This is the final in a three-part series on the budget tax measures that began with an analysis of the government’s plan to flatten the tax schedule and continued with an analysis of its plan to target tax relief at low and middle earners via an expanded tax offset.
The third leg of the government’s budget (and election) tax package is an expansion of the instant asset write-off which will allow businesses to immediately write off expenses worth up to A$30,000. The key takeaway of this piece is that the plan will likely increase investment, but we ought to think carefully about whether that’s really what we want.
If more investment 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. They get all the tax benefits of investment instantly without having to wait.
Originally, it covered expenses up to A$5,000. In 2015 the Abbott government lifted that to A$20,000 and this year the Morrison government lifted it to A$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 both spending on and returns from investments 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 variable inputs (such as flour for a bakery), the story is pretty straightforward because expenses are incurred at more or less the same time as the revenues are received. In practice, however, businesses have many so-called fixed inputs (like an oven for a bakery) where an expense is incurred immediately but its benefits are spread out over 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. In an ideal world, businesses should be indifferent between method one and method two.
The problem with the first method is that it’s impossible for the Tax Office 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 overcompensated 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.
It gives them the upside of both methods and none of the downsides. For an asset with, say, a ten-year lifespan, this over-compensation could represent a significant financial benefit. So in theory it should encourage firms to investment 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 for us to assess how well tax policies have worked in practice. This is improving with initiatives like the Tax Office’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 United Kingdom (here), where the business tax systems are somewhat different, suggest these kinds of policies can significantly boost business investment. But it doesn’t tell us much about the quality of the investment. You often see commentators talk about business investment like it’s a commodity – a homogeneous thing, like wheat or water, about 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, is an example. Without a tax incentive, you mightn’t do it, but if offered one, you might be nudged into doing it.
Investment would go up. So would Australia’s gross domestic product. 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 that in the absence of tax, people will do what’s best for them. We try to design taxes that will change that as little as possible.
When it comes to businesses, that means we want businesses to innovate, and to invest, as they would have in the absence of tax. That means we want bakers to buy new ovens, but only if they would see it as prudent in a world without taxes.
You hear a lot of politicians (and sadly, some economists) talk about how 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. If you assert that businesses aren’t investing enough as it is, then you’d better be able to explain what you mean, what you think enough is, and how you could possibly know.
If you’ve ever heard a business owner say he or she only bought something because it was a tax write-off, then you know the tax architect has failed.
And that’s really the concern with this policy. It will almost certainly encourage businesses to invest more. Business owners will buy new utes and mixers and fridges and all sorts of things – 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 buy things they probably shouldn’t have.
The Labor opposition has proposed a significant expansion of the policy. Businesses would be able to claim 20% of most investments worth more than A$20,000 upfront.
It too would overcompensate businesses for the investments they make so, it too should lead to more business investment, but on a grander scale. All of the arguments against the Coalition’s scheme apply to Labor’s scheme, only more so.
What I’d much prefer to see is a focus on business tax reform with the fundamental concept of neutrality built into its core. A business tax policy that neither discouraged nor encouraged business decisions, but just got out of its way.
That would be no write-off.
Authors: Steven Hamilton, Visiting Scholar, Tax and Transfer Policy Institute, Crawford School of Public Policy, Australian National University