Key tax reform bill would cost Nebraska nothing
Nebraska’s Legislature will consider major tax reform proposals to slash income and property taxes in 2023. Historic revenue surpluses provide lawmakers a rare opportunity to dramatically cut income and property tax rates, improving the state’s friendliness for both families and firms.
Yet one key tax reform can be enacted for “free.” LB 492, introduced by Senator Brad von Gillern, would make full expensing Nebraska’s permanent, pro-growth treatment of physical capital investments in machinery and equipment. Research finds that a policy of full and immediate expensing incentivizes capital formation in a state. And full expensing is especially important for Nebraska’s economy, which depends on physical capital-intense industries like agriculture and manufacturing.
Any tax analyst knows that tax cuts aren’t free, so how could this tax cut be free for Nebraska? In short, full expensing has been Nebraska’s tax policy for the last five years because Nebraska conforms with full expensing in the federal tax code. Making full expensing permanent would cost Nebraska no new revenue.
Here’s the kicker – full expensing is phasing out in the federal tax code, which will cause a business tax increase in Nebraska unless the legislature acts.
Not only is full expensing the right tax policy for the Cornhusker State, making full expensing permanent would prevent a tax hike that lawmakers never voted to approve. Indeed, allowing full expensing to phase out would contradict the state’s clear plan, already enacted in LB 873 in 2022, to cut individual and corporate income taxes.
It wouldn’t make sense to cut income tax rates on the one hand, and then allow the income tax base to be improperly expanded on the other hand.
So, what is full expensing for business capital investments, and why is it important?
Full expensing is the appropriate way to define business income. Income is the difference between revenue and costs. For a manufacturing business, costs include things like labor and machinery, while revenue, of course, comes from the sale of manufactured products.
Tax law allows businesses to fully deduct labor costs against taxable income in the year the labor costs are incurred. This is essentially “full expensing for labor costs,” and is the appropriate way to arrive at a definition of taxable income. Yet physical capital costs don’t always receive the same treatment. Instead of allowing a business to deduct the cost of manufacturing equipment in the year the cost is incurred, the tax code sometimes accounts for capital costs on a depreciation schedule of 5-20 years, depending on the type of equipment.
Amortization and depreciation are keys concept in bookkeeping, yet depreciation is not the appropriate tax treatment of capital investments. A business capital cost should be fully recognized and deducted against taxable income the year the cost is incurred, equivalent to the tax treatment of labor costs. Any alternative treatment for capital essentially taxes businesses on an inflated definition of income and thus marginally disincentivizes capital investments in Nebraska. Without full expensing, businesses are taxed for income that is in excess of actual income on a cash-flow basis.
Oklahoma made full expensing its permanent tax law in 2022. Other states are likely to follow in 2023 because the tax increase will otherwise impact businesses this year.
As American businesses weigh the importance of reshoring their supply chains, they will consider the tax treatment of new capital investments in the states. Nebraska can stand out as welcoming capital investment by providing full expensing in its state tax code.
Full expensing ended in Nebraska on January 1 because of changes in the federal tax code. Businesses will be subject to a tax hike this year that is not the legislature’s fault. But the legislature can fix the problem by cancelling the business tax hike and restoring full expensing in Nebraska.