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Need to Know: Full Expensing
The best idea you probably haven't heard of
New Zealand's tax settings are holding back productivity. Here's one change that could go a long way to fixing it.
How Does It Work?
'Full Expensing' lets businesses immediately write off their longer-term capital investments as a business expense, rather than slowly depreciating them over time.
Because a dollar now is more valuable than a dollar in the future, a shift to full expensing incentivises businesses to make major upfront investments in plant and equipment, with a mind to long-term gain.
Businesses will already know that operating costs – paying salaries, buying coffee for the staffroom or paper for the printer - are instantly written off. But investment in a machine that lifts productivity for decades is taxed.
Full expensing changes that because it treats all investments equally by extension, encouraging investment in plant and equipment, growing our economy long-term.
Why Do We Need It?
More beneficial incentives around taxation can help boost the productivity of business and the economy overall. The average Kiwi produces around $68 of output an hour. Adjusted for international standards, that’s 27 per cent less than Australia, and 39 per cent less than the United States.
We can only increase our productivity and profitability with the most up-to-date equipment and technology. If we can incentivise investment in plant and equipment today, that makes a difference for our economy tomorrow.
Business investment in plant and equipment is one of the most proven methods of boosting productivity, and as economist Paul Krugman put it:
Productivity isn’t everything, but, in the long run, it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.
New Zealand's 'Factory Tax'
If you run a capital-intensive business, particularly manufacturing or construction, you’re on an uneven playing field to many other industries.
In effect, New Zealand’s tax system effectively has a factory tax.
If you invest in building a factory, you pay extra tax than if you use that money for something else. Responding to incentives, many businesses will hold off vital investment in plant and machinery, in favour of shorter-term solutions in labour or operating costs. It makes sense in the short-term but can increase the challenges businesses face in the future.
This is a distinctly New Zealand problem. We rank bottom on the Tax Foundation’s Capital Cost Recovery Index of 38 rich countries. Kiwi businesses recuperate just 49.6 per cent of their capital investments, compared to the next lowest, Colombia, with 58 per cent, and the OECD average of 70.7 per cent.
New Zealand businesses pay more tax on long-term capital investments than any other higher-income country.
A golden rule of economics is that when you tax something, you get less of it. When we tax productive investment, it’s no wonder we are in a productivity lull.
What Evidence Shows
New Zealand trialled faster depreciation as part of our pandemic stimulus programme, raising the cap for an instant tax deduction from $500 to $5000 for the year to March 2021. This small change led to a 15.5 per cent increase in investment in plant machinery and equipment that year, while the overall economy was stagnant due to the pandemic. Even when limited by the short timeframe, this was a sizeable change.
Full expensing without a time limit can be transformational for an economy. When Estonia introduced full expensing, it saw investment grow 39 per cent faster than its Baltic neighbours in the following years, despite a similar corporate tax.
Across the world, we see the same story: full expensing means more investment, and investment boosts productivity.
Is There a Downside?
The first is the cost. Any money spent on this is something that can’t be spent on other projects or given back to business in taxes. This pays off in the long-term through higher economic growth but it will be a tough call for any Government to make.
Implementation is also key. Some examples from overseas show temporary measures can limit effectiveness – bringing investment forward in the short-term but limiting longer-term investment. To fully benefit the economy, full expensing should be permanent. As with any part of the tax system, design is important. A simple, easy-to-understand system that favours investment is best for business.
What Can We Do?
The Advanced Manufacturing Industry Transformation Plan (ITP) is the Government’s $28 million programme to boost productivity in the manufacturing sector. The ITP contains a provision to “explore accelerated depreciation,” a welcome first step, but no guarantee of action.
When Business Central submitted on the ITP, we strongly encouraged the adoption of "Accelerated Depreciation", a partial version of full expensing, as an effective way to boost investment and productivity in the manufacturing sector. We have also expressed as much to officials.
While we have not heard an in-principle opposition to accelerated depreciation, the primary barrier is the cost. We maintain the benefits of an investment-friendly tax system outweigh the cost to the taxpayer, and that a system of full expensing is preferable. But prioritisation of some accelerated depreciation could at least move New Zealand from our 38th out of 38 ranking and go a long way in improving productivity.
Some countries are trialling accelerated depreciation for green investment. Germany offers a 50 per cent deduction for electric vehicles, and France speeds up depreciation for renewable energy investments. This too could be an option to win funding, with sources of green investments available from the Government.
Many countries have a schedule of accelerated depreciation in plant, machinery and equipment. If there is a particular area of investment that could boost production in your business, get in touch and let us know.
A thank you to the work done by the Tax Foundation in America, and the UK’s Adam Smith Institute for compiling much of the research that went into this article. Find out more about their research here:
