Tax cuts could help lend Jerome Powell helping hand
The supply side of the economy is not producing enough goods to keep up with demand
Less than two weeks after President Biden signed the Inflation Reduction Act (IRA) into law with great fanfare, Federal Reserve Chairman Jerome Powell effectively brushed away the rhetorical relevance of the bill by declaring that the Fed would "use our tools forcefully" to address inflation which, he cautioned, could cause "some pain to businesses and households."
Lawmakers in Washington can wait for the Fed to potentially cause a recession then scramble to mitigate the damage.
Or they can take proactive action to bolster the production side of the economy by making one of the most pro-growth elements of the 2017 Tax Cuts and Jobs Act (TCJA) permanent: 100% bonus depreciation.
The common definition of inflation is too much money chasing too few goods. In other words, the supply side of the economy not producing enough goods to keep up with demand.
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The Fed’s actions to raise interest rates — causing "some pain to businesses and households" — is an attempt to address only one side of this equation: reduce demand.
However, economists on the left and right are understandably concerned that the Fed’s actions could depress demand so much as to trigger a recession.
What is missing from this inflation reduction strategy are policies that spur the production side of the economy. Naturally, administration officials will point to the recently enacted CHIPS and Science Act of 2022 and the IRA as efforts to spur the production of microprocessors and climate-related technologies.
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But government-subsidized attempts to pick winners and losers are no substitutes for policies that promote broad-based investments in the kind of tools, machinery and facilities that create jobs and boost real economic growth.
Fortunately, lawmakers don’t have to enact any new policies to spark this kind of new investment. They only need to prevent a policy that is already in place from expiring beginning in about four months: 100% bonus depreciation.
The policy allows businesses to expense or write off the purchase of tools, equipment and machinery the same year in which they were purchased.
Why is this economically important? Under previous tax law, these investments had to be depreciated over many years according to arcane rules. Because a deduction taken in the future is less valuable than a deduction taken today, this raised the tax cost of replacing old equipment with newer, more productive equipment. Bonus expensing reduces the tax cost of equipment purchases to zero. And, because it is available to all firms equally, it doesn’t play favorites.
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Tax Foundation economists recently modeled the economic effects of making bonus depreciation permanent and found that doing so would increase the long-run size of the economy by 0.4%, the capital stock by 0.7%, and the number of full-time jobs by 73,000.
Unlike government-subsidized technology programs, bonus expensing has a proven history of successfully boosting investment, jobs and, in some cases, wages. It was first introduced in 2002 to help the economy after 9/11 and has been a part of tax law in some form almost every year since. Multiple academic studies have measured the positive impact expensing has had on spurring capital investment and jobs.
A 2021 study from the National Bureau of Economic Research determined that because of bonus depreciation, firms boosted their investment in equipment by 7.8% and employment by 11.5%. As importantly, the study found that "bonus [depreciation] led to a relative increase in the shares of young, less educated, women, Black and Hispanic workers."
Contrary to the common notion that bonus expensing would lead firms to replace people with machines, the study found that "capital and production workers are complementary inputs in modern manufacturing." Indeed, the investment in better tools makes workers more productive.
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It is a lot easier to prevent the expiration of good policy than rush to enact uncertain legislation in the midst of a recession.
Scott A. Hodge is president emeritus and Senior Policy Advisor at the Tax Foundation, a nonpartisan think tank in Washington, D.C.