How Expensing for Capital Investment Transforms Project Economics: A Case Study Approach

The Tax Foundation, utilizing its macroeconomic model, has consistently identified improvements to cost recovery as one of the most potent pro-growth policy options available. This assessment is based on the long-run Gross Domestic Product (GDP) increase relative to lost revenue. The most impactful policy in this regard is full expensing, which permits businesses to deduct the entire cost of an investment immediately. While macroeconomic models provide aggregate figures for GDP, Gross National Product (GNP), capital stock, wages, and jobs, the tangible impact of these changes often feels abstract. A 1.5 percent increase in long-run GDP, for instance, is not immediately intuitive. However, at a local level, growth manifests concretely: new offices, factories, housing, improved jobs, and higher wages. These localized improvements, aggregated across the nation, constitute the broader GDP increase.

Economy-wide policies like full expensing subtly alter the decision-making calculus for millions of individuals and businesses, making prospective projects marginally more attractive. To bridge the gap between macroeconomic projections and real-world impact, the Tax Foundation conducted an in-depth analysis across 15 distinct case studies. This research delves into how a critical financial metric, the internal rate of return (IRR), shifts under various cost recovery policy scenarios. The findings underscore cost recovery as a pivotal policy instrument capable of transforming marginal investment decisions, thereby fostering more capital investment projects, capital deepening, and expanded opportunities for both workers and business owners.

The Crucial Role of Investment in Economic Growth

Promoting investment is a fundamental policy objective due to its profound influence on long-term economic growth. At its core, economic growth is propelled by three primary inputs: labor (hours worked), capital (physical and intangible assets), and total factor productivity (TFP), which encapsulates efficiency gains and technological advancements. New investment directly contributes to worker productivity through a process known as capital deepening. This means providing workers with more advanced tools and technologies, enabling them to produce more output. For example, a modern tractor enhances a farmer’s capacity, a powerful furnace boosts a steelworker’s output, and superior computing power empowers a statistician with more sophisticated analytical capabilities. This increase in worker productivity is directly linked to rising wages and improved living standards.

The relationship between investment and total factor productivity is a subject of ongoing economic debate. While the Tax Foundation’s model typically holds TFP constant, some evidence suggests that investment can significantly alter TFP. Even if investment doesn’t directly drive the pace of new inventions, it undeniably accelerates the adoption and diffusion of existing technologies, ensuring innovations are quickly put into productive use across the economy.

Investment generally falls into three broad categories:

• Equipment: Tangible machinery and tools directly used in production, ranging from machine tools and lathes in manufacturing to computers, specialized medical devices, and office fixtures.
• Structures: Longer-lived assets integral to the production process, including office buildings, factories, warehouses, and retail storefronts.
• Intellectual Property Products (IPPs): This category encompasses research and development (R&D), software development and purchases, and the creation of artistic and entertainment originals. R&D constitutes the largest and most focus-intensive component.

Understanding Cost Recovery and Its Tax Implications

Companies undertake investments when the net present value of a project is positive, meaning the anticipated future benefits outweigh the upfront costs. The internal rate of return (IRR) is a key metric, representing the discount rate at which a project’s future cash flows equal its initial investment, effectively the break-even rate. If the IRR surpasses a company’s hurdle rate – the minimum acceptable return – the investment is deemed worthwhile.

Tax policies significantly influence investment decisions by altering a project’s IRR. The timing of expense deductions is particularly critical. Immediate deduction of costs (full expensing) allows companies to realize the full present value of tax savings. Conversely, if costs must be depreciated, or spread out over several years, the future deductions are worth less due to the time value of money. For instance, a $1,000 computer system deducted over five years at a 21 percent tax rate yields $42 in nominal tax savings annually. However, when discounted at a 7 percent rate, the present value of these savings is only $184.26, representing a $25.74 penalty on the original investment. Under full expensing, the entire $1,000 is deducted immediately, yielding $210 in immediate tax savings, with no penalty. This acceleration of tax savings eliminates the implicit tax penalty and boosts the project’s IRR. For marginal projects, this shift can be the decisive factor, moving them from "unviable" to "worth pursuing." Crucially, full expensing merely removes a tax bias against investment; it does not create a tax subsidy.

Corporate hurdle rates exhibit considerable variability, influenced by factors such as firm-specific risk profiles, industry dynamics, and prevailing economic conditions. This underscores why even modest improvements in IRR due to tax policy can have a substantial aggregate impact on investment volumes.

A Historical Perspective on US Investment Incentives

The tax treatment of various asset types has evolved significantly over time, with major legislative changes shaping the landscape.

• Equipment: Has a long history of "bonus depreciation," allowing larger upfront deductions, with remaining costs depreciated under Modified Accelerated Cost Recovery System (MACRS) rules over 3 to 20 years. Initially introduced at 30 percent in 2002, bonus depreciation has seen cycles of expansion, lapse, and revival. The TCJA dramatically increased it to 100 percent from late 2017 through 2022, before a scheduled phase-down. The One Big Beautiful Bill Act of 2025 (OBBBA) permanently restored 100 percent bonus depreciation.
• Structures: Tax treatment for structures has been relatively stable since the 1980s, with the last significant change in 1993, extending the asset life of commercial structures to 39 years. While the 2016 House GOP blueprint proposed full expensing for all capital investment, including structures, this provision was ultimately dropped from the TCJA. The OBBBA, however, introduced temporary full expensing for a narrow subset of "qualified production property" structures, specifically for manufacturing facilities, with strict construction and in-service timelines (January 19, 2025, to January 1, 2029, for construction, and July 4, 2025, to January 1, 2031, for service). This temporal limitation poses administrative challenges and may undermine the full potential of the incentive.
• Research & Development (R&D): For decades, R&D expenses were fully expensed. However, the TCJA introduced R&D amortization starting in 2022, requiring domestic R&D costs to be spread over 5 years and foreign R&D over 15 years. The OBBBA reversed course for domestic R&D, reinstating full expensing, but maintained the 15-year amortization for foreign R&D.

These shifts highlight a persistent legislative tug-of-war between encouraging immediate investment and managing federal revenue implications.

Tax Foundation’s Deep Dive: Case Studies Unveil Real-World Impact

While macroeconomic models offer a broad perspective, the Tax Foundation’s 15 case studies provide granular insights into how cost recovery policies impact specific, real-world investment decisions. These studies span four crucial industry groups:

1. Energy and Supply Chain Infrastructure: Utility-scale natural gas plants, natural gas pipelines, package sorting facilities, and solar farms.
2. Manufacturing: Aerospace parts factory expansions, new gas turbine factories, and steel minimills.
3. Technology: Data centers, semiconductor fabs, warehouse robotics R&D, and new drug development.
4. Services: Quick-service restaurants, supermarkets, apartment buildings, and limited-service hotels.

For each project, the IRR was calculated under five policy scenarios:

• Baseline (MACRS depreciation + R&D amortization)
• MACRS + R&D Expensing
• MACRS for Structures; Equipment and R&D Expensing
• Expensing for All (Placed-in-Service Rules)
• Expensing for All (Cash Flow-Based)

This incremental approach vividly illustrates the impact of each policy change. The "cash flow-based" scenario, an experimental fifth case, considers the timing of deductions from when costs are incurred, rather than when assets are "placed in service," which can significantly reduce the value of deductions for long construction projects.

The methodology adopted a simplified discounted cash flow model, combining scale and approximate input ratios from various sources to design representative hypotheticals, rather than relying on proprietary company data. Key assumptions included a company with sufficient taxable income to immediately absorb deductions, taxation of residual income, use of the half-year convention for MACRS, and a constant 2 percent annual inflation rate. A sensitivity analysis was also performed for each project, examining the impact of a half-percentage-point reduction in the operating cash flow margin, to gauge the relative significance of tax policy changes versus operational fluctuations.

Key Findings: Quantifying the Impact of Expensing

Across all 15 diverse case studies, the transition from the baseline scenario (MACRS depreciation plus R&D amortization) to full cash flow-based expensing for all assets resulted in an average increase of 1.57 percentage points in the IRR. This aggregate finding aligns with the macroeconomic understanding that expensing doesn’t aim to render wildly uneconomical projects suddenly attractive, but rather to make a broad spectrum of investments marginally more appealing, nudging more projects from "pass" to "build."

The magnitude of IRR improvements was generally between 1 and 2 percentage points, with the largest gains observed in projects where longer-lived assets constituted a greater proportion of upfront costs. This is consistent with the fact that 39-year assets incur a more substantial tax penalty under MACRS compared to shorter-lived assets.

Analyzing the impact of the OBBBA, which reinstated full expensing for domestic R&D and equipment (100 percent bonus depreciation) and introduced temporary expensing for manufacturing structures, reveals significant progress. The average difference in IRRs between the pre-OBBBA scenario (full phase-out of bonus depreciation and R&D amortization) and the post-OBBBA policy mix was approximately 0.88 percentage points. This represents slightly over half of the potential gains achievable under a full expensing regime for all assets. This indicates that while the OBBBA made commendable strides, substantial opportunities remain to further optimize the investment climate.

Sectoral Insights: A Closer Look at the Case Studies

• Energy and Supply Chain Infrastructure: Projects like the natural gas plant and pipeline saw significant boosts from equipment expensing, often pushing them past viability thresholds. The package sorting facility, with its substantial 39-year property component, benefited greatly from structures expensing. For projects with long lead times, like pipelines, moving to a cash flow-based deduction system offered a notable advantage over placed-in-service rules.
• Manufacturing: The aerospace parts factory expansion, being R&D-intensive, saw its IRR significantly improve with R&D expensing. The new gas turbine factory and steel minimill, both involving large new buildings, experienced substantial benefits from structures expensing, often enough to shift project viability by a full percentage point or more. The manufacturing structures expensing provision introduced by OBBBA directly impacts these projects, although its temporary nature creates uncertainty.
• Technology: Data centers and semiconductor fabs, while heavily reliant on equipment, also saw meaningful IRR improvements from structures expensing due to the scale of their facilities. The semiconductor fab, with its massive upfront R&D, also benefited from R&D expensing, and its multi-year construction timeline made cash flow-based expensing particularly valuable. The warehouse robotics R&D project, focused almost entirely on R&D, saw its viability hinge almost exclusively on R&D expensing. New drug development, being entirely R&D-driven, likewise demonstrated that R&D expensing was the sole policy lever directly impacting its IRR.
• Services: For projects like quick-service restaurants, supermarkets, apartment buildings, and limited-service hotels, structures expensing proved to be the most impactful policy change, often raising IRRs by over a percentage point. This is due to the high proportion of structures costs in their capital investment. The apartment building case study, for instance, illustrated how expensing for residential structures could significantly impact housing construction and, by extension, affordability. The sensitivity analysis for the supermarket project also highlighted how narrow operating margins can, in some cases, dwarf the impact of tax policy changes, rendering projects unviable irrespective of expensing benefits.

Unlocking Further Growth: Policy Recommendations

The analysis clearly demonstrates that while the OBBBA made significant improvements to cost recovery, further policy adjustments could unlock substantial additional investment.

1. Permanence for Manufacturing Structures Expensing: The current temporary nature of manufacturing structures expensing, with its specific start and end dates for construction and in-service eligibility, creates uncertainty and may make the incentive inaccessible for complex, long-duration projects like semiconductor fabs. Making this provision permanent would provide a stable, long-term incentive for manufacturing investment.
2. Extend Full Cost Recovery to All Structures: The current manufacturing structures deduction covers only a fraction of nonresidential structures. Expanding expensing to all commercial structures—including offices, retail, hospitals, and data centers—would eliminate tax penalties across these diverse industries. Similarly, extending expensing to rental residential structures, such as apartment buildings, could be a powerful tool to expand housing supply and alleviate rental costs. A potential political hurdle is the significant upfront revenue cost of accelerating deductions. An alternative, "neutral cost recovery," which adjusts deductions for inflation and the time value of money, offers a nearly economically equivalent solution without the same immediate revenue impact.
3. Expensing for Foreign R&D: The OBBBA’s retention of 15-year amortization for foreign R&D creates a tax penalty that disproportionately affects U.S. multinational companies. Foreign and domestic R&D are often complementary, with global teams collaborating on complex projects. Penalizing foreign R&D can reduce the overall viability of such projects, potentially shifting R&D funding to foreign companies and diminishing the benefits of international operations for U.S. workers through market access.
4. Safe Harbor Leasing or Transferability: A critical barrier to realizing the full benefit of expensing is the "loss-position problem." Companies with insufficient current-year taxable income cannot fully utilize immediate deductions. The U.S. has experimented with solutions like transferability (applied to renewable energy tax credits in the Inflation Reduction Act) and safe harbor leasing (introduced in 1981). These mechanisms allow firms to effectively sell or transfer their tax deductions or credits to other entities with sufficient tax liability, reducing transaction costs and maximizing the incentive effects. Alternatively, allowing firms to adjust net operating losses generated by 100 percent depreciation for inflation and a real rate of return could preserve the value of deductions over time.
5. Full Cash Flow Basis: The final step to optimize cost recovery would be to replace "placed-in-service" rules with a "cash flow-based" standard. This would allow deductions to be taken when investment costs are incurred, rather than when the asset is ready for use, eliminating delays that reduce the present value of deductions for projects with long construction or development timelines.

Broader Economic Implications and the Path Forward

The comprehensive analysis underscores that improvements in cost recovery are not merely technical tax adjustments but powerful drivers of economic vitality. By making a wide array of investments more viable, these policies foster capital deepening, enhance worker productivity, stimulate wage growth, and ultimately contribute to higher living standards across the United States. The case studies concretely demonstrate how such policy shifts can tip the balance for projects ranging from critical energy infrastructure and advanced manufacturing facilities to essential community services and technological innovations.

The One Big Beautiful Bill Act represented a significant step forward in restoring some elements of full expensing. However, the Tax Foundation’s research clearly illustrates that more can be done to create an optimal investment climate in the U.S. By extending full expensing to all structures, reinstating expensing for foreign R&D, and addressing structural impediments like the loss-position problem and placed-in-service rules, policymakers have clear avenues to further bolster domestic investment, strengthen supply chains, and secure the nation’s long-term economic competitiveness and prosperity. These reforms would simplify the tax code, reduce distortions, and encourage the continuous capital formation essential for a dynamic and growing economy.