Is Depreciation a Subsidy?

November 16, 1953

Most socialists and left-wingers have few scruples about the kind of argumentative weapons they use in their attacks on private business. But some charges are sillier than others, and one of the silliest is that “accelerated amortization” constitutes a government “subsidy” to business and a sort of scandal. I would have supposed, to cite only one example, that the speech on the subject by Irving S. Olds, chairman of the board of the United States Steel Corp., on May 3, 1951, would have permanently silenced this nonsense. But as late as a few weeks ago Gordon R. Clapp, chairman of the Tennessee Valley Authority, was still repeating it in all its original impurity.

“Perhaps you have heard,” he told the Memphis Kiwanis Club on Sept. 30, “of tax certificates for accelerated amortization.” These, he went on, constitute a “big bonanza,” a “magic Federal-aid program,” “interestfree loans from the taxpayer,” and, in short, government “subsidies” for the private utilities.

He demanded an “explanation” of them, and so I offer one. All plants, machines, and equipment in time either become obsolete or wear out. Suppose a machine costs $1,000 to install and has a probable useful life of ten years. Then the man who owns it ought to deduct, say, $100 a year from his apparent profits on the machine, and set this money aside. At the end of ten years, if his estimate of the useful life of the machine has been correct, he will have deducted a total of $1,000 as an allowance for depreciation, and he will have this amount to replace the old machine that has become useless. If he has not been making this bookkeeping deduction he has been deceiving himself as to the amount of his real profit. If he has not set aside the funds to replace the machine he may find himself out of business.

Now the tax-collecting Internal Revenue Bureau has been very strict regarding the annual rate at which it permits a company to write off depreciation. But under the Revenue Act of 1950, in order to encourage companies to put up new plants deemed essential to the defense program, Congress permitted them to “write off” such plants within a period of five years.

This privilege offered only one advantage to the company that obtained it. If the defense emergency lasted for only five years, and the new plant became useless at the end of that time through lack of orders, at least the company would not have been paying taxes on profits that turned out to be fictitious because they did not allow enough for the loss on the investment. Otherwise a company stands to benefit from the privilege only on the assumption (disappointed after the second world war) that the corporate tax rate will be lower after the specified five-year amortization period than during it.

In the vocabulary of the Clapps, of course, whenever the government seizes less in taxes from you, even temporarily, than it did before, you are being “subsidized” by it. But even by this reckless perversion of words it is hard to see how permission for a shorter amortization period can be called a “subsidy.” For a facility can not be depreciated by more than 100 percent of its value, and it can only be depreciated once. Whether a $1,000 machine is depreciated over one year or over twenty, only $1,000 in all can be deducted, and if the same rate of tax is levied over the whole period, the same total tax is paid to the government.

There is in fact an inequity in the depreciation rules of the Internal Revenue Bureau, but it is exactly the opposite of what Clapp contends. It consists in allowing corporations to deduct only against original investment and not against cost of replacement. A machine bought at $1,000 in 1939 would probably cost more than $2,000 to replace today. In a period of inflation, industry that is allowed to deduct depreciation only against original costs, and not against cost of replacement, is paying taxes on profits that are illusory when measured in real terms. The real tax rate is even greater than the nominal rate, and capital consumption is concealed.