The present tax system is biased against savings and investment in many ways. One of the most important is that, unlike other expenses, businesses must deduct capital expenses (such as for machinery and equipment) over many years rather than in the year incurred. This raises the cost of capital and reduces investment. Lower investment, in turn, harms productivity growth, international competitiveness, job creation and real wages. Sustainable real wage growth is only possible through productivity growth by internationally competitive businesses. Accordingly, the proper, neutral tax treatment of capital expenses is full expensing.

Internal Revenue Code Section 179, for example, allows smaller firms to expense capital costs and substantially mitigates the bias against investment by small firms. H.R. 4457, which has been reported out of the House Ways and Means Committee, would continue to allow annual investments of up to $500,000 to be expensed. Under present law, however, all but the smallest U.S. firms that make investments in the U.S. must routinely wait seven years—and sometimes 15 years—to fully deduct their investments.

The U.S. has not only the highest corporate tax rate in the world but one of the worst capital cost recovery allowance systems. Bonus depreciation reduces the tax bias against investment and reduces the competitive disadvantage that U.S. firms face by allowing firms to expense half of their capital costs.

Bonus depreciation is not really a bonus at all but moves tax policy substantially in the direction of a neutral tax base—a tax base that is neutral toward the decision about whether to invest or consume and neutral among different investment options. Markets, not the tax code, should dictate the level and composition of investment. The economic literature overwhelmingly supports the proposition that expensing is the “optimal” tax policy and would promote the highest rate of economic growth. Bonus deprecation moves the tax code more than halfway toward that goal.

Bonus depreciation is, in short, an extremely important step towards real tax reform. It should be permanently extended.

In the absence of congressional action, bonus depreciation will expire for investments after December 31, 2013, and the cost of capital for firms throughout the country will increase substantially. This tax increase would move us away from a neutral tax base. It will therefore reduce investment and have an adverse impact on productivity, competitiveness job creation, and real wages.

Some in Congress may perceive making bonus depreciation permanent as “too costly” given our current budget deficit. The initial cost of permanently allowing 50 percent expensing may appear substantial. The Joint Committee on Taxation scores bonus depreciation as reducing federal revenues $79 billion in fiscal year (FY) 2015 and $42 billion in FY 2016, but the revenue reduction steadily declines after the first year, and by FY 2020 it reaches a plateau of $10 billion to $12 billion annually in reduced revenues. This is a reasonable price to pay for a competitive tax system.

Moreover, these estimates dramatically overstate the degree to which bonus depreciation would actually reduce revenues. In the real world, businesses respond to major changes in tax policy. A lower cost of capital will increase investment levels and cause economic growth. Higher economic growth expands the tax base. A dynamic or reality-based score would show that bonus depreciation would reduce federal revenues less initially and actually raise substantial revenue in the out years.

Bonus depreciation is an enormous step in the right direction. It is not a new tax cut. It has been in place for property placed in service since January 1, 2008. Continuing this policy and making it permanent would be a major step toward true tax reform. Letting it expire, in contrast, would be a steep and economically harmful tax increase.