The tax break that could spark a factory boom

The OBBBA, signed into law on 4 July, contains one corporate tax provision that deserves more attention than it has had. The act permanently restores 100 per cent immediate bonus depreciation for domestic equipment, machinery and research spending. Its authors meant it to revive American manufacturing. It certainly changes the arithmetic of corporate capital spending.

How it lapsed and returned

Full expensing is not new. The tax law of 2017 introduced 100 per cent bonus depreciation for equipment, but only temporarily: the rate began stepping down by 20 percentage points a year from 2023, and companies buying machinery this year could write off only 40 per cent immediately under the old schedule. The same law forced companies, from 2022, to spread their domestic research costs over five years rather than deduct them at once, a change that hit software firms and industrial researchers hard. The new act reverses both, backdated for property acquired since January, and makes the treatment permanent.

It goes further in one respect. For a limited period, companies that build new factories and other production facilities in America will be able to write off the cost of the structures themselves immediately, rather than over the decades normally allowed for buildings. That provision is the most direct attempt yet to use the tax code to pull manufacturing plants onshore.

Write it off in year one

With 100 per cent immediate expensing, companies can deduct the whole cost of qualifying physical investment from taxable operating income in the first year, instead of spreading it over a depreciation schedule lasting several years. Capital-intensive businesses, such as semiconductor foundries, chemical processors and makers of automation equipment, get a large cash-flow boost up front. That lowers the hurdle rate for new domestic plants considerably.

The arithmetic is straightforward. At the 21 per cent corporate rate, a company that spends $100m on qualifying machinery can cut its tax bill by $21m in the year it buys the equipment. Under a normal schedule the same deductions would arrive in slices over five or seven years, and a dollar of tax saved in year six is worth much less than a dollar saved now, especially with interest rates where they are. Expensing turns a stream of future savings into cash today.

Why the rate matters

There is a subtler effect on incentives. When a company can deduct the full cost of an investment immediately, the tax system in effect becomes a partner that pays part of the cost up front and takes the same share of the returns later. For a project financed with equity, that removes the tax from the decision at the margin: a plant that was worth building before tax is still worth building after it. Economists regard full expensing as one of the most efficient ways to encourage investment, precisely because it rewards new spending rather than profits earned on past investment.

Debt financing complicates the picture. Interest remains deductible within limits, so a company that expenses a machine and borrows to pay for it can end up with a negative effective tax rate on the investment. That is generous, and it favours large, well-financed firms that can use the deductions straight away over young companies with no taxable profits to offset.

Spending brought forward

Corporate finance teams are already pulling multi-year projects forward into 2025 and 2026 to capture the cash tax savings. There is a catch. Expensing speeds up investment, but it leaves a hole in corporate tax receipts in later years, once the deductions have been used up.

The earlier rounds of bonus depreciation show both the power and the limits of the tool. Studies of the temporary bonus depreciation introduced in 2002 found that companies responded strongly, and small firms most of all, because cash in hand mattered more to them than to large companies with easy access to credit. After 2017, investment by firms that gained most from the tax changes rose noticeably relative to others, though the aggregate boost to business investment was smaller and shorter-lived than the law's supporters had promised.

The case against a boom

The strongest argument against a factory boom is that tax is only one input to the decision, and the others are unfavourable. Interest rates are far higher than in 2017, construction costs have risen, skilled labour is scarce, and tariffs have raised the price of imported machinery and the steel and aluminium that go into new plants. A tax deduction on a machine that costs more to buy and install is worth less than the headline suggests.

Demand is the other constraint. Companies build plants to meet orders they expect to win, and uncertainty about tariffs, trade deals and the path of the economy gives many of them reasons to wait regardless of the tax treatment. The provision lowers the bar for investment, but a project still has to clear it.

Who gains most

The winners are capital-heavy manufacturers with steady profits, such as chipmakers, chemical companies and makers of industrial equipment, along with the suppliers of machinery and construction services they buy from. Research-intensive firms, particularly in software and pharmaceuticals, gain from the restored research deduction. Companies with little taxable income, including many start-ups and loss-making firms, gain least, because a deduction is worth nothing until there are profits to set it against.

The signals to watch are orders for non-defence capital goods excluding aircraft, construction spending on manufacturing facilities, and the capital-spending guidance companies give in their results over the coming quarters. Full expensing will give domestic investment a strong shot of cash in 2025 and 2026. Whether that is enough to offset high interest rates and dear American labour is far from certain, and the government's corporate tax take will probably suffer afterwards. Expect the clearest response from large, profitable manufacturers already planning American plants, and a much weaker one from the smaller firms the policy's champions most want to reach.