Corporate tax reform, key to economic recovery, will soon expire

At a time when we see clear weaknesses in supply chains and needs to shift production towards more environmentally friendly approaches, capital investment is essential. Policy makers have the opportunity to reverse a coming decline in investment incentives by adopting permanent policies to support growth.

The expiry of fiscal policies in major economies could dampen business investment in the years to come.

When companies invest in physical assets, they consider the profitability of a new production facility or a new machine. One factor that affects profitability is the tax treatment of investment costs. If investment costs can be immediately deducted, the business is able to make the investment without worrying about inflation eroding its costs. However, most countries require companies to deduct costs over time – in some cases decades – which increases the after-tax cost of an investment by eroding the value of deductions.

The rules that specify the amount of an investment that can be deducted each year are called depreciation schedules, and the amount available to be deducted is called capital cost allowance.

Last week we published a report on capital cost allowances in developed countries. It showed that on average, the 38 countries of the Organization for Economic Co-operation and Development (OECD) offer companies the possibility of deducting 70.7% of their investment costs over time. The calculation takes into account the time value of money, which is influenced by inflation.

On average, this means that 29.3% of investment costs are not deductible in OECD countries.

Some countries have provisions allowing businesses to deduct the full cost of investment, including Chile, Estonia and Latvia. Other countries, including Canada, the United Kingdom and the United States, offer full deductions for certain equipment investments.

Unfortunately, not all policies are permanent.

As policies expire, the after-tax investment cost will increase. In fact, between 2022 and 2026, the amount of investment costs businesses can deduct is expected to rise from the 2021 level of 70.7% to 68.4%. Weighting the data by GDP, the drop is from 68.7% to 65.1%.

In Canada, a policy that provides immediate deductions for investments in equipment will begin phasing out in 2024 until it fully expires after 2027. The policy was first introduced in 2018.

In the UK, a temporary super-deduction of 130% for equipment will expire at the end of March 2023. The corporate tax rate is also expected to drop from 19% to 25% on that date. The super-deduction has just been implemented in 2021.

In the United States, bonus depreciation, adopted in 2017, will begin to phase out in 2023. By 2027, the treatment of business investment will revert to a much less generous policy.

While a permanent expansion of capital cost allowances would support business investment, capital formation, and long-term economic growth, temporary expansions have much more limited impacts. Companies can speed up some investment decisions that they had already planned, but this only changes when investments take place rather than increasing the overall level of investment.

The policies of Canada, the United Kingdom and the United States are particularly important. In 2019, the three countries accounted for 20% of global private investment. If their policies are not investment-oriented, it will hamper global investment and economic production.

Rather than adopting temporary policies that fade away and expire, policymakers should focus their efforts on long-term reforms to support investment. In fact, Canada, the United States and the United Kingdom should aim to permanently provide immediate deductions for investments in machinery and equipment, and for all other capital investments, provide adjustments for the inflation and the time value of money.