Depreciation Policy: Whither Thou Goest

SOUTHWESTERN LAW JOURNAL Depreciation Polic y: W hither Thou Go est Henry J. Lischer Jr. 0 Recommended Citation 0 Henry J. Lischer Jr., Depreciation Policy: Whither Th ou Goest , 32 Sw L.J. 545 (1978) https:/ /scholar.smu.edu/smulr/vol32/iss2/1 Follow this and additional works at; https; //scholar; smu; edu/smulr - II. III. D WHITHER THOU GOEST by TABLE OF CONTENTS EPRECIATION for federal income tax purposes is a device by which the taxpayer receives a tax benefit for the acquisition cost of long life property. Depreciation allows the taxpayer an annual income tax deduction over the useful life of the property for a portion of the cost of the property. It is a device to determine more accurately the periodic net income of the taxpayer, because the cost of long life property is an expense which should be accounted for during the time period in which the property produces revenues. Although depreciation might seem to be a fairly staid and non* B.B.A., J.D., University of Iowa; LL.M. (in Taxation), New York University. Associate Professor of Law, University of Alabama. controversial subject, it is not. Due to varying social and political pressures, depreciation provisions in the Internal Revenue Code have proliferated and have generated considerable controversy. It has been alleged that depreciation can be used to increase investment in depreciable property;1 to increase the number of jobs in the economy, hold down prices, relieve pressure on the capital markets, and reduce or steady interest rates;2 and even to win the cold war with Russia. 3 On the other hand, components of contemporary depreciation have been criticized as wasteful,4 outmoded, 5 and unfair;6 and complete elimination of the depreciation deduction has been proposed.7 This Article considers various elements of the concept of depreciation for federal income tax purposes. Initially, the historical development of the depreciation concept is considered. Next, depreciation as it presently exists under the Internal Revenue Code is presented, and various options for changing depreciation are evaluated. Finally, current issues facing policy makers are explained. I. HISTORY OF DEPRECIATION In many respects depreciation is an unusual feature of financial and tax accounting. Although depreciation is considered an expense of generating revenues, it is different from other expenses in that depreciation involves no current cash expenditure because the expenditure was made previously when the property was acquired. Nonetheless, today it is considered appropriate and necessary to spread the cost over the useful life of the depreciable property in determining net income. Historically, however, the appropriateness and necessity of a depreciation deduction has been quite controversial. The history of depreciation includes both a tax history and a financial accounting history. The formulation of financial accounting depreciation concepts preceded congressional adoption of a depreciation deduction. Thus, the meaning of depreciation for financial accounting purposes is indicative of the meaning of depreciation which Congress intended for tax purposes. Moreover, the financial accounting meaning and the tax meaning are essentially related in that they both seek to allocate the cost of long life assets over their useful lives so as to reflect net income accurately.' Accordingly, the concept of depreciation for financial accounting purposes is relevant to the study of depreciation for federal income tax purposes. A. FinancialAccounting History Rudimentary financial records date back to the earliest reaches of civilization, 9 but early record keeping was simplistic and unsophisticated by current standards, reflecting the less complicated economic and financial systems of the day.' 0 The earliest direct references to depreciation appeared in the sixteenth century." Prior to that time, most economic activity revolved around agriculture and horticulture, operations which were labor-intensive rather than machinery-intensive. 2 Because only a small element in the productive process was depreciable,' 3 relatively little concern about depreciation was generated.14 Another reason why depreciation was largely ignored was that most of the agricultural operations were directly supervised by the persons who owned the enterprise. 5 Thus, there were no absent owners to whom an accurate determination of income had to be provided. This contrasts with contemporary enterprises where most investors are passive nonparticipants and actual operations are performed by professional managers. Moreover, because such owner-operated enterprises were sold only infrequently, the accurate determination of periodic income was less important.' 6 With the onset of the industrial revolution, business activities became increasingly larger and complex,17 necessitating more sophisticated financial information systems. The industrial revolution also brought into use large amounts of equipmen (...truncated)