ITEP and depreciation

One week ago I gave an example to show how accelerated depreciation can lower a corporation’s “effective” tax rate (link). I assumed X Corp makes a capital expenditure, which it depreciates over 5 years for GAAP accounting, but is all deducted immediately for income tax purposes. For the 5 years combined, the total depreciation for GAAP and tax purposes are equal. The difference between the two series is a matter of timing. To keep it simple I said nothing about what X Corp would do with its initial tax savings.

ITEP published two articles critical of accelerated depreciation on November 19:

- New ITEP Report on Depreciation Breaks: The Most Important Tax Giveaway that People Don’t Know About

- The Failure of Expensing and Other Depreciation Tax Breaks

The first article gives a link to the second one. The second article shows two tables labeled Table 1a and Table 1b. Table 1a shows the GAAP depreciation and Table 1b tax deductions for accelerated depreciation. Over 20 years the sum of depreciation and tax deductions are equal. The authors follow with: “The final line in both Tables 1a and 1b illustrates the present value of the after-tax profits in each year. ... Taking into account the “time value of money” in this way, we see that the investment generates an after-tax profit of $1,020 if economic depreciation applies and $1,888 if full expensing is allowed.”

The last sentence suggests the company benefits from accelerated depreciation. On the other hand, the federal government collects the same sum of taxes either way, so the federal government gets no extra benefit from allowing accelerated depreciation.

The first ITEP article calls accelerated depreciation a giveaway and an interest-free loan. A giveaway and a loan are not the same, so which is it?

Their analysis, backed up with the math, appears persuasive. However, there is something missing. What will the company do with its initial tax savings? Table 1b assumes nothing, which fits with the authors’ saying that the federal government in effect makes an interest-free loan. That is a weak assumption. Assume instead the company invests its initial saving of $1995 to earn 5% taxable interest yearly, drawing down the savings in years 2-20 to pay the difference in taxes, $128 - $23. Per my calculation the amount of interest each year averages – it varies slightly – $95.27. The federal government will collect an average of $95.27 * 21% = $20.28 more in taxes annually. For 19 years that is $385 more than the $462 taxes shown in each table! The federal government in effect makes a loan at 5%*21% = 1.05%. That’s not interest-free, but it is low.

Assume instead the company invests the initial savings to earn 6.1% taxable interest yearly (the same as the $10,000 machine). Then for 19 years the federal government will collect $539 more than the $462 taxes shown in each table! The federal government in effect makes a loan at 6.1%*21% = 1.28%. That’s still low, but not zero.

I am neither much in favor nor much against accelerated depreciation. If, unlike the authors assume, the accelerated depreciation is used by a company that eventually loses money rather than making a profit, the federal government’s overall tax revenue is less than zero. It’s a money loser. The accelerated depreciation is not quite like a tax credit, which is more a giveaway than a loan. However, in money losing cases, it has a similar de facto effect as a tax credit.