[OPE-L:3996] Re: More Depreciation Questions

Gerald Lev (glevy@pratt.edu)
Thu, 16 Jan 1997 07:24:58 -0800 (PST)

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John wrote in [OPE-L:3995]:

> [...] Further,
> if profits are taxed, then again the question is not academic to the
> capitalist. [...]
> In the U.S., tax codes permitted only straight line
> depreciation prior to and immediately after WWII. According
> to Certified Public Accountants with whom I have discussed some
> of this, in the U.S. corporations must chose methods of depreciation
> dictated by the tax authorities, now called the Internal Revenue
> Service(IRS). Whatever profits reported to the IRS must match those
> reported to shareholders.

It is the case in practice that one aspect of the depreciation method
decision [e.g. straight line, percentage of declining balance, sum of
digits, double declining, sinking fund] for corporations is the effect of
the choice on profit-based taxes. The relationship between depreciation
and taxes occurs because depreciation is normally an allowable expense to
the firm and added allowable expenses decrease net profit. With a sliding
tax rate, a depressed net profit also decreases the tax rate such that the
entire tax cost to the firm is reduced.

Yet, I think these accounting questions have to be kept separate from the
basic theoretical issues related to depreciation. That is -- although this
is a question that may have meaning in terms of empirical measurement -- I
think one first has to examine depreciation free from the role of the

> On a theoretical level, questions concerning Marx's concept
> of "moral depreciation" remain. Further, we still have the
> matter of how a rate of profit is to be calculated given one
> chooses something like straight line depreciation (which Marx
> seems to do in CAPITAL) as a method of recovering an investment
> in fixed capital. Indeed, it was my hypothesis that in using
> this method, capitalists tacitly assume that prices will drop
> within the lifetime of the fixed capital.

Let's consider some of the "tacit" assumptions that firms make in making
depreciation method and [fixed] capital budgeting decisions. Some
assumptions and variables:

(1) How do firms know what the prices of new technologies are going to be
in the future? At best, all they can do is examine _past_ trends and then
make assumptions about the degree to which past trends will continue in
the future.

(2) Firms can, of course, develop new technologies that become elements of
constant fixed capital internally, e.g. through R&D expenditures. Yet,
these firms can not know beforehand what the total costs of developing the
new technologies are. At best, all they can do is _estimate_ cost by
making assumptions about the pace and success of that research.

(3) Where a firm has internal research on new technologies, the benefits
of those technologies can exclusively benefit that firm. That is,
since the new technologies are proprietary, the firm can be the only firm
within a branch of production that utilizes these technologies. They then
can benefit through the mechanism of "surplus profits" and the
redistribution of surplus-value within the branch of production. This
would benefit the firm in question but it would also retard the diffusion
of the new technology within other firms.

(4) On the other hand, there are firms which specialize in the production
of means of production and then sell those commodities on the market to
other firms. Here, there is not the same issue concerning the diffusion of
the technology as in (3). Yet, from the perspective of the firms
purchasing these commodities, they have even less information about the
price and quality of these future commodities. Their estimates of the pace
of change related to price and quality are, therefore, even more
uncertain. A related question is the degree of concentration within the
branch of production that produces these means of production since that
has an effect both on the pace of change and industrial pricing decisions.

(5) As noted above, the capital budgeting decision is complicated not only
because the firms don't know the future prices of those capital goods when
they are sold by other firms -- similarly, they don't know in advance what
the array of available products will be and what their quality will be.

(6) An additional complication is that when technological innovations are
first introduced, not only is the price higher, but the quality of the
product is very uncertain. Under these conditions, a firm may withhold
purchasing the new technology in order to see how those products work for
other firms. That is, given the uncertain nature of the technology itself,
firms may adopt a "wait and see" attitude before committing themselves to
large capital expenditures. This is reinforced by the "learning by doing"
curve that firms experience using fixed capital and the change in the
nature of the technologies themselves as various "generations" are
invented and each new generation has less "bugs."

For all of the above reasons, any decision that a firm makes about future
depreciation of constant fixed capital is very uncertain and, ultimately,
is no more than a "guesstimate" regardless of the mathematical
sophistication of the depreciation method chosen or the state of market
research within the firm. Quite simply, they don't know. They can't know.

> That is, if we are to separate depreciation from
> profit in empirical studies, to whom does one turn for
> answers -- the capitalist accountants or the national income
> accountants?

Since depreciation accounting, as you note, is tied to tax-reduction
strategies, we don't have the "real" numbers. Neither does the
government. Consequently, there are problems with the numbers generated by
both the firms and the state. Unfortunately, in the interests of further
developing Marxian empirical studies, it is very doubtful if those firms
and the state will "open the books" for our benefit.

In solidarity, Jerry