America's manufacturing boom is running on borrowed time (and borrowed dollars).
Over the past few years, we've experienced a surge of investment in domestic manufacturing. This is due to a variety of factors, including the de-globalization trend that began when the pandemic exposed the dangers and weaknesses of fragile and overly complex supply chains.
Just as important, however, is an obscure provision of the tax code that is already being phased out. Starting in 2018, the federal government began allowing businesses to expense 100% of capital investments, meaning they could deduct the full value of those investments from their taxes right away, instead of having to spread those tax benefits out over the life of the investment.
This type of tax incentive can be a powerful motivator. Manufacturing investments generally come with huge price tags, from multimillion-dollar machines to billion-dollar factories.
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When a business purchases a piece of equipment for, say, $50 million, that money leaves their bank account right away (unless they secure financing, in which case they’re paying interest and the true cost is much higher – especially with interest rates at the highest level in a generation). It only makes sense that they should be able to take the tax deductions to which they’re entitled right away, too.
Starting in 2022, however, full capital expensing began to be automatically phased out in the U.S. By 2026, it will be eliminated completely – unless Congress acts.
We’re seeing orders for capital goods leveling off, which could reflect the phasing out of full capital expensing. Worryingly, this is happening despite a surge in spending on new factory construction driven primarily by federal subsidies.
Fortunately, Congress recently reached a tentative agreement to restore full expensing until the end of 2025, but that’s just a temporary solution. What we really need is to make full expensing a permanent feature of the tax code.
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This isn't just a matter of doing the right thing for American industry. It’s also imperative to keeping the U.S. competitive in the global economy.
The U.K., for instance, recently made its full capital expensing policy permanent. If we don’t follow suit, some companies will decide that it makes more sense to invest in countries that offer this commonsense incentive.
Currently, Congress is doing what it does best – kicking the can down the road and delaying the inevitable while handing out hundreds of billions of dollars in subsidies to offset the impact of the phase-out that has been taking place over the past two years.
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But that kind of spending can’t continue forever, especially with the national debt now reaching levels not seen since the end of World War II.
Moreover, government subsidies for politically favored investments have a market-distorting effect, causing money to be invested in sub-optimal ways as businesses chase taxpayer handouts instead of letting consumer demand guide their investment decisions.
The beauty of full capital expensing is that it makes no value judgments about how businesses should be investing their money. As long as the investments have a legitimate business purpose, anything goes.
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That’s how you create a dynamic economy that produces innovations that politicians and bureaucrats could never even conceive of.
In other words, we’re turning a sustainable manufacturing boom into an economic sugar high.
That’s why it’s so vital to restore full expensing. Under current law, businesses can only deduct 40% of capital investments this year, and next year they will only be able to deduct 20%. Even if the new agreement becomes law, though, in 2026 we’ll be back to the old policy of depreciation, which forces businesses to spread tax deductions out over the life of an investment.
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Full expensing is also fairer, because it does not force companies to wait years to receive the full tax benefits they are owed. In fact, depreciation schedules serve as a disincentive to invest, because inflation and the time-value of money erode the value of deductions that are explicitly intended to facilitate investment.
We can only keep the manufacturing boom going for so long by shoveling borrowed dollars into the economic boiler. In the meantime, the calculus keeps getting steadily worse for businesses that are trying to innovate and grow.
Julio Gonzalez is the CEO and founder of Engineered Tax Services Inc.
