Stimulus bill: Tax breaks for small biz

President Bush, surrounded by members of Congress and his Cabinet, signs the Economic Stimulus Act of 2008.

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(FORTUNE Small Business) -- The economic stimulus bill signed into law by President Bush today included one tax break for small businesses added by the Senate, but lost another as Congressional leaders bowed to White House pressure to move quickly without adding too many amendments.

The key addition affecting small businesses is an expansion of "bonus depreciation," which allows investments in tangible property, computer software, or improvements to leased property to be more speedily depreciated, adding to a business' tax savings. Businesses of all sizes will be allowed to depreciate in this tax year 50% of the cost of an asset put into use in 2008.

The Senate Finance Committee estimates that this amendment will funnel $43.9 billion in federal tax savings to businesses over the next two years.

Another provision that now becomes law will increase the level of so-called "Section 179" deductions that small businesses can expense instead of depreciate. Initially included in the House of Representatives' stimulus bill, this language allows businesses with up to $800,000 in annual qualifying equipment purchases to deduct investments in any tangible business purchases (not including buildings, but including computer software) of up to $250,000, instead of depreciating them. These caps are increases from the $500,000 annual revenue maximum and $125,000 deduction limit under current law.

A third provision proposed by the Senate that would have allowed businesses to deduct operating losses against income from as far as five years back was dropped from the final bill.

"From a small-business perspective, we're very happy with the final product," says National Federation of Independent Business tax counsel Bill Rys. The new expensing rules, he says, "apply broadly, so we think it'll help all different sectors of small business owners."

While the tax changes should help some businesses' bottom line, there are growing questions as to how effective they'll be at the broader goal of boosting consumer spending.

A study by Moody's Economy.com chief economist Mark Zandi estimated that expanding bonus depreciation would generate only $0.27 in new economic activity per $1 of government cost. The $600-a-person income tax rebates that are the stimulus package's centerpiece, by comparison, would produce more than $1 for each dollar spent, while expanded unemployment benefits and food stamps - initially proposed by Senate Democrats, then dropped in the face of a threatened Republican filibuster - would have generated $1.64 and $1.73, respectively, according to Moody's calculations.

Indeed, when a similar bonus depreciation package was passed in 2002 to help boost the economy in the wake of the Sept. 11 attacks, it had only minimal affect on business owners' investment decisions, according to several economic studies. A January 2004 poll by the National Association of Business Economists found that 73% of companies questioned said they hadn't made any additional purchases in response to the tax break.

Rys says he's hopeful that the impact will be greater this time, since it's earlier in the economic downturn than when bonus depreciation was put into effect in 2002.

Worries have also emerged this week about the stimulus deal's effect on state governments, after the liberal-leaning Center on Budget and Policy Priorities released a report showing that the bonus depreciation will cost not only the federal government, but state governments that couple their corporate income tax rates to the federal rate. All told, according to figures released by CBPP this morning, 23 states will lose about $1.7 billion in tax revenue this year - a particular concern given that Zandi had called for federal relief to state governments, whose expected budget cuts in response the economic downturn are otherwise "sure to become a substantial drag on the economy later this year and into 2009," Zandi cautioned.

CBPP chief economist Chad Stone says that an alternative measure that would have extended federal tax breaks but not state ones was rejected.

"We argued that an investment tax credit would work better, since it would affect the rate but not the base," says Stone. "But that's not what happened."

The question now is whether the final stimulus package will not only help businesses at tax day, but also help get more customers walking in the door.

"Businesses are not apt to make big investments when the environment is one where there's not enough demand for their product anyway," says Stone, echoing the concerns of other top economists. "If all you do is add to their cash flow in a weak economy, you're not going to get much extra spending out of them."

Correction: An earlier version of this story described the $800,000 Section 179 cap as applying to a business's annual revenue; the cap actually applies to a business's annual equipment spending. FSB regrets the error.