Report to Congress 

on the 

Depreciation of Business = Use Passenger Cars 

Department of the Treasury 

April 1991 
DEPARTMENT OF THE TREASURY 

WASHINGTON 

ASSISTANT SECRETA R Y April 1.991 

The Honorable Dan Rostenkowski 

Chairman 

Committee on Ways and Means 

U.S. House of Representatives

Washington, D.C. 20515 

Dear Mr. Chairman: 

Section 7612(f) of Public law 101-239, the Omnibus 

Budget Reconciliation Act of 1989, directs the Secretary of the 

Treasury or his delegate to conduct a study of the proper class 

life for cars and light trucks and submit a report to the 

Congress within one year of enactment. The Omnibus Budget Reconciliation Act of 1990 extended the date for submission of 

the report to April 15, 1991. Pursuant to those directives, I 

hereby submit the IIReport to Congress on the Depreciation of 

Business Passenger Cars." A report on the depreciation of light

trucks is expected to be submitted in July. 

I am sending a similar letter to Representative

Bill Archer. 

Sincerely, 

enneth W. Gideon 

Assistant Secretary

(Tax PoZicy) 

Enclosure 
DEPARTMENT OF THE TREASURY 

WASHINGTON 

ASSISTANT SECRETA R Y April 1991 

The Honorable Lloyd Bentsen 

Chairman 

Committee on Finance 

United States Senate 

Washington, D.C. 20510 

Dear Mr. Chai.rman: 

Section 7612(f) of Public law 101-239, the Omnibus 

Budget Reconciliation Act of 1989, directs the Secretary of the 

Treasury or his delegate to conduct a study of the proper class 

life for cars and light trucks and submit a report to the 

Congress within one year of enactment. The Omnibus Budget 

Reconciliation Act of 1990 extended the date for submission of 

the report to April 15, 1991. Pursuant to those directives, I 

hereby submit the IlReport to Congress on the Depreciation of 

Business Passenger Cars.I1 A report on the depreciation of light 

trucks is expected to be submitted in July. 

I am sending a similar letter to Senator Bob Packwood. 

Sincerely, 

\Kenneth W. Gideon 

Assistant Secretary

(Tax Policy) 

Enclosure 
Table of Contents 

Chapter I. Introduction and Principal Findings ................................................................ 1 

A. Mandate for This Study ......................................................................................... 1 

B. Principal Findings .................................................................................................. 2 

Chapter r[. Industry Background ...................................................................................... 5 

Chapter III. Data Collection and Methodology ................................................................ 7 

A. Public meetings ..................................................................................................... 7 

B. Description of the Data .......................................................................................... 7 

C. Structuring the Data ............................................................................................... 8 

D. Methodology .......................................................................................................... 10 

Chapter IV. Results of the Analysis ................................................................................. 15 

Chapter V. Issues in Setting Class Lives .......................................................................... 21 

A. Estimation Issues ................................................................................................... 21 

B. Administrative Issues ............................................................................................. 22 

C. Conceptual Issues .................................................................................................. 23 

Chapter VI. Conclusion and R.ecomendations .............................................................. 25 

Appendix A. The Mandate for Depreciation Studies ....................................................... 27 

Appendix B. Models Studied and Sample Sizes .............................................................. 29 

Appendix C.Determination of Equivalent Economic Lives from the Age-Price Profile 

and Pattern of Sales ........................................................................................................... 31 

References ......................................................................................................................... 33 

Acknowledgments ............................................................................................................. 33 

Tabie of Figures 

Figure 1.. Relationship of Age-Price Profile and Various Straight-Line 

Depreciation Schedules ..................................................................................................... 12 

Figure 2.--Representative Compact Model ....................................................................... 15 

Figure 3. Representative Intermediate Model ................................................................. 16 

Figure 4.--Representative Standard Model ....................................................................... 17 

Figure 5.--Representative Foreign Model ......................................................................... 18 

Figure 6.--Nonfleet Passenger Cars .................................................................................. 19 

Table of Tables 

Table 1.--Investment in Business-Use Passenger Cars by Industry Sector ....................... 5 

Table 2.--Distribution of Passenger Car Sales .................................................................. 6 

Table 3.--Unadjusted and Adjusted Equivalent Economic Lives of Fleet Cars 

by Size Class ..................................................................................................................... 19 

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Chapter I. Introduction and PrincipaI Findings 

A. Mandate for This Study 

This study of the depreciation of business-use passenger cars has been prepared by the 

Office of Tax Analysis (OTA) in response to a Congressionalmandate in the Omnibus Budget 

Reconciliation Act of 1989 (P.L 101-239). Section 7612(f) of the Act, which became effective 

December 19,1989, directed Treasury to conduct a study on the proper class life for cars and 

light trucks and to report its findings to the Congress within one year. The Omnibus Budget 

ReconciliationAct of 1990 extended the due date for the report to Apd 15,1991. A report on 

the depreciation of light trucks is expected to be submitted to Congress later this year. 

OTA conducts studies of the depreciation of other assets, including assets not expressly 

requested for study by the Congress, as part of its general mandate under Section 168(i)(l)(B) 

of the Internal Revenue Code (IRC), asmodified by the Tax Reform Act of 1986. (See Exhibit 

1 of Appendix A.) This provision directed the Treasury to "monitor and analyze actual 

experience with respect to all depreciable assets", and granted Treasury the authority to change 

the classification and class lives of assets. The Technical and Miscellaneous Revenue Act of 

1988(TAMRA)repealed Treasury's authority to alter asset classes or class lives,but the revised 

Section 168(i) continued Treasury's responsibility to "monitor and analyze actual experience 

with respect to all depreciable assets" (see Exhibit 2 of Appendix A). 

The General Explanation of the Tax Reform Act of 1986 indicates that the determination 

of the class lives of depreciable assets should be based on their anticipated useful lives and the 

anticipated decline in their value over time, after adjustment for inflation (see Exhibit 3 of 

Appendix A). Under current law, the useful life of an asset is taken to be its entire economic 

lifespan over all users combined, and not just the period it is retained by a single owner. The 

General Explanation also indicates that, if the class life of an asset is derived from the decline 

with age of its market value, such life (which, to avoid confusion, is hereafter referred to as its 

equivalent economic life) should be set so that the present value of straight-line depreciation 

over the equivalent economic life equals the present value of the decline in value of the asset 

(both discounted at an appropriate rate of interest). 

As described in Chapters III and IV,an unadjusted equivalent economic life was derived 

for a broad spectrum of business-use passenger cars. In its study of the depreciation of rental 

clothing (tuxedos), where it was assumed that separate accounts were not kept for each tuxedo, 

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OTA computed the equivalent economic life from the estimated decline in value with age of 

the tuxedos, without considering the potential gains or losses incurred upon the retirement of 

each tuxedo’. In this report, such calculated equivalent economic life is referred to as the 

unadjusted equivalent economic life. 

Business-use passenger cars have unique characteristics. Unlike most other business 

equipment, passenger cars are typically sold before the end of their useful life as vehicles. 

Moreover, unlike anumber of other business assets forwhich an established resale market exists, 

used business-use passenger cars are nearly always acquired for household (or non-business) 

use? The analysis of the depreciation of business-use passenger cars in this report is thus 

somewhat different from the analysis used in prior OTA depreciation studies. In those studies 

the analysis took into account the decline in the asset’s market value with age, the pattem of 

asset retirements, and the tax consequences of the retirements. Such analysis, however, ignores 

the economic implications of the relatively infrequent sales of used assets. By contrast, an 

adjusted equivalent economic life for business passenger cars was derived in this study that 

accounts not only for the decline in value of the cars with age, but also for their conversion from 

business to non-business use and the tax gains and losses that arise from their sale at different 

ages. However, because of the relatively short period passenger cars remain in business use, 

retirements are ignored in calculating their adjusted equivalent economic life. 

Under current law, passenger cars used in a trade or business, including taxicabs, have a 

class life of threeyears, regardless of whether they are owned,leased, or rented by their business 

users. Under Section 168(e)(3)(B)(i)of the IRC, however, passenger cars are assigned to the 

five-year property recovery class, regardless of their class life. Likewise, under Section 

168(g)(3)@), the alternative depreciation system recovery period for passenger cars is five 

years. 

B. Principal Findings 

A distinction between fleet and non-fleet vehicles is generally recognized in the industry, 

which is briefly described in Chapter II. meet vehicles are defined by the industry aspassenger 

1 Treasury submitted a report to Congress in August 1989 on the depreciationof rental clothing (Report to Congress 

on the Depreciation ofClothing Heldfor Rental). InMarch 1990, Treasury submitted separate reports to Congress on 

the depreciationof scientific instruments,fruit and nut trees, and horses (Report to Congress on the Depreciation of 

Scient@cInstruments;Report to Congress on the Depreciation of Fruit and Nut Trees;Report to Congress on the 

Depreciation ofHorses). 

2Forthis study,OTAacceptsthe industry assertionthat nearly all salesof business-usepassenger cars aremadedirectly 

or indirectly to households. 

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cars held by their business owners in groups of 10 or more. All other business-use passenger 

cars are defined as non-fleet vehicles. meets mostly include vehicles owned by long-tennleasing 

firms and daily rental firms, but also include vehicles owned directly by their business users 

(private fleets). Non-fleet vehicles includepassenger cars owned by their business users as well 

as cars leased by their business users from non-fleet lessors and retail dealerships. 

The principal findings of this study are that passenger cars used in business fleets have 

an adjusted equivalent economic life of 2.8 years, and that non-fleet business-use passenger 

cars have an adjusted equivalent economic life of 4.5 years.3 Weighting the present values 

underlying the twolives by each sector’s share of tax-depreciable investment in passenger cars 

yields an average adjusted equivalent economic life ranging from 3.5 years to 3.8 years, 

depending on the relative weight given to non-fleet leased vehicles. This weighting issue is 

discussed in more detail in Chapter V. 

Wile the estimated equivalent economic lives are signrficantly different for fleet and 

non-fleet passenger cars, OTA does not recommend establishing separate asset classes for 

business-use passenger cars under the Modified Accelerated Cost Recovery System (MACRS). 

As discussed in Chapter V, the difference in economic lives for fleet and non-fleet vehicles is 

explained mostly by differences in miles travelled during the first two years of service. We 

mileage and other use-related characteristics are closely correlated with fleet/non-fleet status, 

such status does not by itself determine a vehicle’s intensity of use. Moreover, any distinction 

based on ownershipwould pose difficult administrativeproblems of definition and enforcement. 

As noted in Chapter VI, based on the above findings Treasury recommends that the class 

life for MACRS asset class 00.22 (Automobiles,Taxis) be changed from 3 years to 3.5 years. 

3 Passenger carsare defined as four-wheeled vehicles manufacturedor sold primarily for use on public streets, roads, 

and highways, and rated at 6,000 pounds unloaded vehicle weight or less. Limousines and taxi cabs are included 

without regard to weight. Multipurpose vehicles, sport utility vehicles, and passenger vans are not included in this 

report. 

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Chapter II. Industry Background 

While sales of passenger cars to households are an important part of the national economy, 

sales to businesses are also sigruficant. According to the Bureau of Economic Analysis (BEA), 

business spent $50 billion in 1989 on new passenger cars, accounting for one-third of total 

domesticpassenger car sales and about 12percentof total business investmentin new equipment. 

As noted, for this study business-use passenger cars have been classified into two major 

categories: fleet cars and non-fleet cars. According to industry classification, fleets consist of 

cars owned by fhs with 10 or more cars. All other business-use cars are defined for this study 

as non-fleet cars. The majority of fleet cars are owned by long-term (30 days or more) leasing 

firms and short-term (less than 30 days) rental firms, with a small portion owned directly by 

theirbusiness users (privatefleets). Non-fleet cars aremostly owned by small andmedium-sized 

business firms in a wide variety of industries, including small lessors. These distinctions by 

type of ownership are of interest due to the differences observed in resale prices and holding 

periods. Table 1 shows 1989 investment in passenger cars by each industry sector. 

Table 1.--Investmentin Business-Use 

Passenger Cars by Industry Sector, 1989 

(Ilnits in Thousands, Dollars in Billions) 

Percentage

Industry Number of Acquisition Distribution 

Sector Vehicles Cost Number 

Fleet I 1,953 1 25.0 I 56.3 I 49.9 

Lease I 894 I 1 25.8 1 

Rental I 907 I 1 26.2 1 ~ Private 1 152 1 I 4.4 I ~~ -~ 

Nun-feet 1,S14 25.1 43.7 50.1 

Total 3,467 50.1 100.0 100.0 

Sources: Bureau of Economic Analysis, Automotive Fleet Fact Book. Acquisition cost by 

sector estimated by OTA. 

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The composition of passenger cars acquired for business purposes differs somewhat from 

those acquired for non-business purposes. Table 2 compares the distribution by size class of 

all passenger cars sold in model year 1989 with that for business fleet^.^ Business fleets are 

more heavily concentrated in compact and intermediate models, with lease and private fleets 

especially heavily concentrated in intermediate-sized models. The results presented in this 

study, though, are for the depreciation of business-use vehicles only. Because the depreciation 

pattem varies by size class, and because the distribution by size class differs between vehicles 

acquired for household use and business use, the results shown in this report for business-use 

cars cannot be generalized to all passenger cars. 

Table IZ.--Distributionof Passenger Car Sales, 

Model Year 1989 

(Number of Cars in Thousands) 

Size 

Class 

Domestic plus selected 

imports 

Subcompact 

Compact 

Intermediate 

Standard 

Luxury 

Other imports 

Total 

All Passenger Business-Fleet 

cars 

I Number I Percent I Number I Percent 

8,409.5 81.5 1,922.5 92.6 

2,264.7 21.9 334.1 16.1 

2,110.9 20.5 544.2 26.2 

2,428.8 23.5 676.7 32.6 

832.7 8.1 178.9 8.6 

772.4 7.5 188.6 9.1 

1,908.5 18.5 154.3 7.4 

10,318.O 100.0 2,076.8 100.0 

Source: Automotive Fleet Fact Book, p. 22. 

4 The classification of cars in this table differs &om that used elsewhere in this report. Automotive Fleet Fact Book 

includes government fleet cars, and classifies only selected imports in the specific size class categories. We 

adjustments to fleet data were generally made in this report to exclude govement cars and to include all imports in 

a single category ("forsign"), such adjustmentswere not made in Table 2 for comparability with the available data for 

"AllPassenger Cars". 
Chapter III. Data Collection and Methodology 

A. Public meetings 

Public meetings were held at the Treasury Department in January and March of 1990 to 

determinethe scopeof the study,discussthe study design and general methodology, and describe 

the kind of data needed for the study. The first public meeting was announced in the Federal 

Register on December 21, 1989, and invitations were extended to each of the major trade 

associations representing different sectors of the business-use car and light truck industry. 

Invitations were also sent to executives of the largest leasing and rental firms in the United 

States. 

At these meetings, it was determined that the scope of the study should include all 

automobiles and light/medium duty trucks designed for use over-the-road and used in a trade 

or business. This coverage was generally understood by Treasury and industry participants to 

include both fleet and non-fleet vehicles, and vehicles that are leased or owned by their users. 

Although no attempt was made to define "light" or "medium-duty" trucks, data collection for 

trucks was limited to those with a gross vehicle weight of 33,000 lbs. or less. This decision 

effectively eliminated large tractor-trailer trucks from the scope of the study, and it preserved 

flexibility in ultimately defining light and medium duty trucks for classification purposes. 

Unlike many of the previous depreciation studies conducted by OTA, no survey of the 

industry was conducted or proposed. Instead, data were solicited directly from a limited number 

of owners of business-use vehicles based on vehicle specifications that were proposed and 

developed at the public meetings. This data-collection procedure was adopted because of the 

relatively short time frame granted by the Congress for completion of this study, and because 

of the availability of machine-readable data from several of the firms that agreed to participate 

in the study. 

B. Description of the Data 

Firms participating in the study were asked to provide OTA with detailed data on 

characteristics of cars and light trucks either disposed of during the last few years or in their 

fleet inventory at the time the data were provided. Each observation in each data set was to 

include, at a minimum, the vehicle's Vehicle Identification Number, original acquisition cost, 

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the month and year of acquisition, the sale price (net of refurbishing costs), and the month and 

year of disposition. Some data sets also included the type of disposition and the mileage of the 

cars at disposition. All of the data were received by OTA from May through August of 1990. 

Data for fleet passenger cars were received from four major national leasing firms and 

three large private fleet owners5. Data for non-fleet vehicle dispositions and mileage were 

obtained from a sample of business tax returns prepared by the Statistics of Income Division of 

the Internal Revenue Service. Despite repeated requests to the major rental car trade associations 

and other industry representatives, QTA was unable to obtain passenger car data from the daily 

rental sector of the industry. 

Although the daily rental sector accounts for nearly one-half of fleet passenger car 

purchases, not allof this investment is capitalized and depreciated for tax purposes, since many 

of the vehicles are sold within the same tax year they are acquired. This holding period has 

declined in recent years, as both domestic and foreign auto manufacturers (some of whom hold 

large equity stakes in daily rental firms) have increased their sales to such firms by agreeing to 

re-purchase the cars at guaranteed prices after just several months of use. These cars are then 

typically sold by the manufacturers to their retail dealerships and are in turn sold by such 

establishments to households as "nearly new" used cars. 

Passenger car data from three of the leasing firms and two of the private fleet firms were 

analyzed in detail.6 Although OTA had requested data on dispositions for the period 1983 

through 1989, only one of the leasing firms was able to provide a significant number of 

dispositions prior to 1985. Thus, the great majority of the dispositions represent sales, wrecks, 

and other dispositions during the years 1985 through 1989. 

C. Structuring the Data 

Since depreciation of passenger cars is likely to vary by model and class, and since the 

composition of passenger car fleets varies over time, passenger cars were classified by 

manufacturer's model whenever possible. A manufacturer's model is defined as a set of 

5 The American Automotive Leasing Association (,UTA)and the National Association of meet Administrators 

("A) assisted in this study by coordinating the collectionof data from their participating member firms. 

6 Data provided by one of the leasing h s and one of the private fleet firms were not analyzed because the datawere 

incomplete. However,due to the relativelylarge sample of complete data,these firmswere not asked to resubmittheir 

information. The five data sets that were analyzedprovided in total useable observations for 773,000passenger cars, 

with 469,000 dispositions and 304,000 cars in inventory. The vast majority of the observations (97 percent) were 

provided by the tknw:leasing hs. 

-8-
passenger cars with the same basic design features over a number of different model years, and 

includes all passenger car observations with those features from all relevant model years. By 

construction, it includes cars that may differ in characteristics such as body type, engine type, 

and optional eq~ipment.~ 

For the fleet analysis, 35 specific domestic models and 11 foreign nameplates were 

identFfied that represent allmajor manufacturers (both domestic and foreign) and six different 

classes. Models were chosen for study only when there were a sufficiently large number of 

vehicle dispositions spread over several years. Consequently, little or no weight was given in 

the overall results to models discontinued early in the sample period or introduced late in the 

sample period. 

Since many of the same models occurred in more than one data set, a total of 145 

model-data sets were separately analyzed. (See Appendix B for a listing of the models studied 

and the number of dispositions observed for each class.) Lease fleets included a much wider 

variety of models than private fleets. The models and nameplates listed in Appendix B account 

for 392,121 passenger car dispositions, or about 84 percent of the total useable passenger car 

observations in the sample. Non-fleet vehicles could not be stratified by make, model, or size 

class due to the relatively small number of observations for this sector. 

Both the unadjusted and adjusted equivalent economic lives were derived (as described 

below in Section D) for each model chosen for study in each data set. Data from model years 

1985 and 1986 were analyzed separately in obtaining the adjusted equivalent economic lives 

for fleet vehicles.* Models were then grouped into one of six size classes, as defined by 

Automotive Fleet Fact Book. A weighted average equivalent economic life was derived for 

each class in each data set, with weights equal to the fim's model year 1989 investment in that 

model? These results were than aggregated over firms (data sets) to obtain equivalent economic 

lives for each class. 

7 Models were identified consistently across data sets and over time using the standard 17 digit Vehicle Identification 

Number 0assigned by the manufacturer. For example, the "Ford Taurus" model includes all observationswitha 

VIN carline/series code indicating Fod Taurus for model years 1986 though 1990, including four-door sedans and 

station wagons. Due to smaller sample sizes, foreign carswere generally analyzed at the broader "nameplate" level, 

which refers to all of themodels produced by one production division of a manufacturer. 

8 A model year is defined as a manufacturer's annual productionperiod that includes January 1of the year referenced. 

A model year typically begins in September or October, but canstart earlier. 

9 Inderivingthe weighted average, the estimated equivalent economic lives for each model were converted to present

values, and these were weighted by each model's share of investment. The weighted average present value was then 

converted into anaverageequivalenteconomiclife. Thisweightingprocedurewas followedateachlevel of aggregation. 

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Finally, equivalent economic lives for each class were weighted by the observed fleet 

share of 1989investment in the class to obtain a single equivalent economic life for fleets. The 

non-fleet sample was too small (121new passenger car dispositions)to stratlfyby model,model 

year, or class. Consequently, a single equivalent economic life for non-fleet vehicles was 

estimated over all models and model years. 

D. Methodology 

As suggested in the General Explanation of the TaxReform Act of1986, the class life of 

an asset is to be determined from the decline in its value with age. ?%is life (which for clarity 

has been referred to as the asset's equivalent economic life) can be either longer or shorter than 

its useful life (Le., the period over which the asset provides service), depending upon whether 

the pattern of its decline in value with age (its "age-price profile") is more or less rapid than 

straight-line depreciation. An asset that declines in value less rapidly than straight-line 

depreciation has a longer economic life, and an asset that declines more rapidly in value than 

straight-line depreciation has a shorter economic life, than the asset's useful life. (For a more 

complete discussion see Hulten and Wykoff [19811.) 

For each model chosen for study in each data set,both an unadjusted equivalent economic 

life and an economic life adjusted for sales were derived. The unadjusted equivalent economic 

life was obtained by equating the present value of economic depreciation (i.e., the decline in 

value of the asset) with the present value of straight line depreciation,both discounted at a four 

percent real rate. The straight line depreciation is calculated over a recovery period equal to 

the unadjusted economic life. In calculating the unadjusted equivalent economic life, the tax 

implications of the actual sales (from which the age-price profile is obtained) are ignored. In 

particular, both straight line depreciation and economic depreciation are considered over the 

entire useful life of the vehicles." (See Appendix C for a more detailed description of the 

analysis.) 

The decline in value is obtained from an estimated age-price profile, which represents the 

average inflation-adjustedvalue of the model (relative to its average initial acquisition cost) at 

each age. In contrast to the Box-Cox procedure used by Hulten and Wykoff (1981) and Wykoff 

(1989), in this study the age-price profile for each model was determined statistically by fitting 

10 The unadjusted equivalent economic life is obtained numerically using a computer program that chooses a test 

solution for that life, uses this solution to calculate the present value of straight line depreciation,and then determines 

a new solution based on the resulting difference in present values. This process continues until the present value of 

depreciationover the straight line life equals the present value of economic depreciation with a very small tolerance. 

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a fifth-order polynomial of vehicle age (in months) to inflation-adjustedrelative resale prices. 

All normal sales over the entire sample period for the model were used to determine the 

parameters of the regression equation." 

It was important to estimate the decline in value of a model from fairly complete data that 

include, at a minimum, the first two years of each model's life. In general, only model years 

1985 and 1986 met these conditions. Since data for dispositions prior to 1985were generally 

not provided by the industry, a large percentage of first-year and second-year sales for model 

years prior to 1985 were missing. Conversely, relatively few cars in model year fleets from 

1987 through 1989had been disposed of by late 1989 or early 1990. 

Whereas the unadjusted equivalent economic life is obtained by equating the present 

values of straight-line and economic depreciation over the entire useful life of the passenger 

cars, the adjusted equivalent economic life is obtained by equating the present values of 

straight-line and economic depreciation only over the period the passenger cars remain in 

business use. In addition, the adjusted equivalent economic life also takes into account the 

present value of the loss (or gain) incurred upon the transfer of the passenger cars from business 

to non-business use. Thus, in contrast to the unadjusted equivalent economic life, the tax 

implications of sales of vehicles (which result in their transfer to non-business use) are taken 

into account. 

The straight line depreciation is calculated over a period equal to the adjusted equivalent 

economic life, and both straight-line and economic depreciation are considered only up to the 

date of sale. Gains and losses are computed as the difference between the straight-line adjusted 

basis and the actual value at the time of sale. Because most of the vehicles are sold well before 

the end of their useful life and experience a present value of economic depreciation over their 

retention period that exceeds the present value of the (hypothetical) Straight-line depreciation 

(including the gain or loss on disposition),the adjusted equivalent economic life is less than the 

unadjusted equivalent economic life. 

Figure 1illustrates the relationship between the age-priceprofile and various straight-line 

depreciation schedules: the current law alternative depreciation system (ADS), the unadjusted 

straight-line equivalent economic life, and the adjusted straight-line equivalent economic life, 

11 Ackerlof (1970) suggested that because buyers of used passenger cars have imperfect information regarding the 

quality of the carpurchased, only "lemons"are sold. Although this point may have some relevancefor household-use 

vehicles,it wouldappearto be less important for business-use cars,most of which are sold after arelativelyshort period

of use. 

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------ 

1.o 

0.9 

0.8 

0.7 

0.6 

0.5 

0.4 

0.3 

0.2 

0.1 

0.0 

Altematie 

DepreciatlonSystem 

Straight-Line 

Equivalent(mad].) 

Straight-Line 

Equivalent (adJ.) 

Age-Price 

Profile 

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 

Age in Years 

for a single representative domestic compact model. The age-price profile (solid line) drops 

rapidly over the model’s first year of service, and then at successively slower rates over ages 

two,three, and four,before turning down sharply after age foul2The adjusted basis as calculated 

under ADS (long-dashed line in Figure 1)reaches zero after five years for all passenger cars. 

(For convenience, the applicable half-year convention is ignored.) 

For this model, the adjusted basis using the unadjusted straight-line equivalent schedule 

(short-dashed line) reaches zero at 3.8 years. As discussed below, when this model’s observed 

pattem of dispositions is taken into account (and the resulting gains and losses included in the 

analysis), the adjusted basis under the adjusted straight-lineequivalent schedule (dotted line in 

Figure 1)reaches zero after 2.9 years. 

Representatives of the lease sector of the industry have argued that the cmnt law 

altemative depreciation system (which enters the adjusted cmnt earnings component for 

corporate taxpayers subject to the altemative minimum tax) is too slow, especially when the 

12 The estimatedage-priceprofile is determined by fitting a fifth-orderpolynomial through the actual relative price

observations. Although the polynomial crosses the x axis at an age of about 5 years, there are no observationsfor cars 

older than 4.5 years. 

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relatively short retention period of passenger cars characteristic of their industry is recognized.I3 

Thus, if a car from the model shown in Figure 1were sold at age two by a taxpayer using ADS, 

the taxpayer’s adjusted basis in the car at that age would be about 60 percent of the car’s original 

cost (point B in Figure l),whereas its sales price, as reflected in the age-price profile, would 

be about 37 percent of its original cost. 

While such taxpayers would be able to claim a tax loss, the present value of the depreciation 

deductions (representedby the path AB in Figure 1)plusthe present value of the loss (represented 

by the distance BD), would be much less than the present value of economic depreciation 

(represented by the path AD). If the cars remained in business use after their disposition, this 

deficiency over the first two years would not be particularly relevant, since the present value 

of the depreciation deductions and disposition gains and losses would be considered over the 

entire useful life of the car, regardless of ownership changes. However, industry representatives 

claim that no more than fivepercent of the business-use cars sold are purchased by other business 

users. In accepting this statementdescribing aunique aspect of the resale market for business-use 

vehicles, OTA also accepts the corresponding implication that the present values should be 

equated only over the more limited period during which passenger cars are used for business 

purposes. 

Even if taxpayers were allowed to depreciate the cars along the unadjusted straight-line 

equivalent schedule (short-dashed line), the present value of the depreciation deductions 

(represented by the path AC) plus thepresent value of the loss incurred at disposition (represented 

by the distance CD) would still be less than the present value of economic depreciation to the 

time of disposition. This is not surprising. By construction, the present values of depreciation 

under the unadjusted equivalent straight-line schedule and that of economic depreciation are 

equal only when the asset is held untilthe end of its useful life. A disparity will always arise 

if the asset is typically converted to non-business use prior to that age. 

The adjusted equivalent straight-line schedule is designed to reflect both the disposition 

of the cars prior to the end of their useful life and the gains and losses incurred upon disposition. 

If taxpayers depreciated their cars along this schedule (represented by the path AE), then a gain 

(rather than a loss) would occur when the car is sold at age two (represented by the distance ED 

in Figure 1). The adjusted straight-line equivalent schedule reflects the entire observed pattern 

of dispositions, and not just those dispositions at age two. Thus, even if the taxpayer were to 

-~ ~ 

13 See, for example,Piesand Fischer (1990). 

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use this schedule, a disparity in present values would generally arise. The present values over 

the period of the cars’ business use will be equal only on average for all taxpayers who own 

this particular model of passenger car. 

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------ 

---- 

Chapter IV. Results of the Analysis 

This chapter presents the results of applying the methodology described above in Chapter 

ID[. For illustration, four specific models (representative compact, intermediate, standard, and 

foreign models) are discussed. The aggregate results for fleet and non-fleet passenger cars are 

then presented. In Figure 2, the age-price profile for the representative compact model (model 

year 1986) owned by lease firm A is again shown, together with the unadjusted and adjusted 

straight-line equivalent schedules. Also shown is the observed disposition probability curve 

(long-dashed line in Figure 2). Lease firm A on average holds this model 2.8 years, and no cars 

of this model are held by this firm beyond 4.5 years. 

Figure 2: Representative Compact Model 

1.o 

0.9 

0.8 

0.7 

0.6 

0.5 

0.4 

0.3 

0.2 

0.1 

0.0 

Age-Price Profile, Straight-Line Equivalent 

Schedules, and the Disposition Probability 

Age-Price Profile 

Straight-Line 

Equivalent (unadj.) 

Straight-Line 

Equivalent (adj.) 

___._.._.__. 

Disposition 

Probability 

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 

Age in Years 

Figures 3 through 5 show the age-pnce profile, unadjusted and adjusted straight-line 

equivalent schedules,and dispositionprobabilitycwe forrepresentative intermediate,standard, 

and foreign models, respectively, that were among the 46 models studied for this report. The 

intermediate model (model year 1986) is owned by lease firm B, the standard model (model 

year 1986) is owned by lease fm C, and the foreign model (model year 1985) is also owned 

by lease firmB. 

-15-
E 

------ 

While the shapes of the age-price profiles for the representative compact model (Figure 

2) and the representative intermediate model (Figure 3) are similar over the first three years, 

the curve for the intermediatemodel declines more rapidly after age three, resulting in a shorter 

unadjusted equivalent economic life for that model. While the adjusted equivalent economic 

life for the intermediate model is also shorter, the difference in adjusted equivalent economic 

lives between the two models is not very significant. This is the result of a somewhat wider 

range of holding periods for the compact model, which results in relatively more dispositions 

in later years at a gain than for the intermediate model. 

epresentative lnterme 

Age-Price Profile, Straight-LineEquivalent 

Schedules, and the Disposition Probability 

1.o Age-Price Profile 

0.9 

Straight-Line $ 0.8 Equivalent(unadj.) 

m 

D

p 0.7 

Q Straight-Line 

.-5 0.6 Equivalent (adj.) ‘ij ..--......-. 

Q 

0.5 Disposition 

-2 0.4 Probability 

m

> 

$ 0.3 

-

(g 0.2 

0.1 

0.0 

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 

Age in Years 

For the representative standard model (Figure 4)and the representative foreign model 

(Figure 5), the age-price profiles decline less rapidly in the early years, resulting in longer 

unadjusted equivalent economic lives than for the compact and intermediate m0de1s.l~ The 

adjusted equivalent economic life for the representativeforeign model (3.6years) is longer than 

14 The slight uptum in the age-priceprofile at 4.5 years for the representative foreign model in Figure5 is a result of 

sparse data on dispositions after age 4. The fitted curve turns down after age 5 and reaches zero at 5.7 years of age. 

-16-
'J 

------ 

for any of the representative domestic models. This is due not only to a higher unadjusted 

equivalent economic life (4.7years), but also alonger average holding period (3.1 years) relative 

to the representative domestic models. 

Figure 4: RepresentativeStandard Model 

1.0 

0.9 

E 0.8 p 

P

g 0.7 a 

C .g 0.6 .­

rn 

p 0.5 

p

-5 0.4 

3 

$ 0.3 

-

2 0.2 

0.1 

0.0 

Age-Price Profile, Straight-Line Equivalent 

Schedules, and the Disposition Probability 

Age-Price Profile 

Straight-Line 

Equivalent (unadj.) 

Straight-Line 

Equivalent (adj.) .------..... 

Disposition 

Probability 

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 

Age in Years 

Table 3 summarizes the estimated adjusted and unadjusted equivalent economic lives by 

class for fleet passenger cars. As described above, the lives shown for each category represent 

the weighted average of the lives for each model studied, as noted in Appendix B. The overall 

life for private fleets (over all models) is nearly the same as that for lease fleets. The fleet 

estimates presented in Table 3 combine the results for both fleet types. This similarity in overall 

lives is not surprising, since industry representatives claim that private fleets are managed much 

the same way as lease fleets, and that private non-leasing firms will switch between leasing and 

-17-
E 

------ 

el 

Age-Price Profile, Straight-Line Equivalent 

Schedules, and the Disposition Probability 

1.o Age-Price Profile 

0.9 

Straight-Line 

g 0.8 Equivalent (unadj.) 

a

e 0.7 a Straight-Line 

.EL 0.6 Equivalent (adj.) .-

p 

2 0.5 Disposition 

-2 0.4 Probability 

m _.-_._ 

> 

$ 0.3 

-

2 0.2 

0.1 

0.0 

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 

Age in Years 

buying from year to year depending on market and firm conditions. The overall unadjusted 

equivalent economic life of 3.7 years for fleet passenger cars found in this study is somewhat 

shorter than the results reported by Wykoff (1989) regarding business-leased passenger cars.” 

Figure 6 presents the age-price profile, unadjusted and adjusted straight-line schedules, 

and disposition probability curve for the entire sample of non-fleet passenger cars. It is clear 

that the age-price profile for the non-fleet vehicles drops less rapidly in the first two years of 

service than for any of the fleet categories shown in Figures 2 through 5. In addition, the pattem 

of dispositions is different than for fleet vehicles, with significant disposition probabilities at 

both relatively young and relatively old ages. 

15 Wykoff reported annual economic depreciation rates for business-leased passenger cars that imply an unadjusted

equivalent economic life of about 4.5 years. These depreciation rates were estimated for four specificpassenger car 

models owned by a leasing firm. AlthoughWykoff s study differssomewhatfrom this one in scope and methodology,

thedifferencein unadjustedequivalenteconomiclives appearsto be largelydue to ahigherht-year rate of depreciation

found in this study. 

-18-
------ 

r, 

Table 3.--Unadjusted and Adjusted Equivalent 

Economic Lives of Fleet Cars by Size Class 

Adjusted Life 

Size Unadjusted Model Year Model Year 

Class Life 1985 1986 

Subcompact 3.3 2.4 2.3 

Compact 3.6 1 2.6 I 2.7 

Intermediate 3.6 I 2.7 I 2.7 

Standard 4.2 I 3.1 I 3.1 

4.5 I 3.5 1 3.5 

Foreign 4.5 I 3.8 I 3.9 

Total 3.7 2.8 2.8 

Figure 6: Nonfleet Passenger Cars 

Age-Price Profile, Straight-Line Equivalent 

Schedules, and the Disposition Probability 

1.o Age-Price Profile 

0.9 

Straight-Line 

0.8 Equivalent (Unadj.) 

0.7 

Straight-Line 

0.6 Equivalent (Adj.)

...-......_. 

0.5 Disposition 

0.4 Probability

---. 

0.3 

0.2 

0.1 

0.0 

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 

Age in Years 

-19-
Although not evident in Figure 6, the age-price profile does not reach a value 

until age 10, and the unadjusted straight-line equivalent schedulereaches zero at 7.0 years. The 

relatively large difference between the unadjusted equivalent economic life (7.0 years) and the 

adjusted equivalent economiclife (4.5years) for these cars can be attributed mostly to the slow 

decline in value that occurs after age five. 

-20-
Chapter V. Issues in Setting Class Lives 

A. Estimation Issues 

Several estimation issues arose during the course of the study and their resolution affects 

the final results. The most important issue concerns the reliability of the estimated adjusted 

equivalent economic life for non-fleet vehicles, and the related matter of properly weighting 

that estimate in computing the overall adjusted equivalent economic life. Since the fleet 

estimates were based on nearly 400,000 dispositions and the non-fleet estimates were based on 

only 121,non-fleet estimates are far more uncertain than fleet estimates. 

Nevertheless,the differencein the estimated adjustedequivalenteconomic lives (2.8 years 

for fleet vehicles vs. 4.5 years for non-fleet vehicles) appears reasonable in light of differences 

in intensity of use. Mileage data provided by fleet fms show that fleet vehicles are driven an 

average of 25,000 miles per year in each of the first two years of service. Data on mileage 

patterns for non-fleet vehicles obtained from a sample of business tax returns indicate that such 

vehicles are driven an average of 15,000 miles per year during the first two years. Moreover, 

the results for non-fleet vehicles are consistentwith the findings of other studies that were based 

on non-fleet passenger cars.16 

Giventhe largedifference in estimatedlives,properly weighting the estimates into a single 

class life becomes very important. Data from the Bureau of Economic Analysis and the 

Automotive Fleet Fact Book suggest that after excluding daily rental firms and adjusting for 

lower rates of business-use and tax capitalization among non-fleet vehicles, fleets of 10or more 

vehicles account for 40 percent of the annual capitalized investment in business-use passenger 

cars while non-fleet vehicles account for 60 percent. A weighted average adjusted equivalent 

economic life of 3.8 years would be obtained using those shares as weights. 

About one-third of the non-fleet vehicles, however, are acquired by independent leasing 

firms and retail dealers forleaseto both business and non-business users. When used for business 

purposes, these cars are probably driven more like fleet cars than non-fleet cars, and would 

depreciate in a manner more similar to fleet vehicles. This would suggest weighting thefleet 

estimate at 60 percent, and the non-fleet estimate at 40 percent, resulting in a weighted average 

adjusted equivalent economic life of 3.5 years. 

16 Wykoff(1989) reported that the unadjusted resent values of economic depreciation estimated from five studies 

based mainly on household-use cars averaged.%73 @p. 280-282). This study found an unadjusted present value of 

economic depreciation for non-fleetpassenger c;11s of 374. 

-21-
Another important estimation issue concerns the weighting of the adjusted equivalent 

economic lives derived for the different fleet classes. As shown in table 3, these lives range 

from a low of 2.3 years for domestic subcompact vehicles to highs of 3.5 years for domestic 

luxury vehicles and 3.9 years forforeignvehicles. The overallfleet adjustedequivalent economic 

life of 2.8 years was derived by weighting the size class lives by the sample firms' model year 

1989 investment in vehicles in each of those classes. An altemative is to weight the size class 

lives by industry-wide fleet investment in those classes. "hiswould result in an aggregate fleet 

unadjusted equivalent economic life of 3.1 years. However, industry-wide investment data 

include rental firm investment,which is not separately identified. Industry sources indicate that 

rental fleets are more heavily concentrated in domestic lwrury cars and imports than are lease 

and private fleets. 

A final estimation issue concerns the use of the half-year convention for tax depreciation 

purposes and itsimpactonthe calculatedequivalent economiclife. Inits study of the depreciation 

of rental clothing, OTA found that consideration of the generally required use of the half-year 

convention for tax purposes reduced the calculated equivalent economic life by about one-half 

year. However,thisresult was largely dueto the seasonalpattern of investmentin rental clothing, 

which placed most investment in the fit half of the fiscal year. Fleet passenger car investment 

is fairly smoothly distributed over firms' fiscal years, with about one-half of vehicles acquired 

by the middle of the fiscal year. Assuming that non-fleet investment follows a similar pattern, 

the neglect of the half-year convention forthe analysis in this report is not likely to be significant. 

. Administrative Issues 

The significant difference in estimated adjusted equivalent economic lives for fleet 

vehicles and non-fleet vehicles raises the issue of establishing separate MACRS classes for 

business-use passenger cars based on type of use, ownership, or some other related criterion. 

While the data clearly indicate that vehicles held in fleets depreciate more rapidly than non-fleet 

business cars, this difference appears to arise from difference in the intensity with which such 

vehicles are used, rather than their ownership or use. A classification of passenger cars based 

on anticipated mileage pattems or anticipated holding period at the time vehicles are placed in 

service would pose major definitional and enforcement problems. 

A classification system that distinguishes vehicles based on the size of a fm's leasing 

activity would approximate a classificationbased on intensity of use, and would be simpler to 

administer (although still not without some difficult problem). Such a classification system, 

-22-
* however, would create an incentive for leasing as compared to owning passenger cars that is 

not necessarily desirable. Additional accounting and compliance complexity would be 

introduced for firms that both own and lease vehicles. Both the American Automotive Leasing 

Association,which representslarge leasingfirms,and the National Vehicle Leasing Association, 

which represents small and mid-sized leasing firms, have expressed reservations to Treasury 

concemhgthe establishmentof separateMACRS classes forpassengercars based on ownership. 

C. Conceptual Issues 

The General Explanation of the Tax Reform Act of 1986 states that the class life for an 

asset class should be determined primarily by equating the present value of straight-line 

depreciation and the present value of economic depreciation. It did not indicate whether the 

fact that the owners of the assets may in some cases not be able to claim depreciation deductions 

over a portion of the assets’ useful life should be considered. Treasury believes that in the case 

of business-use passenger cars, a very large fraction of which are transferred from business use 

to non-business use well before the end of the vehicle’suseful life, this fact should be considered. 

More specifically, Treasury believes that in equating the present values of straight-line and 

economic depreciation for business-use passenger cars, only that part of the useful life over 

which the asset is used for business purposes is relevant. Treasury believes that the gains or 

losses incurred by taxpayers at the time the asset is converted from business use to non-business 

use should alsobe consideredin determining the classlife. For this reason,the recommendations 

in the following chapter are based on the estimated adjusted equivalent economic life of 

passenger cars, which takes these factors into account. 

The unadjusted equivalent economic lives, which do not fake these factors into account, 

have also been presented in this report. These estimated unadjusted equivalent economic lives 

are, however, longer than the economic lives OTA would have estimated had it focused on the 

entire useful life of passenger cars (and not just the period over which the cars are used in 

business). More specifically,the reported equivalenteconomic lives do not allow forthe ultimate 

retirement (scrappage) of the vehicles. This is not a very sigmficant omission when attention 

is focused only on the period the vehicles are held for business use, but it is important when 

vehicles are studied over their entire useful life. In such case, a more conceptually correct 

-23-
economic life is derived from the retirement-adjusted age-price profile. The latter is obtained 

by multiplying the unadjusted age-price profile by the survivor function, which is the fraction 

of investment of a given vintage that remains in service at each age.I7 

'Ilk study estimated an unadjusted equivalent economic life for non-fleet passenger cars 

of 7.0 years. Based on a survivor function for all passenger cars derived from results reported 

by Hu (1983), the equivalent economic life adjusted for retirements is 6.3 years. This life is 

quite close to the 6.2 year retirement-adjustedequivalent life that correspondsto the economic 

depreciation for passenger cars observed by Hulten and Wykoff (1981). Thus, although the 

data obtained for this study cover only the period passenger cats are used in business, the data 

for non-fleet vehicles provide an estimate of a total equivalent economic life for passenger cars 

that is nearly the same as that suggested by the work of Hulten and Wykoff. 

17 See,for example, page 22 of Report to Congress on the Depreciation of Scientific Instruments. 

-24-
Chapter VI. Conclusion and Recommendations 

This study has found that the adjusted equivalent economic life of fleet passenger cars, 

excludingdaily rental fleets,is 2.8 years, while the adjusted equivalent economiclife of nan-fleet 

passenger cars is 4.5 years. These differences appear to be attributable to differences in miles 

driven during the first two years of service. While there is some merit to establishing separate 

asset classes for these two different classes of passenger cars, the benefits do not appear to 

exceed the considerable definitional and compliance problems that would arise. 

When the estimated economic lives are weighted by business investment in fleet and 

non-fleetpassenger cars, an averageeconomicliferanging from 3.5 years to 3.8 years is obtained, 

depending on the relative weight given to non-fleet vehicles. Due to the relative uncertainty of 

the non-fleet estimate, and the exclusion of daily rental fleets from the study, a class life of 3.5 

years seems appropriate. Thus, Treasury recommends that the class life for MACRS asset class 

00.22 (Automobiles, Taxis) be changed from 3 years to 3.5 years. 

Under current law, this recommendation, if adopted, would have no effect on the 

depreciation deductions claimed by taxpayers for passenger cars. Section 168(e)(3)(B)(i) 

assigns automobiles and light general purpose trucks to the five-year property recovery class, 

regardless of their class lives. If this provision were repealed,passenger cars would be assigned 

to the three-year property MACRS recovery class, whether or not the recommended change in 

the class life were enacted. (The three-year property recovery class generally includes property 

with a class life of four years or less.) Likewise, under Section 168(g)(3)@),the alternative 

depreciation system recovery period for automobiles and light general purpose trucks is five 

years, regardless of their class lives. If this provision were repealed, taxpayers using the 

alternative depreciation system could depreciate their passenger cars over three years (based on 

the current law class life) or over 3.5 years (based on the recommended class life). 

-25-
Appendix A. The Mandate for Depreciation Studies 

Exhibit 1.. 

Section 168(i)(l)(B)of the Internal Revenue Code as Revised by the Tax Reform Act of 1986 

(i) Definitions and Special Rules. 

For purposes of this section-­

(1) Class Life. 

03) Secretarial authority. The Secretary, through an office established in the 

Treasury-­

(i) shall monitor and analyze actual experience with respect ta all depreciable 

assets, and 

(ii) except in the case of residential rental property or 

nonresidential real property-­

(I)may prescribe a new class life for any property, 

@) in the case of assigned property, may modify any

assigned item, or 

a)may prescribe a class life for any property which 

does not have a class life within the meaning of 

subparagraph (A). 

Any class life or assigned item prescribed or modified under the preceding sentence shall 

reasonably reflect the anticipated useful life, and the anticipated decline in value over time, 

of the property to the industry or other group. 

Exhibit 2. 

Section 168(i)(l)of the Internal Revenue Code as Revised by the Technical and Miscellaneous 

Revenue Act of 1988 

Definitions and Special Rules. 

For purposes of this section-­

(1) Class Life. Except as provided in this section, the term "classlife" means the class 

life (if any) which would be applicable with respect to any property as of January 1, 

1986, under subsection (m) of section 167 (determined without regard to paragraph

(4)and as if the taxpayer had made an election under such subsection). The Secretary,

through an office established in the Treasury, shall monitor and analyze actual 

experience with respect to all depreciable assets. 

-27-
Exhibit 3. 

Provisions for Changes in Classification from the General Explanation of the Tax Reform 

Act of 1986 (pp. 103-104) 

The Secretary, through an office established in the Treasury Department is authorized to 

monitor and analyze actual experience with all tangible depreciable assets, to prescribe a new class 

life for any property or class of property (other than real property) when appropriate, and toprescribe 

a class life for any property that does not have a class life. If the Secretary prescribes a new class 

life forproperty, such life will be used in determiningthe classification of property. Theprescription 

of a new class life for property will not change the ACRS class structure, but will affect the ACRS 

class in which the property falls. Any classification or reclassification would be prospective. 

Any class life prescribed under the Secretary’s authority must reflect the anticipated useful 

life, and the anticipated decline in value over he, of an asset to the industry or other group. Useful 

life means the economic life span of property over all users combined and not, as under prior law, 

the typical period over which a taxpayer holds the property. Evidence indicative of the useful life 

of property, which the Secretary is expected to take into account in prescribing a class life, includes 

the depreciation practices followed by taxpayers for book purposes with respect to the property, 

and useful lives experienced by taxpayers, according to their reports. It further includes independent 

evidence of minimaluseful life -- the terms for which new property is leased, used under a service 

contract, or financed -- and independent evidence of the decline in value of an asset over time, such 

as is afforded by resale price data. If resale price data is used to prescribe class lives, such resale 

price data should be adjusted downwardto removethe effects of historical inflation. This adjustment 

provides a larger measure of depreciation than in the absence of such an adjustment. Class lives 

using this data would be determined such that the present value of straight-line depreciation 

deductions over the class life, discounted at an appropriate real rate of interest, is equal to the present 

value of what the estimated decline in value of the asset would be in the absence of inflation. 

Initial studies are expected to concentrate on property that now has no ADR midpoint. 

Additionally, clothing held for rental and scientific instruments (especially those used in connection 

with a computer) should be studied to determine whether a change in class life is appropriate. 

Certain other assets specifically assigned arecovery period (including horses in the three-year 

class, qualified technological equipment, computer-based central office switching equipment, 

research and experimentation property, certain renewable energy and biomass properties, 

semiconductormanufacturing equipment,railroad track, single-purposeagricultural or horticultural 

structures,telephone distributionplant and comparableequipment, municipal waste-water treatment 

plants, and municipal sewers) may not be assigned a longer class life by the Treasury Department 

if placed in service before January 1,1992. Additionally, automobiles and light trucks may not be 

reclassified by the Treasury Department during this five-year period. Such property placed in 

service after December 31, 1991, and before July 1, 1992, may be prescribed a different class life 

if the Secretary has notified the Committee on Ways and Means of the House of Representatives 

and the Committee on Finance of the Senate of the proposed change at least 6 months before the 

date on which such change is to take effect. 

-28-
Appendix B. Models Studied and Sample Sizes l8 

Subcompact (16,636) Intermediate (247,831) 

Chevy Cavalier (4) Dodge 600 (3)

Ford Escort (3) Chrysler New Yorker (3)

Ford Mustang (2) Chevy Celebrity (4)

Pontiac 6000 (5)

Compact (64,472) Pontiac Grand Prix (3)

Olds Cutlass Ciera (4)

Dodge Lancer (3) Olds Cutlass Supreme (3)

Ford Tempo (4) Buick Century (4)

Pontiac Grand AM (2) Ford Taurus (3)

Mercury Topaz (3) Ford Thunderbird (3)

Plymouth Reliant (4) Chevy Citation (3)

Olds Cutlass Calais (1) Chrysler LeBaron GTS (3)

Dodge Aries (3) Mercury Sable (3)

Mercury Marquis (3)

Standard (34,501) Plymouth Caravelle (3) 

Ford Crown Victoria (3) 

Chevy Caprice (5)

Mercury Grand Marquis (3)

Olds Delta 88 (4)

Buick LeSabre (3) 

Luxury (21,347) 

Buick Electra (4)

Cadillac (3)

Ford LTD Brougham (4)

Lincoln (3)

Olds Delta 98 (1) 

ForeiFn (7,334) 

Mercedes-Benz (3)

Honda (3)

Jaguar (3)

Nissan (3)

Toyota (3)

Volvo (3) 

BMW (3) Mazda (3)

Volkswagen (3)

Porsche (3)

Audi (3) 

18 The total number of dispositions for all models in the class is shown in parenthesis after the class name; the 

number of data sets in which a paxticular model appeared is shown in parenthesis after the model name. 

-29-
Appendix C. Determination of Equivalent Economic Lives from the Age-Price

Profile and Pattern of Sales 

This appendix first describes the equations used to calculate the unadjusted equivalent 

economic life for each specific passenger car model. The computation of the adjusted equivalent 

economic life, which allows for the disposal of assets before the end of their useful life, is then 

discussed. 

The first step involves obtaining the age-price profile for a particular model. The relative 

value of the cars as a function of age is obtained for each model by fitting the observed average 

salesprices (excluding wrecks) at each age by afifthdegree polynomial. Average disposition prices 

are calculated for each month in which dispositions take place. All sale price observations are 

adjusted for inflation and divided by the initial cost of cars to obtain relative values, V(t). The 

regression equation is: 

v(t>-1=a,t +a2t2+a3t3+a4t4+a$, (1) 

where the normalized value is unity at age zero, t represents age, and the a, are the regression 

c~efficients'~. The negative of the derivative of the fittedfunctionV(t) provides the asset's economic 

depreciation as a function of its age. The present value of this economic depreciation function 

(PVED) is the total discounted value of economic depreciation. It is found by integrating the 

discounted value of depreciation from age zero to the age at which the asset value is at a 

(typically zero). 

M 

PVED =-Jm(al+2a,t +3a,t2 +4a4t3+5a,t 4)e 4dt 

where M is the age at which the minimum asset value is reached (its useful life), and r is the 

discount rate. 

The present value of straight-line depreciation over a life L is given by: 

e4 1-e-rL PVSL(L)= -dt =~.

r=o L rL (3) 

The straight-line life with the same present value as PVEDcan be determined from Equation 

3 by numerical methods. This life is the unadjusted equivalent economic life. 

19 Average sale price observations are weighted in the regression by the initid cost of the MIS represented. 

-31-
The fact that the assets are not all held until the end of their useful life is now considered. 

Current law requires the taxpayer to treat as a gain (or claim a loss) an amount equal to the difference 

between the adjusted basis of the asset and its sales value. Equation 4corrects Equation 3 to include 

the fact that assets are converted (via sale) to non-business use prior to the end of their useful life, 

and to take account of the tax gain or loss claimed when the assets are sold. 

where y is the shortest and z is the longest holding period in the disposition probability 

distribution characterized by the function D(t), and where E is the adjusted equivalent economic 

life. In this study, the value of D(t) is obtained from the observed pattem of dispositions". 

The first integral provides the present value of straight-line depreciation, plus any gains or 

losses for passenger cars retired before the adjusted economic life weighted by the disposition 

probability, D(t). The first term in the outer bracket of the integrand reflects the aggregate present 

value of straight-line depreciation up to the time of sale. The terms in the inner bracket express the 

present value of the gain or loss at the time of sale. The gain or loss is the difference between the 

remaining basis, 1-t/E, and the relative value, V(t), of the asset at the time of disposition. Similarly, 

the second integral provides the present value of economic depreciation for the portion of assets 

disposed of after the adjustedequivalent economic life. The first term in the bracket in the integrand 

reflects the present value of straight-line depreciation, while the second term likewise adjusts for 

the present value of the gain on sale (the adjusted basis for cars of age greater than E is zero). 

Equation 5 corrects Equation 2 to allow for the fact that not all the cars are held untilthe end 

of their useful life: 

PVED' =-~zD(T)(~T(a,r +%,t +3a3t2+4a4r3+5a,t 

0 

Equation 4 is solved for that life, E, that provides the same present value as determined from 

Equation 5 using a combination of analytical and numerical techniques. This is the adjusted 

equivalent economic life reported for each model type. For fleet vehicles, separate adjusted 

equivalent economic lives were calculated for 1985 and 1986 model years for each of the models 

and data sets. A single estimate was obtained for the non-fleet vehicles. 

20 The disposition probability distribution is calculated by first fitting the cumulative disposition function,which 

measuresthe fraction of the initial costthat has been sold by age t, by a fifth degreepolynomialfunction.This function 

is then differentiatedto obtainthedispositionprobabilitydistributionD(t). Where appropriate,thefunctionis truncated 

so that only the bell shaped portion of this functionisused torepresentthe dispositionprobability distribution. 

-32-
References 

Ackerlof, George, "The Market for Lemons," Quarterly Journal of Economics 84 (1970), pp. 

488-500. 

Bobit Publishing Co., Automotive Fleet Fact Book, 1990, Vol. 29 Supplement, Redonda Beach, 

CA. 

Hu,Patricia, "Scrappage and SurvivalRates of Passenger Cars and Trucks in 1970-1982," submitted 

to Department of Energy (1983), Oak Ridge National Laboratory, Oak Ridge, TN. 

Hulten, Charles R. and Frank C. Wykoff, "The Measurement of Economic Depreciation," in 

Depreciation, Inflation, and the Taxation of Income From Capital, ed. by C. Hulten, The Urban 

Institute (Washington, D.C., 1981)pp. 99-103. 

Pies, Roger A. And David J. Fischer, "How Dispositions Affect Determination of Depreciation

Class Life," Tax Notes, April 2, 1990, pp. 85-96. 

U.S. Department of Commerce, Bureau of Economic Analysis, unpublished capital stock 

worksheets, 1990. 

Wykoff, Frank C., "Economic Depreciation and the User Cost of Business-Leased Automobiles," 

in Technology and Capital Formation, ed. by D.W. Jorgenson and R. Landau, MIT Press 

(Cambridge, 1989). 

Acknowledgments 

This report was prepared by Robert E. Yuskavage and Hudson Wlner. William Chen and James 

Dutrow provided programming assistance. 

-33-