By Adam N. Michel and Josh Loucks
Vice President Kamala Harris recently announced a new proposal to expand the tax deduction for start-up costs for small businesses from $5,000 to $50,000. Without the immediate deduction, the deduction of start-up costs must be spread out over 15 years. The Harris proposal allows us to dig deeper into the various business expenses that can’t be fully deducted and to demonstrate how delayed deductions hurt business growth.
A deduction delayed is a deduction partially denied because time and inflation erode the value of the write-off years later. Under the normal tax system, a $100 investment deduction that must be incrementally used over 15 years is only worth about $74 to the business in present value (assuming 2 percent inflation). Fifteen years of waiting erodes a quarter of the deduction’s value to the business, which increases the after-tax cost of investing. When costs rise, investment falls.
This problem is even worse for investments in residential buildings and other structures. These longer-lived investments must be depreciated or deducted over 27.5 years and 39 years, respectively. At 2 percent inflation, the present value of the deduction for an investment in a structure is cut in half.
Fixing this problem of waiting to recoup the cost of new investments, particularly for structures, could be the most important change to the tax code to boost investment and economic growth.
For a timely example of one way to even out the tax treatment of some business investments, consider legislation recently reintroduced by Sen. Mike Braun (R‑IN) and Rep. Kevin Hern (R‑OK) (S. 4924 and H.R. 9069). The proposed modification would shorten the depreciation schedules for structures to 20 years and allow the remaining deductions to be indexed for inflation and the time value of money. This system is often called neutral cost recovery.
According to a Tax Foundation analysis of a similar proposal from 2022, the changes would reduce revenue by $187 billion on a static basis over 10 years. However, the reform is projected to boost long-run gross domestic product by 1.2 percent, increase capital stock by 2.3 percent, and expand employment by 230,000 jobs. When scored dynamically to account for the larger economy, the bill is projected to increase federal revenue by roughly $127 billion over 10 years. Neutral cost recovery is a tax cut that more than pays for itself.
This neutral cost recovery proposal is one of three critical pieces to fix the tax code’s broken treatment of business investments. Congress should allow full immediate deductions (called full expensing) for all short-lived assets (20 years or less). This policy was temporarily included in the Tax Cuts and Jobs Act of 2017, but it began to phase out in 2023 and will return to the normal depreciation system after 2027. All other costs, including research spending and all start-up costs (not just $50,000), should also be eligible for immediate deduction.
Although full expensing is also the proper treatment for investments in structures, it comes at a high cost of about $413 billion over the budget window (conventionally scored). Neutral cost recovery delivers a similar economic benefit as full expensing with a smaller reduction in revenue, albeit without some of the simplification benefits that come with full expensing. Either way, both treatments help reduce the after-tax cost of investing in structures compared with the current system.
Shifting away from the current depreciation rules toward full investment deductions is a more economically neutral treatment for business investment and, thus, creates a powerful incentive for new capital spending and domestic construction. Higher investment and productivity growth also lead to wage gains and new employment opportunities.
Many of the issues that Harris is campaigning on—such as housing affordability, manufacturing, transportation infrastructure, and domestic semiconductor production—would benefit from full immediate deductions for expenses, whether they be start-up costs, research spending, or new building construction. Full expensing removes current disincentives to expand existing businesses or build new ones.
Washington often relies on regulations, subsidies, and trade barriers to “help” American businesses compete. These market-distorting interventions do more harm than good. The Harris proposal to expand immediate business write-offs is a small example of a way to reduce existing tax disincentives to doing business in America. Extending similar treatment to all investments and keeping business tax rates low—something Harris is not proposing—would level the playing field between types of investments, expand investment opportunities, and drive widely shared employment growth and wage gains.
