The real value of the government’s “phenomenal” $20k asset write off

The government’s small business budget has been a big success, it seems. They got positive headlines about the Budget being stimulatory, and now approval ratings of the PM are back up.

It’s a PR success. And a lot of that is due to attention lavished on the $20,000 tax write-off for small business.

It’s “Phenomenal” apparently.

Get ready for a lot more asset write-off announcements in future. Because they buy the government a lot more headlines than they deserve.

You wouldn’t know this from reading about it, but the “$20,000” asset write off is worth only about $1000.

Here’s why:

The $20,000 is not taken off the tax bill of a small business. Instead it’s a deduction from income – same as when an individual gives to charity.

After a small business takes $20k off their income, they save the 28.5 per cent tax they would have paid on it. 28.5% of 20k is $5700.

That’s the actual value of being able to instantly write off a car or machine from your tax this year.

But here’s the thing. Businesses could always write off asset purchases against their income. They just had to do it more slowly.

Using a depreciation schedule from the ATO website, I calculated how much a small business would have been able to save off their tax under the old rules.

It’s $5700.

The only advantage is that under the new policy, a business can claim all that $5700 in this tax year, instead of claiming it in dribs and drabs over the next decade.

Here’s a graph for how your depreciation works under instant write off versus slow depreciation.

Years since purchase on the horizontal axis.
Years since purchase on the horizontal axis.

We can measure how much benefit instant access to the write-off provides. All we need to do is make an assumption about how small business values money over time. We do that with a discount rate. Lets assume a discount rate of 8 per cent.

If that is the case, the net present value of the flow of money is $4660. Only $1040 less than the value of the money right now.

(If you assume small business is even more patient, the value of the instant write-off is even less. At a 2 per cent discount rate the NPV is $5350 and the net value of the new policy is a mere $350.)

In summary, the government is getting great value from this policy in media coverage terms.

Compare it to another tax break they gave small business in the Budget – a five per cent tax cut for unincorporated businesses. You probably haven’t seen mention of that anywhere.

But this five per cent tax cut (full disclosure, I run an unincorporated business!) is worth even more to the Budget bottom line. That’s it in the blue bubble on the right side – worth $1.8 billion. This graphic was in the glossy brochures journalists got in the Budget lock-up.

budget glossy

It’s one of the most expensive measures in the Budget. And it has barely got a headline. The government will not make that mistake again.

Expect asset write-off thresholds to be even higher in the next Budget as governments seek a headline that says something like $100,000 Asset Tax Bonus for Small Business.

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thomasthethinkengine

Thomas the Think Engine is the blog of a trained economist. It comes to you from Melbourne Australia.

3 thoughts on “The real value of the government’s “phenomenal” $20k asset write off”

  1. I think you’ve made a couple of errors. The classic problem with discounted cash flows is what discount rate to use. The correct one is the opportunity cost, and for small businesses with high growth opportunities, the opportunity cost is high. 20% would not surprise me. Getting cash now and now over five years of depreciation is much more valuable than your calculation states. Secondly, this scheme applies to all small businesses, most of which are sole traders and could easily have an average tax rate higher than you assume (they pay tax under the same scheme as PAYG employees). It is a very interesting and stimulative scheme, as we know from the last time it was done. The value of this measure is not chicanery. It can be attacked for other reasons, since it is basically a short term disruptive subsidy.

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    1. Hi Tim, thanks for the comment!

      I take your point on the tax rate. Some will be paying more than 28.5 per cent because they will be paying at their own marginal rate. (Some will be paying less.)

      As for depreciation, the right rate to choose was something I puzzled over. I modelled the change with rates of .02, .05, .08 and .2.

      The people who access the scheme will be those with higher discount rates. But what is the right rate to choose to represent the average small business?
      In trying to figure out the right rate I thought about the cost of funds for a small business (a small business loan can cost about 7 per cent; as well as interest rates more broadly) but I was also aware that a lot of small businesses are money eaters, not money spinners.

      Starting a small business is not the action of someone with a high discount rate.
      For small businesses on average (including those who won’t use the depreciation provision) I reckon 8 per cent is probably a fair value.

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