This post is the final in a three-part series, which began with my analysis of the Government’s plan to flatten the tax schedule and continued with its plan to target tax relief at low- and middle-income taxpayers via an expanded tax offset.
In this last part, I’ll cover the Government’s plan to expand its instant asset write-off plan, allowing businesses to immediately write off expenses worth up to $30,000. The key takeaway of this last part is that the plan will likely increase investment, but we ought to think carefully about whether that’s really what we want. If it increases the productive capacity of the economy, then terrific. But if it’s just spending on things businesses don’t really need, then it’s nothing but taxpayer-subsidised waste.
The instant asset write-off was introduced by the Rudd Government in its 2010 Budget with the stated goal of boosting business investment. The policy allows businesses to claim capital investments as expenses upfront rather than having to spread these expenses out over the lives of the assets. That means all the tax benefits of investment today without having to wait. Originally, it covered expenses up to $5,000. In 2015 this was lifted to $20,000 and this year even further to $30,000.
A primer on business taxation
In principle, business taxes are levied on profits—revenues less expenses. And for good reason. By allowing firms to deduct their expenses from their revenues to determine the tax they owe, taxes affect the upside and the downside of an investment equally. Indeed, if you could figure out a way to allow businesses to deduct all of their true costs—in the broadest possible sense—then taxes wouldn’t affect business decisions at all.
When a business only has so-called variable inputs (flour for a bakery), this story is pretty straightforward because expenses are incurred at more or less the same time as revenues are received. In practice, however, businesses have many so-called fixed inputs (an oven for a bakery) where an expense is incurred immediately but its benefits are spread out over time (the ability to bake many loaves of bread over many years).
If the business borrowed to pay for the asset, then there are in theory two basic ways these kinds of expenses could be recognised at tax time. The first is if the business is able to claim as annual expenses on its tax return the interest on the loan plus the value of the asset’s lost productive capacity in that year (we call this economic depreciation). The second is if the business is not able to claim the interest expenses but is instead allowed to claim the entire value of the asset as a single expense in the first year.
These two methods each have pros and cons for the business. The second lets you claim more now which lowers your tax bill today but then you lose the ability to claim your interest expenses in future years which raises your tax bills in the future. It turns out that these two methods are conceptually equivalent—in an ideal world, businesses should be indifferent between them. Neither encourages nor discourages investment relative to a world without taxes.
The problem with the first method is that it’s impossible for the ATO to determine for every single asset held by every single business the true rate of economic depreciation. In practice, it formulates standardised depreciation schedules for different circumstances (for example, straight-line depreciation that allows a fixed portion of the asset to be written off each year). But this is necessarily imperfect, so businesses inevitably will either be under- or over-compensated so they’ll either under- or over-invest.
What the instant asset write-off does is to allow businesses to claim the entire value of the asset as an expense upfront, as with the second method, but it also allows them to continue to claim their interest expenses in future years. So they get the upside of both methods but none of the downsides. For an asset with, say, a 10-year lifespan, this over-compensation could represent a significant financial benefit. So in theory this should encourage firms to invest more.
Will the instant asset write-off encourage investment?
Mostly because of limited data availability, we have little Australian evidence of the effect of taxes on businesses. This is a shame because there’s a long history of policy changes in this area offering ample opportunity to assess how well tax policies have worked in practice. This is improving with initiatives like the ATO’s ALife database covering personal taxation, but governments of both stripes could do a lot more to support the development of a strong local evidence base to guide tax policy.
Evidence from the US (here, here and here) and the UK (here), where the business tax systems are somewhat different, suggest these kinds of policies can have a significant effect on the quantity of business investment. But what they don’t tell us much about is the quality of that investment. You often see commentators talk about business investment like it’s a commodity—a homogeneous good like salt or wheat of which only the quantity matters. The more of it the better, never mind the details.
But that couldn’t be further from the truth. Businesses face complex choices along countless dimensions. Not all investments are created equal. In the absence of taxes, there are a whole range of investments that businesses would deem unworthy. Replacing your perfectly functional, if a bit tired, delivery van with a brand new one, for instance. But if offered a tax incentive, you might be nudged into doing it.
Investment would go up. So would GDP. Mission accomplished.
Tax policy shouldn’t push or pull, but get out of the way
Not so fast.
Tax policy can absolutely be used to manipulate behaviour. But in its most basic form, it’s about collecting the money we need to fund schools, hospitals and pensions. In doing so, tax architects follow their version of the Hippocratic oath—first, do as little harm as possible. We assume people do what’s best for them, so we want to shunt them off their intended course as little as possible.
When it comes to taxing businesses, that means we want businesses to innovate, to invest, to hire and pay their workers just as they would if we didn’t tax them. We want a baker to buy a new oven, but only if they would see it as prudent in a world without taxes—we don’t want taxes to deter them from buying the new oven they need, but we also don’t want to encourage them to buy a new oven when the old one works just fine.
You hear a lot of politicians (and sadly some economists) say that more investment is necessarily better. But that’s wrong. Investment is only good when it raises the productivity capacity of the economy and in a way that more than pays for itself. Otherwise, it’s not really investment. It’s waste. And if you think businesses aren’t investing enough as it is, then you’d better have a good explanation for why.
If you’ve ever heard a business owner say they only bought something because it was a tax write-off, then the tax architect has failed.
And that’s really the concern with this policy. I can tell you, based on the evidence at hand, that it will likely encourage businesses to invest more. Business owners will buy new utes and mixers and fridges and all sorts of things. And partly at taxpayers’ expense. But we really have no idea whether these will be good investments or whether tax policy will have induced all these businesses to engage in a whole lot of waste.
The Labor opposition has proposed a significant expansion of the policy that would see businesses able to claim 20% of most investments worth more than $20,000 as upfront expenses. This proposal, too, would overcompensate businesses for the investments they make so, too, should lead to an increase in business investment. All of the arguments above apply equally to this proposal, just on a grander scale.
What I’d much prefer to see is a focus on business tax reform with the fundamental concept of neutrality at its core. A business tax policy that neither discourages nor encourages business, but rather gets out of its way.
That kind of tax reform would be no write-off.
Other articles in the Budget Forum 2019
Refundable Franking Credits: Why Reform Is Needed (and Why It Should Be Targeted) – Part 1, by John Taylor and Ann Kayis-Kumar
Refundable Franking Credits: Why Reform Is Needed (and Why It Should Be Targeted) – Part 2, by John Taylor and Ann Kayis-Kumar
“All Without Increasing Taxes”? A Closer Look at Treasurer Frydenberg’s Refrain Repeated Eight Times in His Budget Speech, by John Taylor and Ann Kayis-Kumar
Tax Offsets and Equity in the Scheme for Taxing Resident Individuals, by Sonali Walpolaand Yuan Ping
Forecasts and Deviations – the Challenge of Accountable Budget Forecasting, by Teck Chi Wong
Targeted Tax Relief Makes the Tax System Fairer but the Economy Poorer, by Steven Hamilton
A Simpler Tax System Should Spark Joy—Eliminating Tax Brackets Sadly Doesn’t, by Steven Hamilton
A Budget That Supports Indigenous Australians?, by Nicholas Biddle
Women in Economics 2019 Federal Budget Reflections, by Danielle Wood
Tax Progressivity in Australia: Things Aren’t as Simple as They Seem, by Chung Tran and Nabeeh Zakariyya
Coalition and Labor Voters Share Policy Priorities When They Are Informed About Inequality, by Chris Hoy
Future Budgets Are Going to Have to Spend More on Welfare, Which Is Fine. It’s Spending on Us, by Peter Whiteford
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