After the discussion in my post yesterday on the Investment Boost subsidy scheme announced in the Budget I thought a bit more about who was likely to benefit the most from it.
The general answer of course is the purchasers of the longest-lived assets.
Why? Because if you have an asset which IRD estimates to have a useful life of 100 years, your straight line depreciation deduction normally would be 1% per annum for each of those 100 years. But under investment boost, you get to do almost the first 21 years of deductions in the first year (the 20% Investment Boost deduction plus your 0.8% normal depreciation), and then the annual deduction each year thereafter is reduced by a little. But money today is very valuable relative to money given up (ie higher taxable income because of reduced future annual deductions) decades hence.
If on the other hand, you have an investment asset that has an estimated life of only 5 years (and there are many of them) it would normally be depreciated (straight line) at 20% per annum. Under Investment Boost, you get to deduct 36 per cent in year 1, but that additional depreciation upfront is clawed back over only the following four years. The Investment Boost additional upfront deduction has a positive present value, but it is fairly modest for such short-lived assets.
And what are the longest-lived assets? They will mostly be buildings. And, as we know, last year the government (with Labour’s support) moved to abolish tax depreciation altogether on commercial buildings (with an estimated useful life in excess of 50 years).
And that hugely magnifies the advantage of the Investment Boost policy for purchasers of new commercial buildings. Not only are they very long-lived assets but because there is no general tax depreciation on these assets, there is no depreciation clawback. The 20 per cent Investment Boost deduction is just pure gift (recall that the actual value to companies of all these deductions is 28 per cent of the value of the deduction itself – the company tax rate).
I did a little illustrative exercise in the table below, comparing the present value of the Investment Boost deduction for three different types of assets: commercial buildings, a winch (which IRD estimates has a 10 year useful life), and a printer (IRD estimates a five year useful life). Under the policy, in year 1 you get to deduct 20 per cent of the value of the asset plus normal depreciation calculated on the remaining 80 per cent. I’ve evaluated each option using a discount rate of 5 per cent (choice of discount rate won’t change the relative story across assets).
On plausible scenarios, Investment Boost is much much more beneficial to purchasers of commercial buildings than it is to most other assets (eight times as much for the same capital outlay on an asset with a life of five years[but see update at end of post]). There are, of course, other business assets with longer useful lives than 10 years (my winch example) but if you skim through the IRD schedule not that many more than 15.5 years.
And this a sector that just a year ago the government thought should get no tax depreciation at all…..
And a reminder, per yesterday’s post, that the IRD Fact Sheet on this policy says that (new or extended) rest homes will get to benefit from this (substantial) deduction, but that rental accommodation built afresh for any demographics to live in will not.
I challenge you to find the intellectual coherence in that.
Of course, you wouldn’t have got from anything announced on Budget day the sense that new commercial building purchasers were going to be by far the biggest winners. The Minister’s press release on the policy talks of how
To achieve that growth, New Zealand needs businesses to invest in productive assets – like machinery, tools, equipment, vehicles and technology.
But not a mention of commercial buildings. And perhaps more strangely, there is no discussion at all in the IRD/Treasury RIS of which sectors will benefit most, let alone the consistency with last year’s policy initiative on tax deprecation for commercial buildings, or of the rather anomalous situation where some new commercial residential accommodation (rest homes) gets the subsidy, while most of that market doesn’t. Quite extraordinary really.
It needn’t have worked out that way. Had the policy been set up to allow (say) double the normal rate of depreciation, until the asset was fully depreciated – rather than a flat 20 per cent in the first year – then there’d have been no benefit for commercial buildings at all (and whatever the merits of that at least it would have been consistent from one year to the next). Doing it in combination with restoring tax depreciation for commercial buildings might have involved initial backtracking but would at least have the merit of some consistency and coherence now.
UPDATE: A commenter notes that I really should compare scenarios with replacement at the end of the asset’s useful life. That is right. It will matter for the absolute comparison between 5 and 10 year assets (reduces the PV margin of a 10 year asset to 15% or so), and for the absolute scale of advantage of commercial buildings, but – since there is no clawback at all in respect of commercial buildings – it does not change the point that Investment Boost most strongly favours commercial building investment. Moreover, and all else equal, an investor with even a mild degree of risk aversion would favour cash in hand (20% immediate deduction on a 100 year life asset) over the uncertainty of the deduction regime at each replacement of shorter-lived assets.
croaking cassandra 
Does it make that much difference? It feels like this policy is very a fiddly and penny-pinching approach to unlocking capital investment and – according to Treasury estimates – will add 0.1% to GDP.
The government should be more focused on generating demand in the economy by spending more money on large scale or long-term ongoing projects.
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In long term GDP terms the policy is modest but $1.8bn of taxpayers’ money is being spent on it in 25/26.
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Yes.
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Is it being spent though? From a Keynesian perspective it is a small tax reduction which has a different effect on the economy than government spending.
The other thing that makes it confusing and obtuse is that to get this ‘investment boost’ private sector entities will need to front up the cash – or debt – for some big expensive items in order to claim a slightly bigger tax rebate than they would have.
I think that’s all it is, an increase in what you can claim as a business expense – another wee job for you accountant. Am I missing something?
That probably sums up the budget – ‘Am I missing something?’
I understand why – Willis is trapped between Keynesian reality and a strong desire for major tax cuts for businesses. But the debt to GDP limit and slowing growth make it impossible to deliver those cuts along with the needed spending cuts – in an orderly fashion. I.e. where the NZ economy doesn’t collapse.
Not an easy political position to be in as highlighted by Jack Tame, but I’ll give Willis credit for threading a very delicate needle by accepting political compromise and economic pragmatism – to a large extent.
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why is your word press making it difficult to comment ?
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Not sure (wasn’t aware until now there was an issue, altho it seems to happen from time to time)
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Hi Michael It’s been great to read your analysis on Investment Boost. I think your analysis overstates the relative advantage to long-lived assets as a like-for-like comparison for the shorter-lived assets is to model repeated investment at the end of life, e.g. the printer example should have a sequence of 19 replacement investments to equal the 100 year life of the commercial building. Assuming unchanged policy, each replacement investment is eligible for the 20% tax expensing. I expect that the PV of benefits will still be less than for the 100yr building, but the gap will be less significant.
Regards Eric
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Thanks. Yes, that thought had been playing in the back of my mind. Doesn’t affect the specific point that under present commercial buildings are far and away most favoured (since no clawback at all), but there is an issue if standard depreciation applies to all assets.
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Just quickly checked the 5 vs 10year comparison, allowing for a new five year purchase in year 6. The PV of the deductions is 15% more for the 10 year asset than for the 2 five year ones
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Thanks, that makes sense given the discounting.
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On the commercial building (with no std depreciation) vs the 5 year asset replaced 19 times, the PV of the commercial building benefit from Investment Boost comes out at around 2.2 times that on the successsive shortlived asset. Any risk aversion and the 100 year asset (all cash upfront) is even more attractive.
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Any thoughts on how (or whether) this affects local government capital purchase depreciation? A lot of long-life infrastructure in that sector. And of course, they are all contemplating setting up CCOs under the new Local Water Done Well policy direction.
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Spot on Mike. Same would be true in spades if Govt had allowed full immediate deductibility.
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I thought that you might also consider who this tax change will benefit. As a small business owner in Australia and the operator of company with revenue under $50m we are able to deduct any capital costs under $20k -this might be software through to plant equipment or a car. The most significant impact for us is the reduction in paperwork. No more endless calculations as say $2k of software is depreciated 33% a year etc etc Bookkeeping and accounting costs have dropped both in terms of time and cost. Completion of annual accounts is a much easier process. This is a business-friendly move and should be applauded. Whether the full settings are correct is up for debate, but for once, this will make life a lot easier for the 80% or so businesses in NZ who employ less than 12 people.
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I’m generally sympathetic to things that reduce compliance costs for small businesses. That said, hard to see how Investment Boost does that for NZ firms. It doesn’t replicate the system you describe in Aus.
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Once again the interventionist mindset is at work. The purchase of “new” and “new to NZ” assets that will qualify for the deprecation windfall ignores completely the vertical incremental path of business. A small business newly formed will take the risk with capital that its efforts will reward the capital holders so they may take the “next” step and so on.
Each asset bought puts its shoulder to the wheel and like the human capital depreciates over time and needs replacement. Maybe the step can be for “new” but maybe not. The little treasury mignon with nothing at risk takes the golden arrow and fires it into the incremental growth engine. Those not ready or able to pay for new plant will be set back because the interventionists have given this benefit to those higher up, more deserving , more clout at the top table. Pardon me for thinking that Air NZ needs more “new” aircraft or maybe the Energy providers need new turbines , new trains ? new ships. Who know where this came from but the windmill spruikers and photon farmers will be happy. As a sop your new ute and tractor just gone up in price , by the way , will keep you from seeing what’s happening.
Depreciation against tax is the absolute least the state will allow you to stay in the game and is no reflection of the cost of slowly getting poorer while those who risk nothing slowly increase their take. This boost should have applied to all assets in the chain to really help the flywheel turn.
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Hi Michael
Iâm largely in sympathy with your scepticism regarding this, though with a twist. I think accelerated depreciation has a place, but much more focussed. This policy seems a large spend with little gain in economic growth, let alone productivity.
But the main reason I am writing is that I had been doing similar PV calculations to you, but got different answers. The attached spreadsheet is a little calculator which I hope is self-explanatory. It has two differences from yours below. Firstly, it produces PVs of tax reductions rather than taxable income deductions, because after all it is the tax difference that matters here â the deduction is just a means to an end. Secondly, I discount the first year as well as subsequent years, because the tax reduction comes after the end of the financial year rather than at the beginning or during it. Thatâs consistent with your discounting of the second and subsequent years.
Regards
Bill
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Thanks Bill. Unfortunately WordPress doesn’t take attachments (or photos) in comments.
Yes, agree it is the value of the tax saving itself that ultimately counts, altho that will be strictly proportional to the value of the deduction (at a company level – imputation messes things up for shareholders).
On which year to first discount, I’m not sure either of us is strictly right, since I’d have thought provisional tax would mean that the expected tax saving would on average occur mid-year rather than at the end of the year.
On accelerated depreciation more generally, I remain pretty sceptical (I found the modelling done for Tsy leading up to the 2010 switch from, accelerated depn to a lower company tax rate fairly persuasive). The exception I’d make is that I would prefer an inflation adjusted tax system (failure to do so really matters for long lived assets). Doing that would increase actual depreciation. In the Tax Foundation piece I linked to in Monday’s post they note a couple of countries that do depreciate on real rather than nominal values.
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[…] Boost subsidy introduced in this year’s Budget, and yet (of course) never notes that the biggest returns (by a considerable margin) to that subsidy are for investment in new commercial buil…. The very same sector that the government (perhaps over Treasury objections) increased taxes on […]
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