Capital Spending

Capital spending refers to investments made by businesses in certain “capital assets”, which generally refers to projects in physical buildings, lands or machinery that are designed to produce profit in the future. For example, building a new factory is generally considered capital spending, whereas spending on payroll to staff that factory, spending on widgets as inputs for the factory or spending on advertisements to sell the end-products are not considered capital spending.

Capital spending has a unique and complicated relationship with the tax code. Corporations pay taxes on profits, not revenues. Suppose a company has $10 million in revenue and spends $5 million in payroll and $3 million in inputs (and has zero other costs). They then have $2 million in taxable profits. Now suppose that they spend $2 million in buying new machines to replace their old aging machines. Since the Tax Cuts and Jobs Act of 2017, the business can write off the full $2 million in costs so they would have $0 in taxable profits that year. This is known as “bonus depreciation”.  Prior to 2017 (and again in 2026 after the provision expires), the business could only write off a portion of that $2 million each year, corresponding to the depreciation of the machine. If the machine can last 10 years, they can write off 10% of the value of the investment each year for ten years ($200,000). The Tax Cuts and Jobs Act of 2017 phases in from 100% bonus depreciation to 0% between 2022 and 2026.