Candice Horbacz
The global economic landscape is currently navigating a complex confluence of challenges, including persistent geopolitical tensions, recurrent supply chain disruptions, rising interest rates, and subdued economic growth across numerous developed nations. In this volatile environment, the role of private business investment has surged to the forefront of economic policy discussions worldwide. Governments and international bodies like the Organisation for Economic Co-operation and Development (OECD) are increasingly focused on crafting fiscal policies that bolster critical infrastructure, enhance economic resilience, and, crucially, stimulate growth through robust private sector engagement.
Data from the International Monetary Fund (IMF) underscores the profound disparity between private and public investment, revealing that in 2019, private sector capital deployment in OECD countries outstripped public investment by a factor of five to one. On average, an OECD member nation attracted nearly $300 billion in private investment compared to approximately $55 billion in public funding. This significant imbalance highlights the imperative of fostering a stable and predictable environment for business investment, a factor deemed critical for future economic stability and prosperity.
Central to this environment, though often overshadowed in broader debates on corporate taxation, is the nuanced mechanism of capital cost recovery. This refers to the methods by which tax systems permit businesses to deduct the cost of their investments, typically through depreciation or amortization. These deductions are pivotal, influencing a company’s taxable income, its effective tax rate, and, ultimately, its willingness to undertake new capital expenditures. When businesses are unable to fully and accurately deduct their capital investments in real terms, the incentive to invest diminishes, leading to reduced capital formation, lower worker productivity, and stagnant wage growth. Economists widely advocate for policies that allow businesses to fully deduct their capital investments in real terms, either through immediate expensing or more neutral cost recovery systems, to align tax treatment with economic realities.
Global Divergence in Capital Cost Recovery Policies
The landscape of capital cost recovery varies dramatically across OECD member states. As of 2025, the ability of businesses to recover the real cost of their capital investments ranges from a full 100 percent in Estonia and Latvia, primarily due to their unique cash-flow tax systems, down to a mere 48.4 percent in Chile and 49.1 percent in New Zealand (covering industrial buildings, machinery, and intangibles). This wide spectrum reflects diverse national economic priorities, historical tax structures, and varying degrees of responsiveness to contemporary economic pressures.
The period between 2023 and 2024 witnessed a significant shift in capital allowance rules across many OECD countries. Following the widespread adoption of temporary accelerated depreciation measures in response to the COVID-19 pandemic, many of these provisions either expired or began phasing out. However, 2025 marked a notable improvement in capital cost recovery for several key economies. Canada and the United States, for instance, reinstated full expensing for certain asset types, while Germany and New Zealand introduced increased capital allowances.
On average, businesses operating within the OECD can expect to recover approximately 70.1 percent of their capital investment costs in real terms. The tax treatment, however, is not uniform across asset classes. Investments in machinery typically receive the most favorable treatment, with an OECD average recovery rate of 86 percent. Intangible assets follow, with an average of 78.2 percent, while industrial buildings face the least generous provisions, averaging only 50.3 percent recovery. Historically, the OECD average for capital investment cost recovery stood at 71.2 percent in 2000, experienced a gradual decline thereafter, began to increase in 2018, saw another dip in 2023, and rebounded in 2025, reflecting a dynamic policy environment.
A critical factor impacting the real value of capital cost allowances is inflation. Persistent inflationary pressures, coupled with high interest rates, erode the value of future deductions, thereby increasing the effective cost of new investments. This report assumes a consistent inflation rate of 2 percent for calculation consistency, but such a low rate has been a rarity in recent economic cycles. Notably, only Mexico, Israel, and Chile currently implement inflation adjustments for capital allowances, a policy choice that partially mitigates the adverse effects of rising prices on investment incentives. For example, if the OECD annual inflation rate were 3.6 percent (as observed in 2025), the amount of investment recoverable would significantly diminish, particularly for long-life assets like buildings.
Over the past two and a half decades, statutory corporate income tax rates have seen a significant global decline, including across OECD countries. However, this apparent tax relief for corporations has been partially offset by a simultaneous worsening of the average tax treatment of capital investments for much of the same period. This trend of broadening the corporate tax base through less generous capital allowances explains, in part, why corporate tax revenues have remained stable or even grown in many jurisdictions despite falling headline rates.
Understanding Depreciation Schedules and Capital Allowances
To fully grasp the implications of these policies, it is essential to understand the underlying terminology and mechanics. Businesses typically calculate their profits by subtracting various costs—such as wages, raw materials, and equipment—from their revenue. However, capital investments are often treated differently from other immediate expenses. In most tax jurisdictions, the full cost of a capital asset cannot be deducted in the year it is acquired. This differential treatment inherently introduces a bias against long-term projects requiring substantial capital outlay, favoring instead short-term ventures with minimal capital investment.
Instead, tax systems typically mandate depreciation schedules, which dictate the period over which an asset’s cost can be written off. These schedules are often linked to the asset’s economic life and determine the annual capital allowances a business can claim. While the nominal sum of these allowances over the asset’s life might equal its initial dollar cost, the time value of money—considering both inflation and the required real return on investment—means that deductions claimed in later years are significantly less valuable in real terms than those claimed immediately.
Common depreciation methods include straight-line depreciation, where an equal allowance is deducted each year, and declining-balance depreciation, which bases the annual allowance on the asset’s remaining book value, front-loading larger deductions. For instance, a $10,000 machine depreciated over 10 years using the straight-line method would yield $1,000 in nominal deductions annually. However, with a 2 percent inflation rate and a 5.5 percent real return, the real value of the final $1,000 deduction would be only $522 in today’s terms. Cumulatively, the business might only recover $7,379 in real terms, effectively taxing profits that do not economically exist.
This erosion of real deduction value is compounded by longer depreciation schedules and higher rates of inflation or interest. The consequence is a higher effective cost of capital, which acts as a disincentive for business investment, ultimately leading to reductions in capital stock, lower productivity, and depressed wage growth. The capital cost recovery rate, expressed as a percentage of the net present value of investment costs that businesses can write off, ideally should be 100 percent (representing full expensing or neutral cost recovery). A rate below 100 percent inflates taxable income, overstates tax liabilities, and makes capital investment comparatively more expensive.
Capital Allowances as Drivers of Economic Growth
While often perceived as a technical aspect of tax law, capital allowances wield significant economic influence. Their design can either catalyze or impede investment, directly impacting the trajectory of economic growth.
Lower Capital Allowances Impede Growth: Any cost recovery system that falls short of allowing full expensing—the immediate write-off of an investment in the year it is made—effectively denies recovery of a portion of that investment. This inflates taxable income and increases the tax burden on businesses. The resulting higher cost of capital discourages investment, leading to a diminished capital stock and, consequently, reduced productivity, fewer employment opportunities, and lower wages.
Extensive research substantiates the sensitivity of investment to changes in the cost of capital. Economists Kevin Hassett and R. Glenn Hubbard, in a review of literature, noted a consensus that investment demand is responsive to taxation. Policies that extend asset lives or increase corporate income tax rates tend to decrease capital demand and investment levels, thereby slowing capital stock growth. A 2023 study further highlighted investment’s sensitivity to inflation, finding that a one-percentage-point increase in inflation could reduce optimal investment levels by 0.42 percent, assuming a 22 percent corporate tax rate and a 25 percent depreciation rate. Such reductions in the capital stock inevitably lead to lower wages and slower economic expansion.
Empirical evidence from recent years reinforces these findings. A 2017 study by Eric Zwick and James Mahon demonstrated that bonus depreciation policies in the United States boosted investment in eligible capital by 10.4 percent between 2001 and 2004, and by 16.9 percent between 2008 and 2010. Their work also revealed that small firms were significantly more responsive to these policy changes than larger corporations. Similarly, research on the UK’s accelerated depreciation allowances introduced in 2004 indicated that the investment rate of qualifying companies increased by 2.1 to 2.5 percentage points relative to non-qualifying firms. China’s shift to a consumption-based VAT, which includes an investment tax credit, also demonstrated a positive impact on investment.
Unequal Allowances Distort Investment Mix: Capital allowances also play a crucial role in shaping the composition of capital within an economy by altering the relative costs of different investment types. For instance, lengthening depreciation schedules for machinery could stifle investment in the manufacturing sector, whereas shortening them or allowing full expensing for machinery could stimulate such investment relative to other sectors.
Within OECD countries, there are striking disparities in average capital cost recovery rates by asset type. While businesses can recover an average of 86 percent for machinery and 78.2 percent for intangibles, the rate for industrial buildings plummets to just 50.3 percent. This uneven treatment can steer capital away from long-life assets towards shorter-life assets, potentially impacting long-term infrastructure and industrial development.
The adverse effects are particularly acute in high-inflation environments. With an OECD annual inflation rate of 3.6 percent in 2025, and assuming a 5.5 percent real return, businesses in the OECD would recover only 46.3 percent for buildings, 83.9 percent for machinery, and 75.4 percent for intangibles. This demonstrates that a relatively modest increase in inflation from 2 percent to 3.6 percent can reduce the recoverable investment amount by up to 4 percentage points, especially for long-term assets. High interest rates similarly diminish the real value of future deductions.
Tax policy choices can indeed significantly alter investment composition. The United States’ Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), which introduced partial expensing for certain capital equipment, reduced the cost of those investments by up to 11.4 percent. Research on JGTRRA found that investment increased most for equipment with longer recovery periods, demonstrating the powerful effect of bonus depreciation on the composition of investment.
Such distortions can have broader economic consequences. When a country reduces its corporate tax rate but simultaneously restricts capital allowances, it risks shifting economic activity from capital-intensive industries to sectors less reliant on capital investment. The UK in the 2010s provides a cautionary tale, where trading longer asset lives for a lower corporate tax rate contributed to a decline in business investment and likely exacerbated regional economic output disparities.
Capital Allowances Across the OECD: A Detailed Look
The diverse approaches to capital allowances are evident in the wide range of recovery rates among OECD countries. Estonia and Latvia lead the pack with a 100 percent recovery rate, a testament to their cash-flow tax systems. At the other end, Chile allows businesses to recover only 48.4 percent of capital investment costs. This spectrum reflects complex interactions of corporate tax structures, depreciation rules, and specific incentives.
Industrial buildings generally face the least favorable tax treatment across the OECD, with an average allowance of 50.3 percent. While Estonia and Latvia offer 100 percent recovery, countries like Costa Rica, Hungary, and Japan provide only 27.9 percent, and New Zealand a mere 20 percent. Machinery, in contrast, enjoys the best tax treatment, averaging 86 percent. The United Kingdom, United States, and Canada currently boast 100 percent recovery for machinery due to full expensing policies, with the UK and US making theirs permanent. Conversely, Chile (70.6 percent), Colombia, Greece, and Poland (all 73.8 percent) offer the least generous treatment for machinery. For intangible assets, the OECD average is 78.2 percent, with Estonia, Latvia, and Canada again leading at 100 percent. Canada has temporarily implemented immediate expensing for patents. Australia, New Zealand, and Portugal (all 54.8 percent) have the lowest recovery rates for intangibles among countries providing allowances, while Chile offers none.
Temporary Measures and the Drive for Permanence
Historically, policymakers often resort to temporarily increasing capital allowances during economic downturns to stimulate investment. The responses to the COVID-19 pandemic and subsequent slow growth periods saw several OECD countries implement such temporary expensing and accelerated depreciation provisions. While these measures can encourage businesses to accelerate planned investments, their temporary nature limits their long-run economic benefits. The "whiplash effect" of on-again, off-again policies creates uncertainty, which is detrimental to long-term strategic investment decisions. Economists widely agree that permanent full expensing across all asset types yields the highest and most sustained economic benefits, promoting genuine capital formation rather than merely shifting the timing of investments.
Country Spotlights: Diverse Approaches to Capital Cost Recovery
Estonia and Latvia: The Cash-Flow Tax Advantage
These two Baltic nations stand out with their cash-flow tax models, achieving a 100 percent capital cost recovery rate. Instead of complex annual depreciation schedules, corporate income tax (22 percent in Estonia, 20 percent in Latvia) is levied only when profits are distributed to shareholders. This system simplifies tax calculations and effectively treats all capital costs as immediately expensable, incentivizing businesses to reinvest profits within their firms, fostering new capital formation and economic growth.
United States: Full Expensing for Equipment and Machinery
The US tax code currently allows for an average capital investment cost recovery rate of 94.5 percent, significantly above the OECD average. This is largely driven by the permanent full expensing adopted in 2025 for machinery. While the temporary bonus depreciation from the 2017 Tax Cuts and Jobs Act (TCJA) had begun phasing out, its permanent reinstatement provides substantial clarity and incentive. The US has also temporarily introduced 100 percent expensing for qualifying structures (covering a significant portion of industrial buildings) for constructions initiated between January 2025 and January 2029. The OECD itself, in its 2018 Economic Survey of the United States, projected a "substantial boost to investment activity" from these policies. Empirical studies have indeed shown that TCJA increased US companies’ capital expenditures by 0.2 to 0.4 percent of total assets, and domestic investment by 20 percent for firms experiencing the mean tax change. Tax Foundation estimates suggest permanent full expensing for equipment and machinery could raise long-run GDP by 0.6 percent and increase the capital stock by 1 percent.
Canada: Strategic Temporary Expensing
In response to the US’s TCJA, Canada implemented temporary full expensing for machinery and equipment used in manufacturing, processing, and clean energy investments. This allowed immediate write-offs, a significant departure from previous multi-year depreciation. Canada also accelerated depreciation schedules for non-residential buildings and intangible assets. While these enhanced deductions were initially phased out between 2024 and 2027, they were reinstated in 2025 until 2029, with a gradual phaseout until 2033. Immediate expensing was also introduced for patents and certain data processing equipment acquired after April 2024. While these temporary measures are expected to boost short-term investment, their long-term impact would be significantly amplified if made permanent, providing the certainty businesses need for sustained growth.
United Kingdom: Permanent Full Expensing
From April 2021 to March 2023, the UK offered a "super-deduction" allowing businesses to deduct 130 percent of plant and equipment costs, designed to ease the transition to a higher corporate tax rate. The 2023 Spring Budget replaced this with full expensing, providing a 100 percent deduction for plant and equipment, placing the UK among the top tier for machinery allowances. The Annual Investment Allowance (AIA), offering 100 percent first-year relief for up to GBP 1 million in plant and machinery investments, was also made permanent. Crucially, the 2023 Autumn Statement solidified full expensing and the 50 percent first-year allowance as permanent features of the tax code, averting a policy expiration that would have seen a return to an 18 percent declining balance allowance (75.8 percent in NPV terms). Model simulations indicate that permanent full expensing could increase GDP by 0.9 percent, investment by 1.5 percent, and wages by 0.8 percent compared to pre-2021 law.
Lithuania: Forward-Looking Full Expensing
Lithuania is set to implement permanent full expensing for machinery, equipment, software, and acquired rights starting January 1, 2026. This forward-looking policy aims to significantly enhance its competitiveness and stimulate long-term investment.
Evolution of Capital Cost Recovery and Corporate Tax Rates Since 2000
The journey of capital cost recovery rates within the OECD since 2000 reveals a fluctuating landscape. The simple average rate initially declined from 71.2 percent in 2000 to 67.2 percent in 2014, before seeing a slight increase in 2018 and 2019. The COVID-19 pandemic spurred a sharp rise in 2020 and 2021, reaching a peak of 71.2 percent in 2022, only to decline to 68.8 percent in 2024, and then rebound to 70.1 percent in 2025. This latest rebound was significantly driven by the adoption of permanent full expensing in key OECD economies.
When weighted by GDP, the average OECD capital cost recovery rate followed a similar, though generally lower, trajectory until 2025. It declined from 65.9 percent in 2000 to 64.1 percent in 2013, then rose sharply after 2017, reaching 69.1 percent in 2022. A subsequent dip to 67 percent in 2024 was followed by a dramatic jump to 79.2 percent in 2025. This surge is directly attributable to the extended full expensing provisions in the United States and Canada, coupled with enhanced capital allowances in Germany and New Zealand. The consistent lower weighted average prior to 2025 suggested that smaller economies often had more generous capital allowance regimes. However, the 2025 shifts have propelled larger economies like the United States (3rd) and Canada (5th) significantly up the ranking for capital investment treatment.
In parallel to these developments in capital allowances, statutory corporate income tax rates have also undergone significant changes. Over the past 25 years, a global trend of rate reductions has pushed the OECD average down to approximately 23.9 percent in 2024, with a slight uptick to 24.2 percent in 2025. The GDP-weighted average corporate income tax rate also decreased, notably between 2017 and 2018, primarily due to the substantial cut in the US corporate income tax rate, settling at around 26.6 percent in 2025. Interestingly, the GDP-weighted average corporate income tax rate has consistently remained higher than the simple OECD average. This suggests that larger economies tend to maintain higher corporate tax rates, while some smaller nations combine higher capital allowances with lower corporate tax rates, enhancing their tax competitiveness.
Conclusion: The Path to Pro-Growth Tax Policy
The analysis of capital cost recovery across OECD countries underscores a critical lesson: while lowering statutory corporate income tax rates is important for reducing distortionary effects, it is only one piece of the puzzle. Overlooking the structure and generosity of capital allowances can significantly undermine the effectiveness of broader tax reforms. Inadequate capital allowances diminish incentives to invest, stifling innovation, hindering productivity growth, and ultimately leading to lower wages and slower economic expansion.
For the global economy to achieve a robust growth trajectory, policymakers must prioritize more generous and, crucially, permanent capital allowances. Permanence provides the certainty essential for businesses to undertake long-term investment decisions, which are vital for sustainable economic development. Canada’s temporary expensing and accelerated depreciation provisions, while beneficial in the short term, would yield far greater and more lasting economic impacts if made permanent, mirroring the strategic shifts seen in the United States and the United Kingdom.
Furthermore, the pervasive challenges of inflation and high interest rates amplify the negative effects of protracted depreciation schedules on business investment. Incorporating inflation adjustments into capital allowance regimes, as practiced by a few OECD countries, offers a partial solution to mitigate these erosive effects.
By adopting comprehensive policies that embrace full expensing and enshrine the permanence of capital allowance provisions, governments can unlock real investment, foster innovation, enhance productivity, and strengthen global competitiveness. This strategic alignment of tax policy with economic growth objectives is paramount in navigating the complex economic challenges of the 21st century.
