Capital allowances, often overlooked in discussions about corporate taxation, play a pivotal role in a country’s corporate tax base. They can significantly impact investment decisions, leading to far-reaching economic consequences. As shown in recent data, the extent to which businesses can deduct their capital investments varies greatly across European countries.
Businesses determine their profits by subtracting costs such as wages, raw materials, and equipment from revenue. However, in most jurisdictions, capital investments are not seen as regular costs that can be subtracted from revenue in the year of acquisition. Instead, depreciation schedules specify the life span of an asset, which determines the number of years over which an asset must be written off. By the end of the depreciation period, the business would have deducted the total initial cost of the asset.
Unfortunately, these depreciation schedules often do not consider the time value of money. This inflates taxable profits, which, in turn, increases the cost of capital investment. A higher cost of capital can lead to a decline in business investment and reductions in the productivity of capital and lower wages.
The map reflects the weighted average capital allowances of three asset types: machinery, industrial buildings, and intangibles (patents and “know-how”). Capital allowances are expressed as a percentage of the present value cost that businesses can write off over the life of an asset. The average is weighted by the capital stock’s respective share in an economy (machinery: 44 percent; industrial buildings: 41 percent; and intangibles: 15 percent).
Among countries without distribution-based systems, Lithuania (88.2 percent), Croatia (87.2 percent), and the Czech Republic (77.6 percent) provided the best tax treatment of capital investment in 2023, while businesses in Norway (60.7 percent), Poland (59.3 percent), and Hungary (58.3 percent) could write off the lowest shares of their investment costs.
On average, in 2023, businesses in Europe could write off 71.9 percent of the present value cost of their investments in machinery, industrial buildings, and intangibles. By asset category, the highest capital allowances were for machinery (86.9 percent), followed by intangibles (82.6 percent), and industrial buildings (52.1 percent).
As European countries try to support investment, policymakers should aim to permanently provide immediate deductions for investments in machinery and equipment, and for all other capital investments, they should provide adjustments for inflation and the time value of money.
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