Depreciation rules and small business longevity

Pages10-32
DOIhttps://doi.org/10.1108/JEPP-01-2012-0006
Published date14 April 2014
Date14 April 2014
AuthorDon Bruce,John Deskins,Tami Gurley-Calvez
Subject MatterStrategy,Entrepreneurship,Business climate/policy
Depreciation rules and
small business longevity
Don Bruce
Center for Business and Economic Research and Department of Economics,
University of Tennessee, Knoxville, Tennessee, USA
John Deskins
Department of Economics, West Virginia University, Morgantown,
West Virginia, USA, and
Tami Gurley-Calvez
Health Policy and Management, University of Kansas,
Kansas City, Kansas, USA
Abstract
Purpose – When a small businesspurchases a capital asset, its costfor tax purposes is spread over the
useful life of the asset throughthe process of depreciation. It has becomecommon in the USA for policy
makers to enhancedepreciation rules in an effort to increasebusiness investment in a less-costlymanner
than across-the-board marginal taxrate cuts. Indeed, short-term depreciationpolicies are often billed by
policy makers as a way to save America’s small businesses. However, little is known about the actual
effects of depreciation policies on small business activity. This paper aims to discussthese issues.
Design/methodology/approach – In this initial attempt to test the political claims regarding the
importance of depreciation rules, the paper uses a 12-year panel of tax returns for Schedule C sole
proprietors to empirically examine whether more generous depreciation policies influence small
business activity at the extensive margin. Specifically, the paper estimates a series of multivariate
models to explain sole proprietors’ decisions to remain in business as functions of their financial,
demographic, and tax situations, including measures of the presentdiscounted value (PDV) of a stream
of tax deductions for depreciated capital under various rule structures.
Findings – Throughout the analysis, the authors are unable to find evidence that favorable
depreciation rules lead to greater rates of entrepreneurial longevity among ScheduleC sole proprietors.
Originality/value – Discrete choice results suggest that increases in the PDVof tax reductions from
depreciation (e.g. depreciating the value earlier in the recovery period) might actually lead to higher
probabilities of small business exit, while survival analysis finds no clear influence of depreciation on
spells of small business activity.
Keywords Entrepreneurs, Self-employment, Tax policy
Paper type Research paper
1. Introduction
Small businesses represent the majority of employers and a very large share of US
output, so their purchasing decisions often drive the growth of the broader economy,
especially during recessionary periods[1]. When a small business purchases a capital
assetsuchasavehicleorafactory,itscostfortaxpurposesisspreadoutover the
useful life of the asset through the process of depreciation. Additionally, small
businesses can often treat capital purchases as current expenditures, subtracting
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/2045-2101.htm
Received 19 January 2012
Revised 6 July 2012
Accepted 6 July 2012
Journal of Entrepreneurship and
Public Policy
Vol. 3 No. 1, 2014
pp. 10-32
rEmeraldGroup PublishingLimited
2045-2101
DOI 10.1108/JEPP-01-2012-0006
The authors are grateful for helpful comments du ring the formative stages of this research from
LeAnn Luna and participants at the National Tax Association’s 2005 Annual Conference on
Taxation, and more recently from David Powell, Jesse Edgerton, Noel Campbell, and three
anonymous referees.
10
JEPP
3,1
the entire purchase price (subject to a legal limit) in the first year under Section 179
expensing rules.
Given the importance of small business investment, depreciation policy has become
an active area for targeting tax breaks toward small businesses in recent years. Indeed,
a highlight of the 2003 tax reforms from a small business persp ective was a limited-
time increase in Section 179 expensing allowances and a temporary acceleration of
allowable depreciation deductions. While not directed at small businesses specifically,
this “bonus depreciation” policy was intended to reduce the cost of investment in such
things as vehicles an d equipment, as par t of a broader effort to stimula te the US
economy during the slow growth that followed the 2001 recession.
The clear intent of more generous depreciation rules is to target tax-related
benefits to small businesses, possibly as a way to increase the overall level of
business inves tment. Such p olicy chang es as increase s in the Sectio n 179 expensi ng
limit and bonus depreciation are viewed as even more directly targeted tax breaks,
especially for smaller businesses. In a sense, they represent a way to reduce the tax
burden on sma ll businesses that is less co stly to the government in t erms of reduced
tax revenue than something more general like across-the-board marginal tax rate
cuts. On one hand, there is empirical evidence indicating that investment activity
does respond to depreciation policy, as would be theorized, in general (see Hall and
Jorgenson, 1967, for seminal work in the area) and in response to the 2003 tax
reforms previously mentioned (House and Shapiro, 2008). On the other hand, other
studies have found that bonus depreciation has not stimulated significant additional
investment (Co hen and Cummi ns, 2006; Knit tel, 2007), th at a significa nt share of
available depreciation benefits goes unused by eligible businesses (Kitchen and
Knittel, 2011), and that the large majority of depreciation deductions are reported by
a very small percentage of larger small businesses or by businesses that do not post
any AGI (Bruce et al., 2010).
One might wonder whether the policies actually increase the long-run level of small
business investment and activity, or merely cause existing small businesses to simply
speed up purchases they would have otherwise made. Furthermore, another concern
might be whether depreciation-related investment incentives might encourage small
businesses to put less-profitable investments in place prematurely, which could amplify
the importance of macroeconomic fluctuations and possibly lead to the failure of some
small firms. Thus, the overall effect of depreciation policy on the long-run longevity of
small businesses is theoretically ambiguous and requires empirical investigation.
Perhaps as a result of the relatively short history of significant depreciation
policy changes and the resulting data limitations, though, very little is known about the
actual effects of depreciation policies on small business activity. We know of no prior
study that has focused specifically on small business effects, although Knittel (2005)
documented the use of the 2003 bonus depreciation and found that the policy tende d to
cause filers to claim larger deductions, but did not necessarily bring many more new
filers into the depreciation deduction sample. Further, no prior analysis has considered
the possible effects of depreciation policies on small business longevity, perhaps
because researchers might harbor some doubt that the policies have had any noticeable
effect on this extensive margin. Even though the policies might not have stimulated
much additional investment, the possibility remains that they might have affected the
business lifecycle. Only with empirical analysis can we be certain.
As researchers and policymakers continue a national debate on prospects for US
federal tax reform, certain forms of which would greatly affect the cost of capital faced
11
Small business
longevity

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT