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Beware of the Stimulus Plan Boomerang

The tax benefits of the new economic stimulus proposal come with a big caveat; but the gains still may be worth the short-term boost.
Stephen Taub and Marie Leone, CFO.com | US
January 31, 2008

The proposed economic stimulus package, which is now in the hands of the Senate, has attracted a lot of attention because it will hand over money to many Americans. However, the final bill is likely to provide some goodies for corporations as well.

For example, it is likely to provide most companies with one year of 50 percent bonus depreciation. Bonus depreciation, which provides businesses with a tax incentive to increase capital spending this year, allows companies to depreciate, for tax purposes, more of an asset's cost upfront.

This will result in initially higher depreciation expense on the tax return, lower taxable income, lower cash taxes, and provide a boost to cash flow, assuming companies are profitable enough or can carry-back losses to prior periods, according to a report from Credit Suisse Securities. Bonus depreciation has no impact on earnings, however.

The initial boost to cash flow from bonus depreciation can be significant, noted the report. Credit Suisse estimates that the additional depreciation could provide $41 billion in aggregate tax savings for S&P 500 companies in 2008, and could increase cash flow by more than 10 percent for 59 companies.

This type of "super bonus depreciation for a profitable company means that a much higher percentage of equipment cost is written off in year one, as an incentive to companies to buy more equipment," explains John Deane, managing principle of the Alta Group, a consultancy specializing in the leasing industry.

But he emphasizes that the write off in year one — which he reckons could be a 35 percent discount on the purchase price — is a depreciation gain, not a credit. The write-off "will come back," although it has a material positive impact on cash flow in the first year. "Effectively, it's like a company is getting a loan from Treasury," adds Deane.

The Credit Suisse report sends up the same red flag. When bonus depreciation expires, the already highly depreciated assets can't provide their "normal" tax shield. "That means lower depreciation expense, higher taxable income, and higher cash taxes, causing a drain on cash flows," explains the report.

In fact, Credit Suisse estimates that upfront bonus could cause a $52 billion drag on aggregate cash flow for the S&P 500 companies in 2009, and could pull down cash flow by more than 10 percent for 87 companies. "The real benefit of bonus depreciation is that it accelerates the tax savings that a company gets from depreciating an asset, creating an additional tax benefit on a present value basis through the magic of the time value of money," notes the investment bank. "It's as if the company is getting a discount on its capex from Uncle Sam."

The report also estimates the aggregate net present value benefit for the S&P 500 companies could range from $3 billion (for 3-year life) to $18 billion (20-year life.) "Companies that invest in assets with long tax lives get the most benefit," it asserts.

Indeed, even at the high end of the range, the report finds only four companies in which the present value benefit of bonus depreciation is over 2 percent of market capitalization. "So, don't be fooled, the real benefits from bonus depreciation are not as significant as the initial boost to cash flow makes it out to be," counsels Credit Suisse. "On the other hand, bonus depreciation or an extension of the carryback period on [non-operating losses] could be a lifesaver for a company facing a liquidity crunch."

The bonus depreciation could also affect a corporation's buy-versus-lease decision, says Deane. To be sure, some company's may be able to use the tax benefit as a bargaining chip. He explains that it is a long-standing position of the Treasury Department to say that an equipment leasing company can take the same tax benefits that its customers receives with regard to depreciation.

If that's the case, then a bonus depreciation would also increase the cash flow, on a gross basis, of an equipment leasing company. At that point, a leasing company could choose to share the benefit with a customer and rework leasing terms to make them more favorable compared to an equipment purchase, concludes Deane.

He points out that this is exactly what leasing companies used to do back in the days of the investment tax credit, which lasted from the 1960s throught the 1980s. As a result, the stimulus package, if it is passed in its current form, could give leasing companies the incentive to be an intermediary that passes on tax benefits to individual corporations that might not otherwise be able to claim the tax break, surmises Deane.




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