The third major advantage of a VAT-type SBT cited by the Treasury is its better treatment of investment:

A stronger incentive for new investment is created by fully deducting capital costs under the SBT compared with depreciation deduction of business income taxes. [10]

Both income (profits) and Value-added tax systems recognize that capital expenditures should be excluded from the tax base, with the profit (or value-added) from that investment included in the tax base. The difference between the two lies in the timing of those deductions; a profits tax allows annual depreciation deductions which sum to the cost of the investment, while a consumption-type VAT deducts the full amount in the year it was made. [11]

An ideal tax system is neutral between consumption and investment, meaning that the true, interest-adjusted cost of consuming goods today, and later consuming the proceeds from today's investment, are equivalent. Investment in the current period produces consumption in later periods, and if that consumption is fully taxed, then the full value of investment is included in the tax base at the time that value is realized. [12] See the example in Table One.

Although depreciation schedules allow, deductions that sum to the historical cost of the investment, the net present value (the sum of the present and future values, discounted to account for the time value of money) of the depreciation deductions is less than that of the investment. This problem becomes especially severe in times of inflation, because the costs of replacing capital investments grow, while the depreciation deductions do not. By allowing full expensing in the year a capital expenditure is made, the SBT does not discriminate against investment, avoids compounding the impact of inflation, and remains nearly neutral between consumption and investment. [13]

The SBT and Capital Expenditures
Because the depreciation deductions allowed in most profits tax systems understate the true cost of capital expenditures, consumption-type VAT's like the SBT are more favorable to capital expenditures than profits taxes. Because many of Michigan's major industries are capital-intensive, this more-neutral treatment of investment is a major advantage of the SBT over the profits tax systems in other states. The full expensing of capital investments under the SBT encourages businesses to invest in Michigan.

TABLE 1

Example: Neutrality Between Consumption and Investment Under a Consumption-Based Value-Added Tax

 

Tax Base: $100 Consumed

Tax Base: $I00 Invested

Year 1

$100

0

Year 2

$100

0

Year 3

0

$112.36

Sum

$100

$112.36

Net Present Value

$100

$100

In the first case, $100 consumed leaves $100 in the tax base. In the second case, the same $100 invested for three years at 6% annual interest leaves zero in the tax base for two years, but yields $112.36 into the tax base in the third year. The net present value of both is the same, meaning the tax system is neutral between consumption and investment.