New tax cuts may encourage companies to replace workers with machines

This tax season many changes brought by the 2017 Tax Cuts and Jobs Act are hitting home, including one with big implications for business spending and local economies. Under the new law, companies can now deduct capital investments immediately from their taxable income rather than spreading out the deduction over many years.

This “accelerated depreciation” provision was one reason the Council of Economic Advisers promised that the bill would spur investment and boost average household incomes by $4,000. Yet our research shows that accelerated depreciation may not raise wages and may even encourage corporations to replace workers with machines. 

{mosads}Such tax sweeteners can indeed encourage business investment, as other researchers have shown. We saw this firsthand on a recent trip to Dallas. We visited a microbrewery that had newly installed a $750,000 canning machine. We were not surprised when a brewer said one reason they upgraded their machinery was the new tax benefit.  Thanks to the change, the brewery’s 2018 tax bill will be more than $100,000 less than it otherwise would have been.

In a new paper, we examine the effects of corporations such as the Dallas brewery being allowed to accelerate depreciation deductions. We find these policies do stimulate businesses to purchase new machinery, as other studies have found.

However, we also find that these policies have only small effects on job creation and virtually no effect on the earnings of the average worker. 

Perhaps most concerning, we find that by artificially lowering the cost of new investment, these policies can drive corporations to replace workers with machines. 

To find out how this new provision will affect workers, we examined the effects of similar policies used in the past. Since 2002, the federal government has sweetened investment deals for corporations by tinkering with depreciation schedules to give businesses more cash back in the year they invest it.

How much money a business gets back from faster depreciation varies by industry, with, some benefiting more from the policy than others. For example, grocery stores and restaurants, which invest mostly in long-lived assets, benefit more from this policy than, say, pharmaceutical companies.

We identified industries that gain the most from accelerated depreciation and looked at communities where these businesses reside. For instance, in Wake County, North Carolina, the proportion of employees working in industries that – like restaurants or grocery stores – benefit the most from bonus depreciation is 80 percent higher than in neighboring Durham, which has a high concentration of pharmaceutical companies.

We then compared jobs, investment and wages across many such communities. Employment rises when a county benefits more from the policy. Between 2002 and 2012, we find that employment rises by 2 percent more in counties like Wake than in counties like Durham. 

Although bonus depreciation increases employment slightly, at least in the short term, it is an expensive way to accomplish this goal. In fact, research shows that it is cheaper for the federal government to create jobs by cutting taxes on low income workers or by spending money on infrastructure or other public services.

When we look at how these policies affect workers’ paychecks, we find an even bleaker picture. Communities that benefited most from faster depreciation did not see faster wage growth.  In fact, in Wake County, wages grew more slowly than in neighboring Durham. And that pattern was typical across the country. 

Furthermore, accelerated depreciation may encourage companies to replace workers with machines. Indeed, we find that speeding up depreciation generated large increases in spending on equipment and machinery, accompanied by decreased spending on workers and wages.  

We saw exactly this pattern when we visited the Dallas microbrewery.  Yes, the brewery added new, productive machinery and increased sales. But the tax incentive didn’t create new jobs for the community. This is obviously not a great outcome if the goal is to create jobs.   

The federal government is currently spending $25 billion per year accelerating business investment under the guise of helping workers. While this policy contributes to economic growth, workers are not reaping the benefits. This incentive is a costly way to create jobs, doesn’t raise wages and moves firms toward more automated production. Policymakers should find another way to help workers.

Eric Ohrn is an assistant professor at Grinnell College. Juan Carlos Suárez Serrato is the Wagoner Assistant Professor of Economics at Duke University and a Faculty Research Fellow at the NBER. Daniel Garrett, a PhD candidate at Duke University, also contributed to this research.