The New Yorker's 6 Sep Food Issue has a terrifying article by John
Cassidy on evil tax policy guru Grover Norquist's plans for a
prospective second Bush gang second term. The article focuses on
the usual McKinleyite legislative atrocities: labor pays all
taxes, capital none; regressivity; bankrupt the treasury. But it
breezes over a startling scheme that even McKinley wouldn't have
approved of (p. 75) to reduce the term over which capital goods
are depreciated to a shocking one year (for purposes of historical
comparison, the term was 40 years up until 1954, when it was
effectively shortened by Republicans). Although it may not be
obvious, and Norquist paints it as a virtuous policy intended to
encourage investment, this contraction of the term of depreciation
would be a disaster. I will explain.
What the term of depreciation corresponds to is the amount of time after which a good wears out and becomes worthless, according to the tax code. If the term of depreciation is N years, then, under the simplest "straight line" formula, 1/N of the amount invested in a good can be "written off", or claimed as a tax deduction, every year. So if the term of depreciation is 33 years, then I can write off 1/33, or 3%, of the amount I invest, every year. Suppose that I invest a million dollars: then I can write off $30,000 per year. If the tax rate is 30%, then I can take $9000 off the top of my tax bill every year for the next 30 years. Depreciation allowances are thus a little present from the IRS for investing. Given that in certain forms, investment can be a good thing, it seems like a good idea to have some kind of depreciation allowance.
But suppose that the term of depreciation is reduced to one year. Suppose I start out with a million dollars. I invest the whole thing---in a shopping center, for instance. I then get to write off the million dollars on next year's tax return. With a 30% income tax rate, this allows me to take $300,000 off my income tax bill. In effect, you could look at this as a $300,000 gift from the IRS. I started out with a million dollars; now, a year later, I have $300,000 and a shopping center. What happens if I sell the shopping center for $800,000? Answer: I'll have no shopping center, and $300,000 plus $800,000 = $1.1 million. That's a tidy 10% profit.
If I had a million dollars, and were interested in turning it into 1.1 million in the space of a year, this would be a good plan. I could build a shopping center that would be worth $800,000 to someone at year's end, and stroll away with the windfall. Whether it's a shopping center, or a factory, or an office or housing complex, or some machine tools, or whatever, doesn't matter. Nor does it matter whether the shopping center actually makes any money, or whether anyone is at all interested in going there; or, to vary the example, whether the office complex is rent-worthy, or whether the machine tools work. I'm not interested in investment for production, or to fill anyone's needs, since I don't intend to make my profit on the basis of whether anyone finds my goods at all useful. All I'm driven by is the likelihood of being able to sell my good for more than $700,000. My investment is thus purely speculative. Of course, I have to find a buyer. But I only have to find a buyer who is willing to pay a very cheap price for the good---after all, I'm in effect willing to give a 20% discount on the good to anyone who comes along.
The effect of this incredible biasing of the tax code toward speculative investment and away from productive investment is easy to predict. The current voracious pace of real estate development would accelerate into a frenzy. Say goodbye to remaining bits of undeveloped land anywhere near population centers, such as California's Central Valley, a region developers have been slavering over for decades. With agricultural land becoming increasingly scarce, keeping up national food output would require further taxing of rivers and aquifers for irrigation, as well as a major increase in the use of chemical fertilizers and GMO crops. The sewers and roads for the sprawl would accelerate the bankrupting of municipal and state governments, so say goodbye to social services. Although it's hard to imagine, the banal cheapness of today's architecture would be looked back upon as a silver age of charm prior to the era of sheds we would enter. With capital sucked into this speculative frenzy, say goodbye to high wage manufacturing jobs: on a global level, with capital for production drying up and in effect becoming much more expensive, the only way to avoid a tremendous inflation in the price of consumer goods would be to slash labor costs to zero.
There's a considerable empirical basis for my nightmare scenario. The US has twice as much retail square footage per capita as the next closest rivals, European countries. (This of course is at the core of our current predicament: sprawl leads to auto dependency, which leads to petroleum gluttony, which leads to less than fond feelings from the folks in our petrocolonies. The US also spends $200 million per day on maintaining paved surfaces, which cover a land area equal to the combined arable lands of Ohio, Indiana, and Pennsylvania (source: Disinformation Book of Lists, p. 283), a grossly wasteful diversion of resources away from human flourishing.) But why so much retail space? Where does mall and sprawl come from, anyway? Thomas Hanchett's 1996 American Historical Review paper "U.S. Tax Policy and the Shopping-Center Boom of the 1950s and 1960s" argues that the 1954 acceleration was the source of this loathesome blight: prior to this, one couldn't make a profit on commercial development in low density areas, so there wasn't any. (A helpful summary of Cassidy's findings is here.) Thanks to the '54 law, however, the sort of speculative development I described above became very profitable, and for the reasons I described. And that was only with a policy of enhancing the degree to which depreciation is front-loaded. Imagine loading it all the way up front!
It's hard to imagine something more important than getting the thug Norquist as far away from the White House as possible. UPDATE (9/14): A number of readers have written in to call attention to an error in my initial hypothetical: namely, when the property is sold, tax is paid on the income received from the sale. Still, the point remains that "expensing" (single year depreciation) constitutes a tremendous tax shelter, since it allows the purchaser of a capital good to write off the entire purchase price of the good in the year in which it is purchased. In effect, this allows whatever profits (rents, for instance) can be extracted from the good during that period to be indemnified from taxation. Although a lot depends on the details of the legislation, in principle the same could go for any future purchasers of the "used" good. So: a big tax subsidy for capital, inaccessible to labor.
What the term of depreciation corresponds to is the amount of time after which a good wears out and becomes worthless, according to the tax code. If the term of depreciation is N years, then, under the simplest "straight line" formula, 1/N of the amount invested in a good can be "written off", or claimed as a tax deduction, every year. So if the term of depreciation is 33 years, then I can write off 1/33, or 3%, of the amount I invest, every year. Suppose that I invest a million dollars: then I can write off $30,000 per year. If the tax rate is 30%, then I can take $9000 off the top of my tax bill every year for the next 30 years. Depreciation allowances are thus a little present from the IRS for investing. Given that in certain forms, investment can be a good thing, it seems like a good idea to have some kind of depreciation allowance.
But suppose that the term of depreciation is reduced to one year. Suppose I start out with a million dollars. I invest the whole thing---in a shopping center, for instance. I then get to write off the million dollars on next year's tax return. With a 30% income tax rate, this allows me to take $300,000 off my income tax bill. In effect, you could look at this as a $300,000 gift from the IRS. I started out with a million dollars; now, a year later, I have $300,000 and a shopping center. What happens if I sell the shopping center for $800,000? Answer: I'll have no shopping center, and $300,000 plus $800,000 = $1.1 million. That's a tidy 10% profit.
If I had a million dollars, and were interested in turning it into 1.1 million in the space of a year, this would be a good plan. I could build a shopping center that would be worth $800,000 to someone at year's end, and stroll away with the windfall. Whether it's a shopping center, or a factory, or an office or housing complex, or some machine tools, or whatever, doesn't matter. Nor does it matter whether the shopping center actually makes any money, or whether anyone is at all interested in going there; or, to vary the example, whether the office complex is rent-worthy, or whether the machine tools work. I'm not interested in investment for production, or to fill anyone's needs, since I don't intend to make my profit on the basis of whether anyone finds my goods at all useful. All I'm driven by is the likelihood of being able to sell my good for more than $700,000. My investment is thus purely speculative. Of course, I have to find a buyer. But I only have to find a buyer who is willing to pay a very cheap price for the good---after all, I'm in effect willing to give a 20% discount on the good to anyone who comes along.
The effect of this incredible biasing of the tax code toward speculative investment and away from productive investment is easy to predict. The current voracious pace of real estate development would accelerate into a frenzy. Say goodbye to remaining bits of undeveloped land anywhere near population centers, such as California's Central Valley, a region developers have been slavering over for decades. With agricultural land becoming increasingly scarce, keeping up national food output would require further taxing of rivers and aquifers for irrigation, as well as a major increase in the use of chemical fertilizers and GMO crops. The sewers and roads for the sprawl would accelerate the bankrupting of municipal and state governments, so say goodbye to social services. Although it's hard to imagine, the banal cheapness of today's architecture would be looked back upon as a silver age of charm prior to the era of sheds we would enter. With capital sucked into this speculative frenzy, say goodbye to high wage manufacturing jobs: on a global level, with capital for production drying up and in effect becoming much more expensive, the only way to avoid a tremendous inflation in the price of consumer goods would be to slash labor costs to zero.
There's a considerable empirical basis for my nightmare scenario. The US has twice as much retail square footage per capita as the next closest rivals, European countries. (This of course is at the core of our current predicament: sprawl leads to auto dependency, which leads to petroleum gluttony, which leads to less than fond feelings from the folks in our petrocolonies. The US also spends $200 million per day on maintaining paved surfaces, which cover a land area equal to the combined arable lands of Ohio, Indiana, and Pennsylvania (source: Disinformation Book of Lists, p. 283), a grossly wasteful diversion of resources away from human flourishing.) But why so much retail space? Where does mall and sprawl come from, anyway? Thomas Hanchett's 1996 American Historical Review paper "U.S. Tax Policy and the Shopping-Center Boom of the 1950s and 1960s" argues that the 1954 acceleration was the source of this loathesome blight: prior to this, one couldn't make a profit on commercial development in low density areas, so there wasn't any. (A helpful summary of Cassidy's findings is here.) Thanks to the '54 law, however, the sort of speculative development I described above became very profitable, and for the reasons I described. And that was only with a policy of enhancing the degree to which depreciation is front-loaded. Imagine loading it all the way up front!
It's hard to imagine something more important than getting the thug Norquist as far away from the White House as possible. UPDATE (9/14): A number of readers have written in to call attention to an error in my initial hypothetical: namely, when the property is sold, tax is paid on the income received from the sale. Still, the point remains that "expensing" (single year depreciation) constitutes a tremendous tax shelter, since it allows the purchaser of a capital good to write off the entire purchase price of the good in the year in which it is purchased. In effect, this allows whatever profits (rents, for instance) can be extracted from the good during that period to be indemnified from taxation. Although a lot depends on the details of the legislation, in principle the same could go for any future purchasers of the "used" good. So: a big tax subsidy for capital, inaccessible to labor.
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