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Tuesday, January 29, 2013

Kahn: Tax Expenditures and Accelerated Depreciation

Douglas A. Kahn (Michigan), A Proposed Replacement of the Tax Expenditure Concept and a Different Perspective on Accelerated Depreciation, 40 Fla. St. L. Rev. ___ (2013):

The thesis of this article is that the tax expenditure concept is grounded on an erroneous vision of the structure of an income tax system. The tax expenditure concept adopts a binary view of income taxation. It posits that there is an ideal or pure income tax system whose provisions are elements of the normal structure of that system without any influence from non-tax policy considerations. Tax provisions are described either as falling within those core provisions or outside of them. There are no other categories. To the contrary, this article contends that tax provisions lie on a continuum in which some are in the core and some are at different distances from the core. The author contends that virtually all tax provisions, including those within the core, reflect policy considerations. The decision whether to adopt or retain a provision takes into account both its proximity to the core and also the economic and societal consequences (both positive and negative) that the provision will cause. There is no universal tax system for all times. Tax laws are (and should be) constructed to coordinate with the needs and values of society as they change over time. The article also contends that there is not just one proper method of depreciation, and that accelerated depreciation is as consistent with neutral tax principles as is straight line depreciation.

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Sorry, but I disagree. Accelerated depreciation has the effect of reducing effective rates of tax below nominal rates in a hidden but dramatic way. See Seto, Federal Income Taxation 242-252 (2012). I am uncomfortable with an ostensibly "neutral" system that systematically taxes some at different effective rates than others. I am even more uncomfortable with effecting any such lack of neutrality through provisions the effects of which are not commonly understood by the electorate.

Posted by: Theodore Seto | Jan 29, 2013 2:33:19 PM

In response to Professor Seto, I suggest that the same circumstance that he decries exists whenever the realization doctrine is applied to defer unrealized income. The deferral of unrealized income will reduce the effective tax rate of the taxpayer. My contention that accelerated depreciation does not violate neutral tax principles is based on the fact that an application of the realization doctrine to the unrealized appreciation of the remainder interest in a depreciable asset will result in an acclerated depreciation system. As I stated in my article, while there is no requirement to adopt the realization doctrine, the adoption of that doctrine cannot be said to violate neutral tax policy.

Posted by: Douglas Kahn | Jan 29, 2013 5:24:17 PM

Thank you, Prof. Kahn, for the beginning of a critique of tax expenditure analysis. Finally, someone in academia realizes that every item of tax expenditure analysis is a policy decision. Now we need some historical analysis of what tax expenditure budgets said would happen versus revenue actually realized.

Posted by: TexEcon | Jan 30, 2013 9:43:10 AM

Excellent article. The piece's main point -- that the vitriol directed at accelerated depreciation casually assumes that the realization doctrine must be ignored in calculating yearly depreciation -- should not be in dispute. And if one accepts, as he should, that the realization doctrine is a fundamental, albeit not constitutionally required, aspect of the income tax system, provisions related to accelerated deprecation may very well be consistent with a "baseline" tax system, if such a thing exists. Good riddance to tax expenditure analysis.

Posted by: BrealeyMyers | Jan 30, 2013 3:00:30 PM