How the CARES Act Fixed a Tax Bias Against Green Investment


One under-discussed part of the CARES Act, passed in March to provide economic relief during the COVID-19 epidemic, is a correction to a drafting error in the Tax Cuts and Jobs Act of 2017, often known as the “retail glitch.”

The Tax Cuts and Jobs Act provided 100 percent bonus depreciation for many short-lived assets, such as equipment and machinery. This provision allows companies to deduct the full cost of eligible investments immediately, rather than spreading those deductions out over a number of years. It is scheduled to start phasing out after the end of 2022. Stopping short of full expensing is economically harmful, as inflation and the time value of money reduce the value of deductions in future years. This effectively raises taxes on capital investment, leading to lower investment, economic growth, productivity, and wages.

However, the tax reform accidentally excluded qualified improvement property (QIP)  from eligibility, and forced firms to depreciate investments in qualified improvement property over 39 years. Some examples of QIP are light fixtures, commercial flooring, and other forms of interior remodeling that do not physically expand the structure itself.

The CARES Act fixed this change. It made QIP eligible for 100 percent bonus depreciation, allowing businesses to retroactively claim full deductions for QIP placed into service since Dec. 31, 2017.

How does this relate to green technology? Lengthening the cost recovery schedule of QIP means an effective tax increase on new QIP investment, and that means businesses are less likely to invest in new technology that is more energy-efficient. As a result, they would instead continue to use less efficient (and thus dirtier, more carbon-intensive) appliances.

Lighting is a perfect example. In the past decade, light bulbs have become vastly more energy-efficient—LED lights use up to 85 percent less energy than traditional incandescent bulbs, and that means lower carbon emissions. However, if a business has to spread the cost of that investment over 39 years, they won’t be able to recoup the full real value of their investment, so they’re more likely to continue using older, dirtier tech.

An article in the Stanford Law and Policy Review handily explained how long cost recovery schedules disadvantage energy efficiency improvements. Usually, operating costs, whether worker wages or, in this specific case, electricity bills, are deducted the year they’re incurred. However, without full expensing, capital costs, such as new factories, lighting, or office buildings, are spread out over many years—and as a result, companies do not get to deduct the full real value of that investment. Efficiency investments tend to involve an increase in capital costs (spending on more sophisticated technology) in exchange for lower operating costs, but without full expensing, operating costs are tax-advantaged relative to capital costs.

Fixing the retail glitch was a welcome correction and should help increase investment, including in lower-emission technology. However, like the 100 percent bonus depreciation provisions in the TCJA, it will start phasing out soon. Lawmakers should make 100 percent bonus depreciation permanent to grow the economy and make the tax code fairly treat investments like environmentally beneficial improvements.

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