Tax depreciation and risk

Abstract

A major issue under an accretion tax is how to treat depreciable assets, assets that tend to decline in value with time and use. The classic theoretical ideal is economic depreciation, a stream of deductions that exactly replicates the decline in value of each asset over time. Although some parts of U.S. law aim to replicate economic depreciation, tax depreciation is normally allowed at a rate that is faster than economic depreciation. The goal of "accelerated depreciation" is to provide a general subsidy to investment without distorting the choice between assets. Thus, the ideal is to allow acceleration of tax depreciation for all assets but to tailor the degree of acceleration for each asset so that no asset is favored over another strictly due to the tax depreciation rules. Risk affects depreciable assets. For example, it is uncertain how long an asset will function. Some assets wear out and fail much earlier than others. This type of risk is "retirement risk." Retirement risk plays a special role in the analysis of depreciation rules.