners are American, many are not.)
In my last post, I noted that Sen. McCain proposes to enact even more favorable rules for business equipment purchased between 2009 and 2013. He is not, however, the first to advocate such rules. He is merely echoing a number of tax academics and economists, many of whom are liberal Democrats.
For quite some time now, many tax academics and economists have urged that the United States shift to a consumption tax. Under such a tax, businesses would be allowed to expense equipment purchases without limitation. In other words, the super-bonus-depreciation rules that Sen. McCain wants to implement for five years would become a permanent part of the U.S. tax system.
The main argument for such a change is that under a consumption tax, the U.S. economy would grow more quickly.
This is true.
Like temporary bonus depreciation, a consumption tax would have the effect of depressing job and wage growth, forcing some wage-earners to forego consumption. The economic capacity thus freed-up would be diverted to real capital investment, enabling the economy to expand more quickly. That’s the good news.
The bad news (or not, depending on your perspective) is that ownership of this new capital would vest in the owners of capital. In other words, permanent Robin Hood in reverse.
There are other ways to stimulate capital investment. I, for one, believe we should think more about the collateral effects of investment tax incentives before making them permanent - indeed, before using them at all. In any event, using such incentives for short-term stimulus purposes doesn’t make sense.