Starting next year, 100 percent bonus depreciation for short-lived investment—originally enacted in the 2017 Tax Cuts and Jobs Act (TCJA)—will begin to phase down through the end of 2026. Making 100 percent bonus depreciation permanent would boost economic growth and American incomes in any economic environment, but this policy change would be especially valuable if inflation remains elevated in the coming years.

When firms are unable to immediately and fully deduct the cost of their investments, they lose out on the value of those deductions because of inflation and the time value of money (because a dollar earned today is worth more than one earned in the future). Ensuring that firms can fully deduct the cost of their investment becomes even more valuable when inflation is higher because the cost of delayed deductions rises with inflation.

Higher inflation increases the cost of making investments because a deduction in the future is worth less in real terms than it otherwise would be. And the longer inflation is high, the more economically beneficial 100 percent bonus depreciation becomes.

To illustrate, we estimate the economic effect of permanent 100 percent bonus depreciation under our long-run baseline inflation assumption of about 2.3 percent as forecasted by the Congressional Budget Office (CBO). We then compare this to making 100 percent bonus depreciation permanent when inflation remains elevated in the long run, at 4 percent.

We find that under the baseline inflation scenario, making 100 percent bonus depreciation permanent increases long-run economic output by 0.4 percent, raises American incomes by 0.3 percent, and creates about 73,000 full-time equivalent jobs. Under a 4 percent inflation scenario, permanent bonus depreciation increases long-run output by 0.5 percent, raises American incomes by 0.4 percent, and creates about 94,000 jobs.

These differences are not merely the product of nominal values increasing under higher inflation; instead, the economy is larger in real terms under the higher inflation scenario because getting an immediate and full deduction for investment is more valuable to firms when high inflation erodes the value of deductions taken in the future.

Making 100 percent bonus depreciation permanent is more costly under permanently higher inflation. In our baseline inflation scenario, making bonus depreciation permanent would cost about $400 billion over the next 10 years on a conventional basis. This cost rises to $470 billion if inflation settles at 4 percent. On a dynamic basis, the cost rises from $296 billion over 10 years in the baseline inflation scenario compared to a $317 billion cost under 4 percent inflation.

But while the cost rises nominally over the budget window, permanent bonus depreciation retains a high return for the cost. In fact, the ratio of economic benefit to the revenue cost rises under higher inflation.

For example, the dynamic cost of permanent bonus depreciation rises by about 7 percent under 4 percent inflation, but the economic benefit, measured by the size of the economy, rises by about 25 percent. This also implies that the nominal revenue benefit of letting permanent bonus depreciation expire will be outweighed by the economic harm produced by requiring firms to delay their deductions, especially when inflation is high.

Though many economic forecasts expect inflation to cool in 2023 due to the Federal Reserve raising interest rates, the path of future inflation and where it may settle remain uncertain. It is possible that inflation stabilizes but stays elevated in the long run, raising both the economic benefit of making 100 percent bonus depreciation permanent and the relative value of bonus depreciation compared to its revenue cost. This possibility should be front of mind for policymakers as they consider the long-run shape of the tax code.