The Jobs and Growth Tax Relief Reconciliation Act of 2003 and Business Investment

CRS Report for Congress
The Jobs and Grow t h T ax Relief Reconciliation
Act o f 2003 and Business Investment
Analys t in Business Ta xa tion and Finance
Go ve rnment and Finance Division

Congressional Research Service ˜ The Library of Congress

The J obs and Growth Tax Relief Reconciliation Act of
2003 and Business Investment
During the congressional d ebate l e a d i n g u p t o t he enactment of the J obs and
Growth Tax R elief R econciliation Act of 2003 (J GTRRA, P .L. 108-27) in late May,
one of the arguments made on its behalf was t hat i t would s timulate the economy i n
part by encouraging firms to invest more th an they otherwise would over t he nex t few
years. The Act seeks t o enha n c e t he i n cent i v e t o i nvest by accel erat i n g t he t ax
treatment of depreci ation for certain tangible busines s assets.
Thi s report d escri b es t h e p rovi si ons of t h e Act i n t ended t o accom p l i s h t hi s and
ex pl ai ns how t h ey are ex p ect ed t o work i n pract i ce. It concl udes w i t h a d i s cussi on
of the implications of J GTRRA for busines s i nvestment in the nex t year or two. It
will not be updated.
The notion t hat faster economic growth can arise t hrough a sustained revival of
business i nvestment fi nds support i n r ecen t t ren ds i n t he perform ance of the U.S.
economy. Business spending on structures , equipment, and s oftware accounted for
12.5% of real gross domestic product (GDP) i n 2002, down from s hares o f 13.6% in
2001 and 14.4% in 2000. This decrease reflects t he critical role played by a d rastic
w e akening o f business i nvestment to the onset of the recession in 2001 a n d t h e
economy’s m ostly sluggi sh and uneven growth s ince then.
J GTRRA contains two provisions e x pressly i ntended t o s peed up the t ax
treatment of depreci ation for certain tangible assets. One is a t em porary i ncreas e i n
the ex p ens i ng allowance under s ection 179 of the t ax code. T he Act raises t he
amount that a firm m ay ex p e n s e i n a t ax year from $25,000 to $100,000 and t he
threshold at which the allowance phases out from $200,000 to $400,000 between
2003 and 2005. It also adds packaged software to the group of new and used assets
eligibl e f o r e x p e n sing in the s ame p eriod. The s econd provision is a t emporary
ex pansion o f a 30% first-year depreciatio n deduction t o 50% for certain new assets
purchased between May 6 , 2003 and Decem ber 31, 2004. It is equivalent to a 50%
ex pensing allowance. Depending on how much a firm s pends on qualified assets in
a t ax year, a firm may claim both allowances in 2003 or 2004.
Accelerated depreciation can stimulate business i nvestment by lowering the user
cost of capital and by increasing the cash flow of firms with limited access t o d ebt
and equity markets. Proponents of J GTRRA sa y t h a t i t will deliver a s ignificant
stimulus to business investment in the short run by greatly accel erat i n g t he t a x
treatment of depreciation for equipmen t and software from 2003 to 2005. Bu t not all
analysts agree that the Act will ignite a sharp and sustained rebound in business
investment. They point out that certain other fact ors affecting t he domes tic climate
for t his i n v e s t m ent may dam pen or even overwhelm any s timulus arising from
J G TR R A . O f p art i cul ar concern, i n t h ei r v i ew, are ex cess capaci t y i n a w i d e range
of industries, persistently high u n e m p loym ent l evels, and d im ex pectations among
business ex ecutives and o wners about the p rofitability of new investment and s hort-
term growth in GDP.

Business Investment and t he Recen t P erformance of the U.S . E conomy .......1
J G TR R A and A ccel erat ed Depreci at i o n ................................2
TemporaryExpansion oftheExpensingAllowance ...................3
Temporary50%First-YearDepreciationDeduction ...................4
Hypot het i cal Ex am pl e o f A ccel erat ed Depreci at i o n U nder J GTR R A ......5
JGTRRAandBusinessInvestment in theShortRun ......................6
Tabl e 1 . H ypot het i cal Ex am pl e o f D epreci at i o n A l l o wances and A ssoci at ed
Tax S avings in 2003 Under t he J obs and Growth Tax Relief
Reconciliation Act of 2003 and P revious Tax Law ....................5

The J obs and Growth Tax R elief
Reconciliation Act o f 2003 and Business
In the congressional d ebate l eading u p t o t he enactment of the J obs and Growth
Tax R elief R econciliation Act of 2003 (J GT RRA, P .L. 108-27), one of the arguments
made on its behalf was t hat it would s timulate the economy i n p art b y encouraging
firms t o i nvest more than they otherwise would over t he nex t few years. The Act
i n cludes t wo measures ex pressly i nt ended t o boost business i nvest m e n t b y
accel erat i n g t he t ax t reat m ent of depreci at i o n for cert ai n t angi b l e asset s . T hi s report
describes t hese measures and p rovides a hyp o t h e t i cal ex am pl e o f how t h ey are
i n t ended t o w ork i n p ract i ce. In addi t i on, i t ex am i n es t h e l i nks bet w een accel erat ed
depreciation and business i nvestment and discusses t heir implications for domestic
business i nvestment in the s hort run.
Business Investment and the
Recent P erformance of the U .S. E conomy
The n o t ion t hat faster U.S. economic growth can be achieved b y s purring
increased busi n e s s i nvestment finds so me support i n recent economic trends.
Bu siness spending on structures, equipmen t, and s oftware i s an important component
of gross domestic product (GDP), wh i c h i s t h e market value o f all final goods and
services produced within a country in a year. In 2002, this spending accounted for

12.5% of real GDP, down from s hares o f 13.6% in 2001 and 14.4% in 2000.

This dec r e a s e reflects t he important and unusual role p layed b y business
investment in the downturn i n t he economy in 2001 and its sluggi sh, uneven recovery
since t hen. Much of the d ecl ine i n real GDP in the first three quarters o f 2001 can
be attributed to a fall i n nonresidential fix ed investment that commenced in the fourth
quarter of 2000 and h as persisted (with one ex ception) through t he fir s t quarter of
2003. 1 In t h e post -W o rl d W ar II peri od, m o st recess i o n s h ave ori gi n at ed i n a
sign ificant downturn i n consumer spending on durable goods and housing. Bu t t he
one that began i n M arch 2001 and s eemingl y end e d i n f ourth quarter of 2001 was
distinctive i n t hat i t was driven initially by steep cutbacks i n busines s s pending on
capital goods, especially computer and t elecommunications equipment and software.2

1 According t o f igures reporte d b y t he Bureau of Economic Analys is at the Comme rce
D epartment, r eal nonresidential f ixed investment declined in eight of t he nine q u a r t e r s
between the f ourth quarter of 2000 and t he first quarter of 2003.
2 Ben S. Bernanke, “Will Business Inve stme nt Bounce Back?,” Federal Reserve Board, April

Substantial i ncreases in this spending underpinned t he rapid economic growth of the
late 1990s.3 Some analys t s m a intain that a resumption of robust economic growth
hinges in part on a s trong, s ustained recovery in business i nvestment.
JGTRRA and Accelerated Depreciation
How might J GTRRA spur an increase i n business s pending on capital goods?
The answer lies i n t wo provisions of the Act intended t o s peed up the d epr e ciation
of certain business assets for t ax purposes . One provision of J GTRRA temporarily
ex pands the ex p ensing allowance under s ection 179 of the Internal R evenue Code
(IRC). The ot h e r ex p ands a t emporary 30% fi rst -year depreci at i o n d educt i o n
established b y t he J o b C reation and W o rker Assistance Act o f 2002 (J CW AA, P.L.

107-147) to 50% and ex t ends it through t he end o f 2004.

Economic depreci ation i s t he decline i n t he market value of an asset, such as a
commercial building or m achine t ool, as i t i s used over time. The decline t ypically
stems from wear and t ear or obs olescence. As such, i t repre sents a cost that should
be deduct ed i n d et erm i n i n g a busi n ess t ax payer’s t ax abl e i ncom e. Because i t i s
d i f f i c u l t t o m easure accurat el y t h e act ual reduct i o n i n t he val u e o f an asset , t h e
federal t ax code speci fi es depreci at i o n al l o wances for al l t angi b l e depreci abl e asset s
which i n m any c a s e s a r e t hought to be more generous than they would b e under a
system based o n t rue economic depreciation.4 An accel erat i o n o f t he rat e at whi ch
an as s e t i s d e p reci at ed for t ax purposes shrinks the t ax burden o n t he returns
generat ed b y t he asset over i t s useful l i fe. S u ch an accel erat i o n can be achi eved b y
reducing t he recovery period for an asset o r i ncreas ing t he share o f its co st written o ff
in the early years of its use.

2 (...continued)
24, 2003, available a t [ h ttp:// eeches/2003], visit e d o n
3 According t o data r eleased by the Bureau of Economic Analys i s a t the Comme rce
Departme nt, from 1995 to 2000, real GDP incr eased at an average a nnual r ate of 4.0%. T he
ma in components of GDP recorded the f ollowing gr owth rates: p e r s o n a l c onsumption
expenditures, 4.2%; non-residential f ixed investment (equivalent to business i nvestment),

10.1%; r esidential f ixed investment, 5.0%; change i n private inventories, 16.4%;

gove rnme nt ex p e n d i t ures, 2.4%; a nd net e xports, -38.4%. T his c omparison i mplies t hat
gr oss private domestic investment as a whole and business i nvestment i n part i cular
increased their contributions to GDP in that period.
4 In a 2000 report, the T reasury De p a r t me nt f ound that “at current rates of i nflation,
d e p r e c i a t i o n a l l owances under c u r r e n t l a w ge n e r a l l y a r e accelerated relative t o t hose i mplied
by economic depreciation, but that this relationship would r e verse at a high r ate of
inflation. ” T h e report went on t o note t hat t he relationship between economic and t ax
depreciation varies by maj or asset, and t hat “current law f avors i nvestments in equipment
over nonresidential s tructures, and favors intangi bles (e.g., goodwill or intellectual property)
over depreciable property.” See Department of the T reasury, Report t o The Congress on
Depreciation Recovery Periods and Methods (Washington: J uly 2000), p. 27, available at
[], vi sited on Aug. 12, 2003.

Tempor ar y E xpansi on of the E xpensing Allow a nce
Under IRC section 179, business t ax payers (both corporate and non-corporate)
are allowed t o d educt (or ex pense) a cer tain a m ount of the cost of qualified assets
pl aced i n servi ce i n a t ax year. T he al t ernat i v e t o ex p ensi ng i s t o recover t hi s cost at
slower rates u sing the regular depreciatio n s chedules under t he M odified Accelerated
Cost Recovery System (MACRS).5 Qualified assets are defined as certain new and
used depreciable assets acquired for use in t he active conduct o f a trade o r business.
Historically, t hey have consisted m ostly of motor v ehicles weigh ing m ore t han 6,000
pounds (including SUVs) and machinery and equipment u sed i n p r o d u ction,
ex traction, transportation, communications, elect ricity generation , gas and water
production and distribution, and s ewage d ispos al. M ost s tructures are ineligible for
The amount of the cost o f qualified assets that a firm can ex pense i n a gi ven t ax
year is subject to two important limitations . First, t hat amount is reduced dollar for
dol l ar (but not bel o w z ero) when t h e t ot al cost of qual i fi ed asset s pl aced i n servi ce
i n a t ax year ex ceeds a phase-out t h reshol d. Hi st ori cal l y, t he t h reshol d h as been set
so low t hat m ost of t he firms claiming t he ex pensing allowance have been smal l i n
asset s iz e. S econd, the ex p ensing allowance claimed b y a tax p ayer may not ex ceed
his o r h er tax able i ncome from t he active conduct o f t he trade o r business i n which
t h e qual i fi ed asset s are u sed. Busi ness t ax p ayers m ay not carry forward ex p ensi ng
allowances denied under t he dollar limitation, but they may carry forward allowances
denied under t he income limitation.
J GTRRA makes s everal important (though t emporary) changes in the ex pens ing
al l o wance. 6 It increases the m ax imum amount that may b e ex p ensed from $25,000
to $100,000 in 2003 through 2005. The Act also raises the phase-out threshold for
the allowance from $200,000 to $400,000 in the s ame p eriod. Bo t h t h e m ax imum
ex pensing allowa n c e a n d the phase-out th reshold are index ed for inflation i n 2004
and 2005. As a result, a business t ax payer acquiring and p lacing in service i n 2003
assets eligible for ex pensing may write off $100,000 of their t otal cost on its federal
income tax return, provided t he cost is less than $400,000. Lesser amounts m ay be
ex pensed if the t otal cost falls between $400,000 and $500,000. Bu t once t he total
cost reaches $500,000 or more, n o amount may b e ex p ensed. In add ition, the Act
adds packaged o r o ff-the-shel f software t o t he list of assets eligible for ex pensing

5 T he r egular depreciation s chedules derive from what i s known as t he Modified Accelerated
Cost Recovery System (or M ACRS). MACRS applies t o most t angi ble depreciable business
p r o p e r t y placed in service after December 31, 1986. Under M ACRS, depreciatio n
deductions are not determined by measuring t he actual or expected change in the ma r ket
value of an asset as i t i s used over time. Instead, t hey are specified by statute and are
calculated on t he basis of an asset’s useful life f or tax purposes and permi ssible depreciation
methods. Depreciation deductions reflect the h istorical cost of an asset and are not indexed
6 For more i nforma tion on how J GT RRA alters the e xpensing a llowance under IRC section
179, see CRS Report RL31852, Small Business Expensing Allowance Under t he Jobs and
Gr owth Tax Relief Reconciliation Act of 2003: Changes and Likely Economi c E f f e cts ,by

from 2003 through 2005. This addition h as the potential t o ex p and greatly total
deduc t i ons for t he ex pensing allowance, as business purchases of software totaled
$182.8 billion (current dollars) i n 2002, or 16% of nonresidential fix ed investment
and 27% of business s pending on equipment. Assuming C ongress leaves current tax
law i ntact, i n 2006, the ex p ensing allowance reverts to its status in 2003 before the
enactment of J GTRRA.
Temporary 50% First-Year Depr eci ati on Deducti on
J GTRRA also ex pands a t emporary 30% first-year depreciation d e d u c tion
creat ed by J C W A A for cert ai n new d epreci abl e t angi b l e asset s purchased aft er M ay
5, 2003, and p laced in service b efore J anuary 1, 2005. An asset does not qualify for
the 50% depre c i a t i o n d eduction i f a bindi ng sal es cont ract for i t s purchase was i n
e f f e c t before May 6 , 2003. In practice, the d eduction i s equivalent t o a 5 0 %
ex pensing allowance for thes e assets. It i s important to keep in mind t hat t his new
allowance does not abolish t he temporary 30% first-year depr e c i ation d eduction,
which applies t o qualified assets bought between September 11, 2001 and S eptember
10, 2 0 0 4 and placed in service b y J anuary 1, 2005. Business tax p ayers m ay claim
one d e d u c t i o n o r t he other for qualified assets acquired b etween May 6 , 2003 to
September 10, 2004, when the 30% ex pensing allowance i s due to ex pire.
So under current law, business t ax payers may write off 50% of the cost (or
adjusted basi s ) o f q u alified assets. Generally, t he assets eligible for t his partial
ex pensing allowance are al so eligible for t he 30% ex pensing allowance u n der
J C W AA. To qualify, a n a s s e t m ust b elong to one of the following categories: (1)
it has a recovery period unde r M A CRS of 20 years o r l ess; (2) i t i s u sed i n a water
utility; (3) it is computer software that was not acquired as part of t he purchas e of a
business o r i s readily available for purchase b y t he general public, i s not subject to
a non-ex clusive license, and has n o t b e en greatly modified; o r (4) it is an
improvement by a l essor o r l essee t o t he interior of a non-residential building t hat i s
at l east t hree-years o l d . M ost resi d ent i al r ental and non-residential buildings do not
qualify for this treatment.
J GTRRA al so raises the limitation on t he max imum depreci ation deduction for
certain automobiles i n t heir first year of use. The limitation i s i ntended t o det er
ex cessive spending on lux u rious passenger cars purchased m ai n l y for busi n ess u se.
J C W AA raised t he max imum first-year de preciation d eduction b y $4,600 for cars
used solely in business and placed in serv ice b etween S eptember 10, 2001 and M ay
5, 2003. Bu t J GTRRA increases that additional d eduction t o $7,650 for cars bought
and p laced in service b etween May 6 , 2003 and J anuary 1, 2005. 7 Automobiles
el i gi b l e for t hi s t reat m ent are d efi n ed as four-wheel ed vehi cl es wi t h a gross unl oaded
weight of 6,000 pounds or less that are m anufactured for u se on public streets, roads,
and h ighways and bought primarily for u se in business.

7 As a r esult, under J GT RRA, t he ma ximum f irst-year depreciat i o n d e d uction f or eligible
cars i s $10,710, up from $7,660 under previ ous law. T his includes a ny expensing a llowance
under IRC section 179.

Hypothetical Exampl e of Accel erated Depreciation Under
Under current tax l aw, a firm may claim both t he enhanced IR C s ec t i o n 179
ex pensing allowance and the 50% first-year depreci at i o n d educt i o n for t h e s am e
depreciable asset o r assets in 2003 to 2005. In fact, i f t he cost of an asset qualified
for both allowances is suffici ently large, a firm m ay recover t his cost u sing the full
ex pensing allowance, the 50% ex pending allowance, and t he MACRS in the asset’s
fi rst year of use. To do so, t he fi rm fi rst m ust d et erm i n e whet h er i t m ay ex p ense any
of the cost under IRC section 179. Any s uch allowance reduces the t ax payer’s basis
in the asset. The nex t s tep i s t o det ermine whether it may apply t he 50% depreci ation
deduction. Any s uch deduction further reduces the firm’s bas is in the asset. Fi nally,
assuming t he asset’s adjusted basis is great er than zero after claiming an ex pensing
allowance and the d eduction , the firm i s entitled t o a depreciation d eduction under
the M ACRS. This procedure i s illustrated by t he following hypothetical ex am ple.
Table 1. H ypothetical Example o f D epreciation Allow ances and
Associated Tax Savings in 2003 Under t he Jobs and Grow t h T ax
Relief R econciliation Act o f 2003 and Previous Tax L aw
P r e v i o us La w C ur r e nt La w
Or iginal Co st ( o r B asis) o f $300,000 $300,000
the Co mp uter System
IRC Sectio n 179 Expensing $0 $100,000
Allo wa nc e
Ad j uste d B a sis o f Co mp ute r $300,000 $200,000
T emporary First-Year $90,000a $100,000 b
Depreciation Deduction
Ad j usted Basis $210,000 $100,000
Normal MACRS First-Yearc $42,000 $20,000
Dep r eciatio n Allo wa nc e
Ad j usted Basis as o f 01/01/04 $168,000 $80,000
T o tal Depreciation Deduction $132,000 $220,000
in 2003
T ax Savings in 2003 $46,200 $77,000
Source: Congressional Research Service
a Und e r p r e vio us law, the temp o r ar y fir st-year d e p r eciatio n d ed uc tio n was ( a nd still is) 3 0 %.
b Und e r c ur r e nt law, the maximum temp o r ar y fir st-year d e p r eciatio n d ed uc tio n is 5 0 %.
c Under the Modified Accelerated Co st Recovery System in place since 1987, comp uter systems are
d e p r eciated o ver five year s, and 2 0 % o f the o r igina l c o st is wr itten o ff in the fir st year , a p p lying
the double d eclining b alance me thod and the ha lf-year conve ntion.

S uppose t hat i n August 2003, the XYZ Corporation buys and places in service
only one tangible depreciable asset: a n ew c o m p u t e r system valued at $300,000.
W h at i s t h e m ax i m u m d epreci at i o n d educt i o n i t m ay cl ai m for t h e com put er syst em
in 2003 under J GTRRA? How does t hat compare with t h e m a x i m u m first-year
depreciation d eduction under p revious law? And how much greater is the t ax savings
from d epreciation i n 2003 under J GTRRA? The answers can be found in the t able
on the p revious page.
It i s cl ear from t he t abl e t hat t he XYZ C o rporat i o n faces a l ower t ax burden i n
2003 under curren t l a w t han under p revi ous law. Because of J GTRRA, t he firm
would b e able t o recover 73% of the o rigi nal cost o f t he computer system in its first
year of use. By contrast, under p revious law, the firm would b e able t o recover only
44% of that cost. Although under both current and p rev i o u s l a w t he firm could
deduct n o m ore t han t he original cost of the asset (i.e., $300,000) over its five-year
recovery period, there i s an important benefit from d educting a l a rger share of that
cost in the first year of the asset’s u se. As that s hare ex pands, t he present d iscounted
value of depreciation deductions over an asset’s tax life rises. This is because a
dol l ar recei ved t oday i s m or e v al uabl e t han a dol l ar recei ved i n a fut u re year.
In creases in the p resent discounted value o f d epreci a tion allowances translate i nto
decreases i n t h e effect i v e cost o f an asset t o buyers.8
JGTRRA and B usiness Investment in the S hort R un
How might J GTRRA directly affect business i nvestment in the s hort run? The
answer i s com p l i cat ed and m arked b y s om e uncert ai n t y. N onet h el ess, t h e k ey
considerations in assessing the Act ’s likel y impact on investment are t he implications
of accelerated depreciation for investment , t he timing and duration of t he tax s ubsidy,
and t he interplay amon g t he other forces influencing i nvestment in the current
economic environment. Acc e l erated depreciation i s t hought to boost business
investm e n t t h rough t wo channels: t he user cost of capital and business cash flow.
This stimulus can be magnified or m uted by a number of other fact ors i nfluenci ng the
deci s i o n to invest, m ost notably the amount of ex cess capacity in the economy,
current and ex p ect ed busi n ess p rofi t s , current and ex p ected demand for domestic
busi n ess out put , t he i n fl at i o n rat e, and current and ex p ect ed l ong-t erm i nt erest rat es.
Most economists agree t hat a key fact or in a firm’s deci sion to invest is the user
cost of capi t al . Thi s cost em braces som e com posi t e of t h e p re-t ax rat es o f ret urn o n
alternative i nvestments (as measured by th e cost o f funds in debt and equity markets),
as well as economic depreci ation and the effective t ax rate on the s tream of income
generated by use of the asset. Basically, t he user cost of capital det ermines the after-
t ax rat e o f ret urn a proj ect m u st earn i n o rder t o be profi t abl e. In general , as t h i s cost
rises (or falls), the number o f i nvestment s t hat can be undertaken profitably and the
desi red capi t al s t o ck of m o st fi rm s d ecrease (or i n crease).

8 For a concrete example of t his effect, s ee Harvey S. Rosen, Public Finance,6th edition
(New York: M cGraw-Hill Ir win, 2002), p. 402.

A change i n t he tax t reatment of depreciation can raise or l ower the user cost of
capital b y m odifying t he t a x burden o n t he returns t o i nvestment. A widely used
measure o f t his burden i s t he marginal eff ective t ax rate on assets acquired t hrough
business i nvestment. This rate i s t he share o f t he internal rate of return on investment
t h at i s t ax ed; i t vari es accordi n g t o s t at u t o ry t ax rat es, d epreci at i o n r u l es, and any
ex plicit investment s u b s i d i e s s uch as an i nvestment tax credit. As the rat e of
depreci at i o n i s accel erat ed, t he user cost of capi t al fal l s , al l ot her t hi ngs b ei ng equal .9
There i s s ome evidence t hat d eclines in the u ser cost o f capi t al i n t urn s pur i n creases
in business i nvestment, t hough considerable uncertainty s u r rounds the likely
magn itude of the i ncrease. 10 A r ecen t CRS analysis found that J GTRRA not only
reduces the t ax burden o n i nvestment in equi pment but am plifies t he ex tent to which
the t ax code favors i n v e s tment in equipm ent over i nvestment in non-residential
structures. Given a real discount rate of 5%, and inflation rate o f 2 %, and a tax rate
of 35%, i t estimates t hat t he marginal effective t ax rate on equipment i s 15% when
50% of the cost m ay be ex pensed in the first year (as under J GTRRA); 20% when
30% of the cost m ay be ex pensed (as under p revious tax l aw); and 26% when none
of the cost m ay be ex pensed. 11 By c o n t r a s t , under current and p revious law, the
marginal effective t ax rate for non-residential s tructures (which, for t he most part, d o
not qualify for accelerated depreciation) is 32%. S upporters o f J G T R R A contend
that much of its stimulative effect on busines s i nvestment will result from reductions
in the user cost of capital.
Some analys ts maintain that accelerated depreciation also s timulates business
investment by boosting t he cash flow o f firms, especially those t hat rely h eavily on
internal funds to finance n ew investment. T he meaning o f cash flow can vary,

9 In a r ecent s tudy, t wo economists estimated the declines in the user cost of capital
associated with the t emporary 30% first-year deprecia t i o n d e d uction created by the J ob
Creation a nd Worker Assistance Act of 2002. T he estimates covered assets with 3-, 5-, and
7-year tax lives and r eflected different assu mptions about the r ate of i nflation, the expected
duration of t he stimulus, and the cost f aced by firms i n adj usting t heir stock of capital t o
desired l evels. Not s urprisingl y, they found that the decline i n user cost varied with the t ax
life of an asset, the degree of adj ustment cost, and annual i nflation r ate. T he declines were
the greatest f or investment in 7-year assets in the presence of l ow adj ustment costs, a l ow
inflation r ate, and a 1-year partial expensing allowance. See Darrel S. Cohen, Dorthe-
Pernille Hansen, and Kevi n A. Hassett, “The Effects of T emporary Partial Expe n s i n g on
Investment Incentives in the United States,” National Tax J ournal , vol. 60, no. 3, pp. 457-


10Recent s tudies have found that a 1% decline i n t he user cost of capital i s associated with
a r ise i n business s pending on equipment of 0.25% to 1% in the s hort r un. Most economists
argue t hat f irms are likely t o be l ess r esponsive t o changes in tax policy r educing t he user
cost of capital when aggr egate output is falling or s tagnant and a broad range of i ndustries
have substantial excess capacity than when the opposite co n d i t i o n s p r evail. This implies
that firms may have a s maller r esponse t o t he accelerated depreciation offered by J GT RRA
under c urrent economic conditions than they would i f t he economy were growi ng at a r obust
pace. See CRS Report RL31134, Using B u s i n ess Tax Cuts to Stimulate t he Economy,by
Jane G. Gravelle, p. 4; and Kevin A. Hassett and R. Glenn Hubbard, Tax Policy and
Investment, W orki ng Paper 5683 (Cambridge , M A: National Bureau of Economic Research,
11J a ne Gravelle of CRS ge nerated t hese estimates in early J une 2003.

depending on the contex t. In this co n t ex t, it can be thought of as the d ifference
bet ween a fi rm ’s revenue and cash p aym ent s for operat i n g, i nvest i n g, and fi n anci ng
activities i n a speci fic period. There i s reas on to believe that cas h flow can play an
important role in the i nvestment decisions of firms with limited o r n o access t o d ebt
and equity markets. A m ajor cause of their d ifficulty in raising funds is inadequate
information about their p rospects for future growth and p rofits on the p art o f l enders
o r investors. Fi rms i n s uch a position face a l ower cost for i nternal funds than
ex ternal funds. S ome s tudies have found a s ignificant positive correlation b etween
changes i n a firm’s net worth or supply o f i nternal funds and its investment
spending.12 The correlation was strongest for firms h aving t rouble raising funds in
debt and equity market s. It would be a mistake, however, t o v iew t hese findings as
conclusive evidence that firms with relativel y high cas h flows spend m ore on new
c a p i t al goods than firms with relatively l ow or negative cash flows. C ash f l o w i s
correlated with productivity growth, and it may b e t his growth t hat d rives added
investment . C o rrelations disclose nothi ng meaningful about possible causal links
between cash flow and investment. P r oponents o f J GTRRA say t hat b y ex p anding
the cash flow of small- and m ediu m - s i zed firms in the short run, it will further
stimulate new business i nvestment.
Another consideration i n a n alyz i ng the implications of J GTRRA for business
investment in the nex t year or two i s t he timing a n d d uration of its provisions
accelerating t he tax t r e atment of depreci ation. P roponents o f t he Act h ave argued
t h at because t h ese p rovi si ons are t em p o r a ry and t aki ng effect when t h e dom est i c
climate for business i nvestment i s r e latively weak, t hey s hould ex ert a s ignificant
stimulus i n t he short run. Few economists would dispute t he notion t hat t emporary
inves t m e n t t a x i ncentives are m ore effective as a tool of economic stimulus t han
perm anent ones, for t he si m p l e reason t h at a t em porary i ncent i v e woul d b e l i k el y t o
convince m ore firms to advance t he timing o f p lanned i nves tments t o t ake advantage
of the t ax benefit. But a similar consensus appears not to have formed around the
question o f t he timing o f i nvestment tax i ncen tives and t heir efficacy. S ome analysts
hold t hat i t i s reasonable t o ex p ect most firms t o b e m ore responsive t o reductions in
t h e u ser cost o f capi t al when econom i c growt h i s proceedi n g at a rel at i v el y b ri sk pace
than when it is relativel y s lack.13
Not all analys ts, however, are convinced that J GTRRA will deliver a s ignificant
boost t o business i nvestment in the n e x t ye a r o r two. These s keptics s ay that any
boost from t he temporary accelerated depreci ation i t o ffers is likely t o b e d ampened
or overwhelmed b y certain other factors likel y t o affect busines s i n v e stment in
coming m onths. One factor, i n t heir view, i s t he ex istence o f ex cess capacity in a
range o f i ndustries. According t o figures released by the Board of Governors o f t he
Federal R eserve, t he indust r i a l s e ctor operated at 74.3% of capacity in the s econd
quarter of 2003; by contrast, during t he height of the bu s i n e s s i nvestment boom of
the 1990s, t he operating rate averaged 83.1% from 1995 through 1998. Skeptics also
note t hat m any economists do not foresee a resumption o f robust growth i n real GDP

12For a revi ew of the r ecent literature on this topic, see R. Glenn Hubbard, “Capital M arket
Imperfections and Investment,” Journal of Economic Literature, vol. 36, March 1998, pp.


13Gr avelle, Using Business Tax Cuts to Stimulate t he Economy,p.4.

in the n ex t year or so, as continuing concerns about job s ecurity, s tagn ant i ncomes,
and r i s i n g l e v els o f household d eb t restrain consumer spending. 14 Another factor
working against a resurgence in business investment anytim e s oon, in the view of
some, i s t he surprising number o f analysts and bus i n e s s m anagers who remain
pessimistic about the ex p ected profitabilit y o f n ew investment in structures and
equipment 18 months into the recovery from the l a st recession.15 In addition,
J GTRRA’s impact on business i nvestment in the s hort run coul d b e w eaker than
proponents h ave argued i f enough business ex ecutives and o wners come t o b elieve
that Congress will ex tend the busines s t ax c u t s included i n t he Act b efore t hey
ex pire. 16 Some maintain that thes e fact ors m ake i t likel y t hat m any of t he firms able
t o t ake advant age o f t he accel erat ed depreci at i o n p rovi ded b y J GTR R A wi l l be m o re
inclined to use t he tax s avings for purposes other t han ex p anding spending on new
pl ant and equi pm ent , such as i n creasi n g d i v i d ends paym ent s t o sharehol ders, ret i ri n g
debt , i nvest i n g i n research and d evel opm en t, acquiring othe r f i r m s , o r h iring n ew
To provide some empirical support for their v iew o f t he likely s timulative effect
of J GTRRA, s keptics point out that despite l o w i nt erest rat es and t he enact m ent of
the t emporary 30% first-year depreciation d e d uction i n M arch 2002, real non-
residential fix ed investment in the first quarter of 2003 was 0.8% lower t han i n t he
second quarter of 2002.

14According t o a gr oup of economic forecasters polled monthly by Blue Chip Economic
Indicators, the l atest average forecast calls for r eal GDP to gr ow 2.3% in 2003 and 3.7% in
2004. Given existing t rends in productivity gr owth, t hese proj ected rates of growth would
appear to be insufficient t o generate s ubstantial gains in new j ob creation. See CRS Report
RL30329, Current Economic Conditions and Selected Fo r ecasts , by Gail M akinen and
Anne V orce, pp. 13-14.
15See Bernanke, “Will Business Inve stme nt Bounce Back?,” p. 9; David L e onhardt,
“Executives More Op t i mistic but Still Expect Weak Gr owth,” Ne w Y or k T i me s , J uly 17,


16See William G. Gale, Short-Term Stimulus, Long-Term Growth and JGTRRA, t estimony
to Senate Democratic Policy Committee, J une 9, 2003, available at
[ h t t p : / / www.t a xpol i c ycent e r .or g] , vi s i t e d o n J une 24, 2003; and Gr a ve l l e , Us ing Business
Tax Cuts t o Stimulate t he Economy , pp. 6-7.