Preserving LIFO accounting, bonus depreciation rules may be policy options to help capital- and inventory-intensive firms from getting hit hard by inflation
Corporations that carry significant inventory and property, plant, and equipment (PP&E) costs face higher taxes in times of inflation than other firms, despite the presence of tax deductions meant to offset those expenses.
Fabio Gaertner, assistant professor of accounting and information systems at the University of Wisconsin-Madison’s Wisconsin School of Business, along with Dan S. Dhaliwal of the University of Arizona, Hye Seung “Grace” Lee of Lehigh University, and Robert Trezevant of the University of Southern California, found that firms which use historical cost-based tax deductions are still hit hard in times of inflation. Existing regulations designed to mitigate the tax effects of inflation do not appear to fully offset the increased tax burden for these firms.
So called “last in, first out” (LIFO) accounting, is meant to mitigate the impact of inflation by allowing firms to assume tax deductions on the most recently produced products to reflect high production costs. Similarly, bonus depreciation rules are meant to reduce the effect of inflation by allowing firms to deduct a percentage of the costs of qualifying assets immediately, with the remaining costs depreciated over time. However, Congress has considered proposals to eliminate LIFO accounting and no longer extend depreciation rules.
“Inflation does increase the real corporate tax burden in the United States, and it hits companies carrying inventory and significant PP&E costs particularly hard,” said Gaertner. “Even if firms take advantage of provisions in the tax code designed to offer relief from inflation, our study shows that these deductions are not enough to fully offset the full effects of inflation.”
Gaertner added, “Policy-makers need to consider these factors as they debate changes to the tax laws that may make it even harder for some companies to cope with inflation.”
Tax deductions for PP&E are based on the price of capital at the time of purchase. As selling prices increase with inflation, the tax deduction for PP&E depreciation will remain flat, thus increasing firms’ taxable income and tax burden. The same is true with inventory, since tax deductions for the cost of producing goods are based on historical accounting rather than on inflation-indexed or current market value.
In testing for the effects of inflation on the overall corporate tax burden, the study provided results which indicate that if LIFO accounting rules were repealed, an average firm in the study using the LIFO rules would see an annual increase in taxes of $2.65 million.
Gaertner discussed his research in a recent Wisconsin School of Business faculty blog post. The paper, “Historical Cost, Inflation, and the US Corporate Tax Burden”, has been accepted by the Journal of Accounting and Public Policy.