How tax revenue effects of accelerated depreciation arise

Year-by-year cost to revenue

Constant annual expenditure

Increasing annual expenditure

The Australian Treasury (1986), Attachment A uses both diagrammatic and numerical illustrations to explain the transitional tax revenue losses associated with accelerated tax depreciation for depreciable assets.

Accelerated depreciation allows faster write-off of capital expenditure than economic depreciation. Thus, the taxpayer attracts higher depreciation deductions up-front compared to an asset's actual decline in value. If the taxpayer holds the asset for some time, eventually, depreciation deductions allowed on the asset will be less than the annual decline in asset value (either because the expenditure has been fully written off or because of the extent to which the tax value has been reduced by the accelerated write-off). When the asset is sold, balancing adjustments are aimed at clawing-back excess depreciation deductions allowed beyond actual decline in value between purchase and sale.

Thus, excess up-front depreciation deductions that taxpayers attract from depreciation being accelerated are eventually clawed back. Nevertheless, aggregating across all taxpayers who invest in depreciable assets, transitional tax revenue losses arise from accelerated depreciation. As explained in Australian Treasury (1986), an understanding of why these transitional revenue losses arise can be obtained from the following.

• With ongoing, economy-wide investment in depreciable assets, in any given year there will be depreciable assets across an economy at all phases in their lives: some just acquired, some mid-way through their operational lives and others being scrapped.

• With depreciable assets at all phases of their lives represented and if aggregate capital expenditure on these assets remains constant, regardless of the ongoing rate of tax depreciation attracted by each asset type, aggregate tax revenue will match aggregate expenditure (assuming eventually each asset is scrapped for zero value). Total tax depreciation deductions attracted by each asset over its life equal purchase price less zero disposal value. When each annual phase of depreciable assets is represented across an economy with fixed annual expenditure on them, total annual depreciation deductions equals that fixed annual amount of expenditure, regardless of the ongoing rates of tax depreciation applying.

• If current rates of depreciation are accelerated for all new depreciable assets acquired after a particular date, those assets acquired before that date will continue to be written off on the old depreciation rates. Meanwhile new depreciable assets acquired after that date attract accelerated write-off. Thus, for a time, early phases of use of newly acquired assets attracting fast write-off would co-exist with later phases of previously acquired assets attracting slow write-off. The net effect, over a transitional period, is aggregate annual depreciation deductions exceeding aggregate (and still constant) annual capital expenditure on the assets - with the excess of deductions representing the annual tax revenue loss.

• After the transitional period, with constant annual aggregate capital expenditure on depreciable assets, the cost to revenue falls to zero. With increasing annual capital investment, the nominal cost to revenue would also keep increasing (but, if growth in investment matched inflation, the real cost would stabilise).

The excess income tax deductions, assuming constant aggregate capital expenditure, are illustrated schematically in Figure 48 for the situation where 10-year prime cost write-off across all depreciable assets is replaced by 5-year write-off. The sketch mirrors that in Australian Treasury (1986).

Figure 49 shows the cost to tax revenue equivalent of the situation depicted in Figure 48, produced by the Kyscope package. Net receipts are automatically generated to produce a specified pre-tax return (10% in the illustration) from depreciable assets and a full year's write-off is allowed in the year that each asset is acquired.

YEAR-BY-YEAR COSTS TO REVENUE

The following estimates of the effect on tax revenue of accelerating tax depreciation of depreciable assets were obtained using MyProject, first, assuming constant economy-wide investment in depreciable assets each year and, secondly, assuming a 10% per annum increase in aggregate capital expenditure on depreciable assets.

Beyond the annual level of capital expenditure, the assumptions - consistent with those in Australian Treasury (1986) - underlying the estimates of changes to tax revenue are:

• all expenditure is undertaken by unincorporated businesses facing a 46% tax rate;

• for many years before accelerated depreciation is introduced the cost of depreciable assets has been written-off using the declining balance method at a rate of 16.67%;

• after accelerated depreciation is introduced at the start of a year, the cost of new depreciable assets is written-off using the prime cost method at a rate of 20% (ie over 5 years);

• purchases of new plant are are spread evenly throughout each year so that depreciation deductions relating to purchases across a year total half of a full year's deductions (including for the first year after the introduction of accelerated depreciation); and

• there is a one-year lag between an income year and tax assessment for that year.

Table 10 shows relevant parts of the MyProject results. The accelerated prime cost depreciation is introduced at the start of Year 13, with the effect of that on tax revenue first felt in Year 14 given the one-year lag in tax assessment.

Table 11 takes the aggregate annual deductions from Table 10 in each of the ten years starting from Year 14 and subtracts the 'baseline' $10 billion of annual deductions - the equilibrium level of annual deductions under any depreciation regime when there is a constant $10 billion level of capital expenditure on depreciable assets. The table then applies the taxpayers' 46% tax rate to those 'excess deductions' to get the year-by-year cost to tax revenue. As expected, the time profile of cost to revenue ultimately reverts to zero (also reflected in the time profile of cost to revenue from the Kyscope package where a full year's write-off is allowed in the year that each asset is acquired).

TABLE 11: Cost to tax revenue of accelerated depreciation with constant expenditure

Year (from Table 10)	Aggregate deductions less $10b baseline $m (a)	Tax revenue cost $m (b)
14	166.5	76.6
15	638.4	293.7
16	1365.1	627.9
17	2304.1	1059.9
18	3419.9	1573.2
19	3683.1	1694.2
20	3069.1	1411.8
21	2557.5	1176.5
22	2131.2	980.4
23	Nil	Nil

Notes to table:

1. From Table 10.
2. Column (a) times 0.46 tax rate.

Two runs of MyProject are used to obtain the net year-by-year increases in depreciation deductions from accelerated depreciation: one to obtain the baseline of deductions before accelerated depreciation; the other to obtain the year-by-year aggregate deductions after accelerated depreciation.

The baseline deductions with increasing expenditure and deductions after accelerated depreciation - both less the $10 billion baseline level of constant expenditure - are reproduced in Table 12 where the year-by-year cost to tax revenue is also shown. Ultimately, the time profile of nominal cost to revenue stabilizes to a 10% per annum increase.

TABLE 12: Cost to tax revenue of accelerated depreciation with increasing expenditure

Year	Baseline deductions $m (a)	Deductions after accel dep $m (b)	Net increase in deductions (b)-(a) $m (c)	Cost to revenue $m (d)	Real cost to revenue $m (e)
14	Nil	166.6	166.6	76.6	76.6
15	83.4	738.4	655.0	301.3	273.9
16	327.8	1775.1	1447.3	665.8	550.2
17	724.1	3255.1	2531.0	1164.3	874.8
18	1266.1	5166.0	3899.9	1794.0	1225.3
19	1950.7	6503.8	4553.1	2094.4	1300.5
20	2777.5	7171.9	4394.4	2021.4	1141.0
21	3748.4	8070.6	4322.2	1988.2	1020.3
22	4867.5	9195.6	4328.1	1990.9	928.8
23	6141.1	8770.8	2629.7	1209.6	513.0
24	7755.1	10647.8	2892.7	1330.6	513.0
25	9530.6	12712.5	3181.0	1463.7	513.0

Notes to table:

1. From the baseline.
2. After accelerated depreciation introduced in Year 13.
3. Net increase in deductions - Columns (b) minus (a).
4. Net increase in deductions - Column (c) - times 0.46 tax rate.
5. Year-by-year nominal cost to revenue - Column (d) - deflated from Year 15 by 10% per annum (the growth rate assumed for investment) so that Year 15 real revenue cost = $301.3m/1.1, Year 16 real revenue cost = $665.8m/(1.1x1.1), and so on.

Version 1.0 © Copyright Wayne Mayo 2009