The Effect of Bonus Depreciation on Investment and Compensation

Abstract

This paper analyzes the relationship between bonus depreciation policies and the level of capital expenditures and employee compensation. This paper is interested in testing the hypothesis that bonus depreciation policies lead to higher investment from firms, which in turn drives productivity and wage growth. Productivity is a measure of an economy’s efficiency and is an important driver of the cost of goods and wages. Given the anemic productivity growth the U.S. economy has experienced since the Great Recession, it is imperative that policymakers find ways to induce firm-level investments in order to give productivity a much-needed boost. Currently, companies are allowed to write off 100% of their capital expenditures in the year of purchase for federal taxes. However, the bonus is set to be phased out beginning in 2022. While bonus depreciation is in place for federal taxes, not all states have adopted the policy for their state corporate taxes. This paper uses the natural experiment resulting from this divergence and data from the Annual Survey of Manufacturers to test the correlation between adoption of bonus depreciation and levels of capital expenditures and wages in the states’ manufacturing sectors. The model controls for some state economic and demographic characteristics, including population, GDP, tax rates, and the value of shipments from firms in the manufacturing sector. Ultimately, the results show that states with bonus depreciation saw, on average, 21.5 percent higher levels of capital expenditure and five percent higher compensation for workers in their manufacturing sectors. These results demonstrate that bonus depreciation provides significant and immediate economic benefits that justify making it a permanent tax policy.