FEATURE ARTICLE: THE GFC INVESTMENT TAX CREDIT

By: David Rodgers, Research Economist, Reserve Bank of Australia (on secondment to the ABS)ⁱ


INTRODUCTION

The Commonwealth Government established a temporary tax credit for business investment as part of its stimulus response to the global financial crisis. Unlike the other elements of the GFC stimulus, the investment tax credit has not been extensively studied.ⁱⁱ This article uses business-level data from the Australian Bureau of Statistics’ Survey of New Capital Expenditure, which underlies the Private New Capital Expenditure and Expected Expenditure release, to analyse the effects of the GFC investment tax credit.

The investment tax credit (‘ITC’) significantly altered the after-tax cost of investment for Australian businesses. All businesses received an extra tax deduction of at least 10 per cent on investment in equipment, plant and machinery committed to during 2009. At a corporate tax rate of 30 per cent, this is equivalent to a fall of at least 3 per cent in the after-tax cost of investment. The amount of the tax deduction also varied with the size of the business. In particular, smaller businesses received an extra deduction of 50 per cent, resulting in larger after-tax savings. Notably, these deductions were in addition to normal depreciation deductions, so businesses were able to deduct more than 100 per cent of the cost of an investment over its life. Australian Taxation Office data indicate companies claimed around $11.5b of bonus deductions under the GFC tax credit (ATO 2017).

Data availability is probably one reason the GFC tax credit has not been extensively studied. As the tax credit differed for large and small businesses, a dataset separating the investment of small and large businesses is needed to study its effects.ⁱⁱⁱ Data that distinguish between investment in equipment, plant and machinery (‘equipment' investment) and investment in building and structures (‘building’ investment) are also useful, as the tax credit applied only to the former. The business-level data from the Australian Bureau of Statistics’ Survey of New Capital Expenditure provide both of these features. In addition, the normal ABS processes that ensure the representativeness and quality of this dataset make it extremely useful for research.


MORE DETAIL ON THE TAX CREDIT

Businesses deduct the costs of capital investment from taxable income over multi-year periods that approximate the economic lives of assets (these deductions are referred to as depreciation deductions). For equipment investments committed to between 13 December 2008 and 31 December 2009, businesses could make an extra, immediate, tax deduction equal to a proportion of the value of the asset.^iv As noted above, this extra tax deduction did not affect the standard tax depreciation deductions for assets, making it possible for a business to make deductions exceeding 100 per cent of the value of an asset over its life. The extra tax deduction was immediate in the sense that it could be deducted in the current tax year. The official title of the investment tax credit was the “Small Business and General Business Tax Break”.

The investment tax credit allowed small businesses - those with annual turnover below $2 million - to make proportionally larger deductions than large businesses.^v Small businesses received a bonus deduction equal to 50 per cent of the value of their investment. Large businesses received 30 per cent for investments committed to before 30 June 2009 and 10 per cent for those committed to during the second half of the 2009 calendar year.

Importantly, when the policy was first announced in December 2008, all businesses were to be afforded an extra deduction of 10 per cent (Swan 2008). Subsequent government announcements over the first half of 2009 made the policy more generous until it reached its final form in mid-May 2009 (Swan 2009a and 2009b). The different deduction rates for small and large businesses were only announced at this time. Notably, while the higher deductions announced later applied retrospectively to earlier investments, it is the rates that businesses thought to be applicable in each period that would have governed their behaviour. The time-series profile of bonus deductions, on this “announced” basis, is shown in Graph 1.

INSIGHTS FROM THE CAPEX DATA

The differences in the way that the tax credit applied, across time, across business sizes, and across types of capital expenditure, can be used to examine the causal effect of the policy on capital expenditure. For example, as small businesses received proportionally larger deductions, capex by small businesses is expected to have increased by proportionally more than capex by large businesses. Importantly, this difference should only begin from the June quarter of 2009, as this is when the larger deductions for small businesses were announced. Similarly, equipment capex is expected to have increased by more than building capex during 2009, given that only equipment capex was eligible for the tax credit. This section examines capex data disaggregated along these dimensions. The disaggregated capex series below are constructed using the same weights as are used for the official capex aggregates.^vi Only capex by employing businesses is included, in order to control for changes in the design of the Capex Survey that occurred during 2009, and mining businesses are excluded to prevent graphs from being dominated by the mining investment boom.^vii


Capex by business size

Graph 2 splits total non-mining capex, using the threshold of 400 employees as a broad indicator of business size. Several features are immediately apparent. The first is that smaller businesses account for a significant amount of capex: businesses with fewer than 400 employees have accounted for around one-third of non-mining capex over the past 10 years. The second is that investment by small and large businesses behaved differently during and after the GFC. Large business investment fell in 2009, as might be expected given the downturn in the Australian economy. In contrast, investment by smaller businesses rose strongly during 2009.

Graph 3 disaggregates total non-mining capex by granular business turnover categories. It also provides quarterly data. Businesses with turnover less than $2m showed the largest increase in capex during the ITC period. This is consistent with these businesses being eligible for the highest rate of bonus depreciation. At the same time, businesses in the next turnover category, $2m-10m, also increased their capex significantly during the ITC period. Capex at the largest businesses, those with turnover greater than $100m, decreased over 2009. Also notable is that the difference between small and large businesses is apparent mainly over the final three quarters of calendar 2009. This is consistent with small businesses learning of their more favourable bonus rate only in May 2009.

Equipment vs building capex

Type of capex is another dimension across which the effect of the GFC tax credit should be visible. Graph 4 shows total capex by type for all industries. Equipment capex, which was eligible for the tax credit, actually rose over the course of 2009. Building investment, in contrast, fell during 2009.

Graph 5 replicates Graph 3 above, but includes only equipment capex. These data show a very clear distinction between the businesses eligible for the highest bonus rate and larger businesses eligible for lower bonus rates. Equipment capex by businesses with turnover below $2m was 58 per cent higher in 2009 than in 2008 (and 40 per cent higher in 2009 than in 2010). In contrast, equipment capex by businesses with turnover between $2m and $10m, who were not eligible for the 50 per cent bonus rate, was only 28 per cent higher in 2009 than in 2008 (and was about the same in 2009 and 2010).

How did businesses respond?

Given that the above indicates that businesses did respond to the GFC tax credit, this section examines the way in which businesses responded. Two broad possibilities are that (i) more businesses invested, or (ii) businesses invested larger amounts when they did invest.

Graph 6 measures the first of these responses: it shows the share of businesses with equipment capex greater than zero in each quarter. Around 19 per cent of businesses with revenue below $2 million invested each quarter during 2009, versus 16 per cent in both 2008 and 2010. Larger businesses also appear to have responded by investing more frequently, particularly in the June quarter of 2009. This peak is consistent with the bonus deduction falling from 30 per cent to 10 per cent at the end of the quarter for these firms.

Among businesses that did purchase equipment, the average size of the expenditure also increased (Graph 7). The average size of equipment investments by small businesses was considerably larger in 2009 than 2008: $20,000 compared to $16,000 in 2008. The average size of investments by larger businesses fell over the course of 2009.

Notably, the share of businesses with turnover below $2 million investing peaked again in the June quarter of 2015 (see Graph 6). During this quarter the Commonwealth Government announced the most significant investment tax credit since the GFC - a $20,000 ‘instant asset write-off’.^viii This policy allowed businesses with turnover below $2 million to immediately deduct investments worth $20,000 or less from their taxable income, rather than follow the normal depreciation schedule for such assets. The lack of an average size response to this policy (see Graph 7) is consistent with the $20,000 ceiling on the value of individual investments.


CONCLUSION

The analysis in this article makes a strong case that the investment tax credit introduced during the GFC had a significant effect on business investment. This is clear from comparing the behaviour of businesses (and types of investment) that received differential treatment under the tax credit. Investment eligible for the most favourable treatment under the tax credit increased by much more than investment eligible for less favourable treatment.

There are a range of factors that could confound the comparisons presented in this article. For example, business size often varies systematically across industries: most construction businesses are small, while most manufacturing businesses are large. The analysis did not control for differences in industry conditions before and after the GFC. The analysis also did not control for the profitability of each business, and only businesses that were tax profitable obtained an immediate benefit from the tax credit.^ix But a range of statistical models that robustly control for these factors also find a strong and statistically significant response of investment to the tax credit.^x These models are not presented in this article but will be detailed in future work.

Further work is also needed to estimate the total effect of the tax credit on macroeconomic outcomes during and after the GFC. That said, the responses to the tax credit shown above, and the average responses obtained from statistical models, are large enough to indicate that the tax credit was important at a macroeconomic level. Recent research has shown similar policies had a significant effect on aggregate investment in the US during and after the GFC (Zwick and Mahon 2017).


Reference List

Australian Taxation Office (ATO) (2017), Taxation Statistics 2014-15, Table 1. Available at <https://www.ato.gov.au/About-ATO/Research-and-statistics/In-detail/Taxation-statistics/Taxation-statistics-2014-15/?page=6#Companiesdetailedtables>

Bishop J (2016), The Size and Frequency of Wage Changes, Feature Article, ABS Wage Price Index, September.

Hendrickson L, Bucifal S, Balaguer A and D Hansell (2015), The employment dynamics of Australian entrepreneurship, Research Paper 4/2015, Australian Government Department of Industry, Canberra.

Leigh A (2012), How Much Did the 2009 Australian Fiscal Stimulus Boost Demand? Evidence from Household-Reported Spending Effects, The B.E. Journal of Macroeconomics, 12(1) (Contributions), Article 4.

Li SM and AH Spencer (2015), Effectiveness of the Australian Fiscal Stimulus Package: A DSGE Analysis, Economic Record, 92, pp 94-120.

Makin A (2016), The Effectiveness of Federal Fiscal Policy: a Review, Treasury External Paper 2016-01.

Senate Economics References Committee (2009), Government’s Economic Stimulus Initiatives, (A Eggleston, Chair), Commonwealth of Australia, Canberra.

Swan, W (Treasurer, Australia) (2008), Investment Allowance to Boost Business Investment, media release 141, Canberra, 12 December. Available at <https://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2008/141.htm&pageID=003&min=wms&Year=2008&DocType=0>

Swan, W (Treasurer, Australia) (2009a), Small Business and General Business Tax Break, media release 13, Canberra, 3 February. Available at <https://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2009/013.htm&pageID=003&min=wms&Year=2009&DocType=0>

Swan, W (Treasurer, Australia) (2009b), Small Business Tax Break Boost, media release 61, Canberra, 12 May. Available at <https://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2009/061.htm&pageID=003&min=wms&Year=2009&DocType=0>

Zwick E and J Mahon (2017), Tax Policy and Heterogeneous Investment Behaviour, American Economic Review, 107(1), pp 217-248.


Footnotes

ⁱ This work is the result of collaboration between the RBA and the ABS. It is the latest in a range of research outputs produced by ABS collaboration with other government agencies, which include Bishop (2016), and Hendrickson et al (2015). The views expressed in this paper are those of the author and do not necessarily reflect the views of the Reserve Bank of Australia or the Australian Bureau of Statistics.

ⁱⁱ The GFC stimulus was examined by a Senate Inquiry in late 2009, and more recently in an external paper for the Commonwealth Treasury (Makin 2016). Neither of these dealt with the investment tax credit in detail. Academic research on the stimulus includes Leigh (2012) and Li and Spencer (2015), both of which concentrate on the effect of the cash transfer components of the stimulus.

ⁱⁱⁱ Most publicly available business-level datasets, for example data on listed public companies, provide little coverage of smaller businesses.

^iv The tax credit applied to depreciating assets for which deductions were available under Subdivision 40-B of the Income Tax Assessment Act (1997). This subdivision captures most equipment investment. Building investment is generally dealt with under another section of the ITAA (the capital works expenditure rules).

^v Under the relevant tax law, eligibility for small businesses status was a complex function of whether or not turnover exceeded $2 million in current and past tax years. The variable used in this article is turnover observed with a lag of approximately nine months, which is a reasonable approximation to these rules.

^vi The Capex Survey obtains responses from a sample of around 9,000 businesses each quarter, and assigns these responses weights (>=1) in order to estimate capex for the population of businesses. Weights are equal to the number of businesses each sample response is taken to represent.

^vii These and other small methodological differences mean the aggregates presented in this article will not reconcile exactly to the official capex data.

^viii Several other investment tax credits were in place in the intervening period. These included an instant asset write-off for assets worth up to $6,500, which was in force from 1 July 2012 to 31 December 2013.

^ix Unprofitable businesses could carry over deductions to future years, but discounting of future cash flows should make future deductions less valuable than deductions made in the current year.

^x These include business-level models that look at differences between small and large firms only within each quarter for each industry (so control for different industry conditions).