Impact of Super Depreciation on Capital Expenditure

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Authorities legislate many tax provisions such as investment tax credit and accelerated depreciation deductions in order to increase capital investment by businesses. Over the years many researchers tried to understand how these tax provisions influence different firms’ investment. The answer to this question is important mainly because it helps policy makers to take appropriate measures and design properly targeted fiscal policies to promote growth.

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One of tax incentives used by policymakers extensively is accelerated depreciation deductions. Accelerated depreciation allows firms to depreciate higher percentage of their newly acquired assets at the first year and thus through discounting and lower present value of future deductions, creates tax incentive in the present.

In US accelerated depreciation method called bonus depreciation was first introduced after September 11, 2001 to promote investment and employment. It was intended to be temporary policy, but after no extension in the period 2005-2007, it was reintroduced from 2008 during financial crisis. As of January 2017, bonus depreciation increased to 100% and will remain 100% until January 2023 and then gradually will decrease to 0 by 2027.

Section 179 deduction is another tax deduction incentive in US that allows eligible firms (restricted by dollar limitation, total asset price limit and aggregate income limit) to fully deduct cost of newly acquired asset in the first year.

Similar accelerated deduction policies were enacted or will be enacted in other countries, with the hope of promoting business capital expenditure. While there are many researchers studied the effects of these policies in investment, their findings are mixed in whether these policies are effective, how much effective they are and which kind of businesses benefit the most from these policies.

Super depreciation

In 2015 Italian government introduced the Law No. 208 of 28 December 2015 (the Italian Budget Law for 2016) which introduced super depreciation regime (Super Ammortamento in Italian) with purpose of promoting capital investment and improve competitiveness. This additional IRES (corporate income tax) depreciation for new tangible assets allows firm to deduct 40% more than asset cost, bringing taxable base deduction to 140%. The law was enacted from October 2015 and is extended by December 2018 (and then to June 2019 but depreciation base reduced to 130%). The eligible assets for this depreciation are those whose tax amortization rate is higher than 6.5%, this includes most of asset types such as varieties of equipment, machineries, vehicles, plants and lightweight constructions but exclude buildings (lower depreciation rate) and land (no depreciation). The new extension from 2018 excludes vehicles and other means of transportation and includes certain intangible assets such as software.

While still in effect, this study will study the effect of this depreciation deduction on capital expenditure in period 2013-2017. This study is different from reviewed literature in two ways: first it investigates the effects of bonus depreciation in the context of Italy; and second it studies the effect of super deprecation with deduction rate higher than 100%. This study will use empirical model used by Hulse and Livingstone (2010).

Literature Review

House and Shapiro (2008) exploit the fact that due to different depreciation lives, benefits gained from depreciation deduction differ between different classes of assets. They found positive but small effect of bonus depreciation on investment. This could be due to the fact that the limited category of investment affected and small size of incentive. Using asset-level data have shown that this effect on investment in assets differs based on (depreciation) life of an asset. For assets with longer lives depreciation cause more reduction in overall present value and hence more reaction to this tax policy. Thus bonus depreciate causes both timing effect (earlier investment) on this class of assets as well as substitution effect (less investment in less-favorable assets). Their analysis also shows positive investment effect during legislation period and prior to enactment (policy timing effect). While their asset-level data analysis shows positive effective of this incentive on investment decisions, their study fails to answer whether these deductions affect aggregate investment permanently.

Hulse and Livingstone (2010) study the impact of bonus depreciation on capital expenditure between 2001 and 2004 using Compustat data. Controlling for many determinants of capital expenditure (such user cost of capital, capital intensity, debt, cash flows and sales growth), they found no strong evidence supporting the policy’s aim at increasing capital investment. The evidence was mixed, while some results suggest positive effect of bonus depreciation on capital expenditure, the others show no significant effect. Overall the results show supportive but weak positive effect of bonus depreciation on investment.

Eichfelder and Schneider (2014) investigate extent of bonus depreciation impact on business investment in Germany using depreciation policy enacted in Eastern Germany before 1999. To promote investment in Eastern Germany, tax depreciation policy granted to Eastern Germany called Development Area Law which is similar to bonus depreciation and allows deduction up to 50%. In addition, Investment Subsidy Law granted to promote investment similar to investment tax credit by direct and tax-exempt subsidies. Unlike bonus depreciation programs which were limited to equipment, Development Area Law also includes investment in long-lived assets such as structures. Since Western Germany was not granted with this policy, it can be used as a control group and deprecation policy as an experiment that only affects Eastern Germany.

Using difference-in-differences identification strategy, and controlling for regional variables and using fixed effects to omit selection bias, they find significant positive impact on investment especially for long-duration assets and big firms and investment, particularly on nonresidential real state and structures. However, by expiration of these bonus depreciation in following year, business investment declines. In contrast to Zwick and Mahon (2017) they find stronger effect of tax deprecation on investment on larger firms, probably because of complexity of this tax incentive and associated tax planning.

Ohrn (2016) uses variation in adoption response to bonus depreciation and Section 179 deduction in state level to investigate the impact of bonus depreciation and Section 179 deduction on investment, as well as employment. States respond to federal bonus depreciation by full adoption, full rejection or partial adoption of bonus depreciation and Section 179 allowance for state corporate tax. He used states’ adoption as an exogenous event and difference in differences strategy to study this effect.

Since each of these policies can change the impact of the other policy on investment, a joint estimation model (which includes interaction term) is used to study these effects. To make sure adopting and non-adopting states are similar on the other aspects, set of control variables have been introduced. In addition, by identifying factors that increase probability of adoption in states level, sample of states who are more likely to adopt these policies have been chosen as a robustness check. The study finds positive impact of each of these policies on investment, and negative interaction term, as impact of one policy increases the impact of other one subsides. This study also finds no significant impact on overall employment; however, bonus depreciation has positive impact on wages of production workers.

Zwick and Mahon (2017) used data from 120000 firms and difference-in-differences methodology to investigate the effects of shifts in accelerated depreciation on equipment investment and if this effect varies among different firms. Based on class of assets owned by each firm and whether they are mostly long-lived or short-lived, they are exposed to different amount of impact by these incentives and these difference can be used to have two different groups: control group with mostly short-duration assets that their depreciation schedules are less affected by this incentive and firms in industries with mostly long-duration assets. (Assuming parallel trend which means these two groups should have similar trends of investment growth in absence of the policy), the results show 10.4% (2001-2004) and16.9% (2008-2010) raise in relative capital investment (eligible to ineligible)

Bonus depreciation also show much higher impacts on small and medium-sized firms compared to larger firms. The findings show 95% higher response in small firms compared with bigger ones. The third source of heterogeneity of response to bonus depreciation is related to when firms can benefit from this bonus depreciation. Firms with tax losses will benefit in the future since larger portion of depreciation deduction will happen in future. This study shows stronger response of the firms in case of immediate cash flow generation in comparison with future cash flow resulting from the policy.

Wielhouwer and Wiersma (2017) study a more flexible accelerated depreciation policy enacted in Netherland during 2009-2011 period. They study the effects of discretionary tax depreciation (DTD) which introduced in Netherland using sample of clients of an accounting firm. To deal with selection bias, they select firms that are more likely to invest in eligible assets. They find out that this policy is more effective than bonus depreciation in promoting investment, especially during the times of crisis. DTD allows firms to accelerate depreciation, similar to bonus depreciation, as well as postponing the depreciation. Hence it is more effective than bonus depreciation in reducing present value of taxable income. They find that investment in assets eligible for DTD increased during this period while at the same time investment in ineligible assets decreased (crowding out effect). The flexibility of DTD to postpone depreciation, allows firms which are in loss to benefit more from tax depreciation. This is in line with Zwick and Mahon’s finding that firms benefit more from bonus depreciation when they benefit from tax depreciation in their present cash flow.

Even though many of this studies that have found positive impact of these incentives on investment, lack of data on asset-level on many of these studies and relying on firm-level and industry-level data that use different mix of assets and investments as a proxy, caused wide variety of estimates for these impacts.

While some studies such as House and Shapiro (2008), Zwick and Mahon (2016), Eichfelder and Schneider (2014), Ohrn (2016) and Wielhouver and Wiersma (2014) find significant effect on bonus depreciation policies on investment, other studies such as Desai and Goolsbee (2004), Cohen and Cummins (2006), Hulse and Livingstone (2010), Dauchy and Martinez (2008) find no or very small effect of these policies on investment. Some possible explanation for these mixed results includes: 1. While the positive impact of these deductions are for long-lived products, large ratio of investments in US are on short-lived equipment. 2. Tax losses in firms and future benefits from deduction, reduce the positive impact of these policies. 3. Short period of implementation of the policies. Edgerton (2010) suggests that because businesses focus more on accounting and profits, bonus depreciation would be less effective in promoting capital expenditure and states that “tax incentives have the smallest impact on investment exactly when they are most likely to be put in place, during downturns in economic activity when cash flows are low.”


Based on the model proposed by Shin and Kim (2002), the capital expenditure for firm i depends on set of control variables, user cost of capital and enactment of bonus depreciation:

CapExpi,t=0+1PreBonust+2Bonust+3UserCosti,t+4CapInti,t+5Debti,t+6CshFlwsi,t+7CshHldi,t+8MktBki,t+9Salesi,(t-(t-4))+10Sizei,t+11CapUtilt+12 ChngLoant+nj…

CapExpi,t = firm i’s capital expenditures in quarter t (cash outflows for new assets for quarter t divided by total assets at the beginning of quarter t).

Bonust indicates periods that super depreciation is enacted (1 if the quarter is in the depreciation period and 0 otherwise)

UserCosti,t = firm i’s user cost of capital for quarter t.

CapInti,t = firm i’s capital intensity for quarter t (net property, plant and equipment divided by

total assets, both at the beginning of quarter t).

Debti,t = firm i’s debt-to-equity ratio for quarter t (total debt divided by total equity, both at the beginning of quarter t).

CshFlws i,t = firm i’s cash flows for quarter t (operating cash flows for quarter t divided by

total assets at the beginning of quarter t).

CshHldi,t = firm i’s cash holdings for quarter t (cash divided by total assets, both at

the beginning of quarter t).

MktBki,t = firm i’s market-to-book ratio for quarter t (market value of equity plus total liabilities divided by total assets, all at the beginning of quarter t).

DSalesi,(t (t 4)) = firm i’s change in sales from the same quarter 1 year ago (sales for quarter t minus sales for quarter t 4, divided by total assets at the beginning of quarter t).

Sizei,t = firm i’s size in quarter t (natural logarithm of quarter t sales, in millions of euros).

CapUtilt = capacity utilization rate for the month preceding the beginning of quarter t (economy-wide).

ChngLoant = percentage change in bank loans (commercial and industrial) for the month preceding the beginning of quarter t (economy-wide).

QTRj = three indicator variables for the second, third, and fourth quarters of the year (any year).

INDi,k = indicator variables for industry k (using NACE codes).

ei,t = error term.

Most of control variables mentioned above can be directly obtained or easily calculated using data from Compustat or Eurostat. User cost of capital can be calculated using the formula:

$$C_s=phi_s(1-tau Z_s/1-tau)(phi+delta)$$

where CS is the user cost of capital in year s, uS is the price of new capital goods in year s, s is the corporate marginal income tax rate, q is the after-tax cost of funds (debt and equity), and d is the rate of physical depreciation.

What we are interested in this regression is beta1, significant positive beta1 shows the effect of super depreciation on capital expenditure and hence the effectiveness of this policy in promoting investment.

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