Small Business Expensing Allowance: Current Status, Legislative Proposals, and Economic Effects

Publication Date: May 2005

Publisher: Library of Congress. Congressional Research Service

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Under current federal tax law, business taxpayers are allowed to deduct (or expense) at least $102,000 of the total cost of qualified assets placed in service in a single tax year from 2005 through 2007. In the absence of such a provision, firms would have to recover the cost over a longer period under allowable depreciation schedules. Certain rules governing the use of the allowance confine its benefits to relatively small firms.

The main focus of this report is the economic effects of the small business expensing allowance. It begins with an explanation of how the allowance works and a brief summary of its legislative history. The report then describes current legislative initiatives to modify the current allowance and concludes with an assessment of its implications for economic efficiency and equity and tax administration. It will be updated to reflect significant legislative activity in the 109th Congress.

Legislative action in the 108th Congress indicated broad bipartisan support for enhancing the allowance both as a means of stimulating increased business investment and aiding small business owners. Under the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), the maximum allowance was raised from $25,000 to $100,000 and the phase-out threshold from $200,000 to $400,000 in 2003 through 2005; both amounts were indexed for inflation in 2004 and 2005; and packaged software qualified for expensing in 2003 through 2005. The American Jobs Creation Act of 2004 (P.L. 108-357) extended the enhancements made by JGTRRA through 2007.

Two bills to extend permanently most of the enhancements in the allowance made by JGTRRA have been introduced in the 109th Congress: H.R. 1091 and H.R. 1388. The only difference between the two proposals is that H.R. 1091 would increase the phase-out threshold to $500,000 from its current level of $400,00, as of January 1, 2006. Neither bill would allow the expensing of off-the-shelf software for business use beyond 2007. In addition, another bill (H.R. 1678) would extend the changes in the allowance made by JGTRRA through 2009. President Bush supports the permanent extension of these changes in his budget request for FY2006.

To most economists, the small business expensing allowance may have important implications for the allocation of business investment, the distribution of the federal tax burden among income groups, and the cost of tax compliance for smaller firms. These effects loosely correspond to the three traditional criteria for evaluating tax policy: efficiency, equity, and simplicity. When seen through the lens of conventional economic theory, the allowance takes on the appearance of a drain on economic efficiency that may worsen the deadweight loss associated with the current federal income tax. At the same time, because the allowance does not alter marginal income tax rates, it has no discernible impact on the distribution of the federal tax burden among income groups. In addition, the allowance has the benefit of simplifying tax accounting for firms able to claim it.