Good news and bad news for tax policy nerds

The good news today comes from Jason DeBacker, a professor at the University of South Carolina and a core contributor to one of the dynamic tax models that OSPC makes accessible to the public through TaxBrain. He is out with a new open source software package called B-Tax for analyzing how changes in tax law affect firms’ incentives to invest. You can read more about the assumptions here, or dig into the source code here.

Jason has been working on B-Tax for some time now with his collaborator Ben Gardner, a student at Brigham Young University and a Building Blocks Associate at OSPC this summer. Ben and Jason tell me that they owe a lot of their progress to work that’s been done on the same topic by researchers at the Treasury Department, the Urban-Brookings Tax Policy Center, the Congressional Budget Office, the Tax Foundation, and other places.

Twenty20.

B-Tax is a valuable open source contribution because it allows anyone with the tech savvy to run the model to learn how both firm-level and individual-level taxes on savings and investment influence investment decisions across industries and asset types.

To make the model available to those without the tech savvy to run its Python code on their own computers, the Open Source Policy Center is developing a web application, similar to TaxBrain, to make B-Tax widely accessible to the public. That project is currently in private beta testing, but we plan to open it up to the public very soon, and you’ll hear from me again when we do.

In the meantime, I want to show you a new interactive visualization that relies on B-Tax to highlight an important tax policy issue, the tax code’s planned phase out of bonus depreciation.

Currently, bonus depreciation rules allow firms to deduct an additional 50 percent of their investment in the year the investment is made. Bonus depreciation applies to equipment, software, and some other assets, but not to longer-lived assets like nonresidential and residential buildings. Bonus depreciation lowers a firm’s marginal effective tax rate because a deduction today is more valuable than a deduction in the future.

Bonus depreciation was originally used as a business cycle stabilization tool to boost investment in response to economic downturns. However, firms have been allowed bonus depreciation for the better part of the last 15 years — from September 2001 through December 2004, and from January 2008 through the present. (There have been some gaps when firms weren’t sure whether bonus depreciation would apply, but each time it was reinstated retroactively.)

Under current law, bonus depreciation will soon begin to phase out. Equipment put into place in 2018 will receive 40% bonus depreciation, equipment put into place in 2019 will only receive 30% bonus depreciation, and equipment put into place starting in 2020 won’t receive any bonus depreciation.

This brings us to the bad news I promised.

Over the next few years, the phase-out of bonus depreciation will drag down business investment. Marginal effective tax rates will rise significantly as bonus depreciation phases out.

You can see this process in the interactive visualization below. Move the slider bar to see how marginal effective tax rates on corporate investment will evolve as bonus depreciation phases out between 2016 and 2020. Each bubble represents a different asset type. Bubbles on the same horizontal line belong to the same broad asset category. You can hover over each to find more information.

To learn who worked on this plot or how to embed it at your own site, go here.

The overall marginal effective tax rate on business fixed investments by corporations will rise from 23.4% to 28.9%. If we consider corporate investment in equipment only, which is the category most affected by the phaseout of bonus depreciation and also the investment category that has been contributing most to real GDP growth in the last five years, the marginal effective rate will rise from 16.7% to 27.5%.

 Because investment is already weak, one might wonder what will happen when marginal effective tax rates on all business investment become 23.5% higher and marginal effective tax rates on equipment become 65% higher.

 In fact, the picture might be even worse. To the extent that firms expect the phase out to go forward as written into law, then they should be moving investment forward, and so some of tomorrow’s investment should be taking place today. What this means is that the tax-influenced difference in investment levels between today and 2020 should be even greater than the difference in marginal tax rates displayed by the visualization suggest, raising even greater concerns about future investment.

 So, the good news is that there is a new open source modeling tool for tax policy researchers. The bad news is that when we start to use the tool, the first thing we see is a looming drag on investment due to the phase out of bonus depreciation. My hope is that B-Tax’s next task will be helping policy makers and policy experts to implement solutions. Alex Brill, for instance, has already shown how the business cash flow tax in the Brady/Ryan blueprint would dramatically and permanently lower marginal effective tax rates on business investment. I suggest reading his in-depth report next.