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75 IRET Policy Bulletin 1 (1999)

handle is hein.taxfoundation/iretpbul0034 and id is 1 raw text is: March 10, 1999 0 - No. 75 INTRODUCTORY DISCUSSION OF THE BASIC CONCEPTS OF DEPRECIATION AND EXPENSING Depreciation, the deduction of the cost of physical capital over time, is employed in the tax code to determine allowable business deductions for the cost of investment. Depreciation is a flawed concept that understates the real cost of plant, equipment, and structures, overstates business income, boosts business taxes, and greatly increases the cost to businesses of acquiring and employing capital. The result is less investment and capital formation than would occur under a more rational treatment of capital expenditures. Expensing, the immediate deduction of the cost of acquiring plant, equipment, structures, and inventory, is the economically correct way to treat investment for tax purposes. This paper is intended to provide the reader with a clear understanding of the concepts of depreciation and expensing, and to show that the proper treatment of capital expenditures can significantly increase the nation's prosperity. It should be noted that all of the major consumption- based tax reform proposals have, at their core, an explicit or implicit shift from depreciation to expensing of investment outlays. Depreciation is aflawed concept that understates the real cost ofplant, equipment, and structures, overstates business income, boosts business taxes, and greatly increases the cost to businesses of acquiring and employing capital. What are depreciation and expensing all about? To determine profit, businesses must subtract their costs from their revenues. Costs include, among other things, labor, raw materials, inventory, and the cost of plant, equipment, and structures. Expensing is the immediate subtraction of the cost of plant, equipment, structures, and inventory from revenue at the time the asset is purchased. Expensing is used in cash flow accounting, the simplest and most common-sense kind of record keeping. Institute for IRET is a non-profit, tax exempt 501(c)3 economic policy research and educational Research organization devoted to informing the public about policies that will promote on the economic growth and efficient operation of the market economy. Economics of 1730 K Street, N.W., Suite 910 * Washington, D.C. 20006 Taxation (202) 463-1400 * Fax (202) 463-6199 e Internet www.iret.org