What Is Capital Consumption Allowance (CCA)?
Capital consumption allowance (CCA), sometimes referred to as depreciation, is the amount of money a country has to spend each year to maintain its present level of economic production.
- The capital consumption allowance (CCA) represents depreciation in the overall economy and is expressed as a percentage of GDP.
- Removing the capital cost allowance from GDP gives you the net domestic product for that year.
- While changes in the CCA may confirm economic trends, it is still a backwards-looking figure.
- CCA that is too high a percentage of GDP indicates poor economic growth.
Understanding Capital Consumption Allowance (CCA)
CCA is calculated as a percentage of gross domestic product (GDP). The percentage of GDP not allocated to the CCA is called net domestic product and represents investment spending.
A CCA that is too high a percentage of GDP is often an indicator of poor economic growth. This situation occurred in the United States during the Great Recession of 2008. According to a U.S. Census Bureau survey, nonfarm investment spending prior to the recession was $1.37 trillion. By 2009, it had declined to 1.09 trillion, a decrease of 20.7%. Real GDP, which is inflation adjusted, fell to $15.21 trillion at the end of 2009 from $15.64 trillion two years earlier. Meanwhile, CCA rose to $1.56 trillion at the end of 2009 from $1.35 trillion in 2007. So, CCA went to 10.2% of GDP by 2009 from 8.67% of GDP in 2007.
Capital goods refer to items that help a producer create consumer products and services. For instance, if a pizza is a consumer good, the oven it came from is considered a capital good. Consumers don’t buy pizza ovens, but they buy the pizzas they cook as fast as they come out. Capital stock also includes heavy equipment used to make other types of things that consumers buy, such as cars, but it also includes smaller things like the computer a novelist works on.
All capital goods have what accountants call a useful life, or how long that capital good will be able to do its job to help a producer keep producing. The average pizza oven, for instance, has a useful life of about 10 years. Every year, that oven gets a lot of wear and tear, so it is worth less than the year before. As such, the pizza place owner will depreciate that oven over its useful life of baking pizzas. Accounting depreciation marks down the value of that oven on the owners books every year until it has a value of $0 at the end of its useful life.
The CCA measures how much the value of the stock of capital goods owned by a country declines in a given year by measuring economic depreciation, which includes not only accounting depreciation but also other reasons for declines in value, such as destruction or obsolescence.
A capital consumption allowance will decline in a nation if enough of the underlying capital goods decline in value. Here are some of the reasons that such a decline might happen:
- Ordinary wear and tear from regular use.
- Capital goods break down before they are supposed to and become unusable. They can also be damaged or destroyed by fire or natural disasters like flooding.
- Capital goods often become technologically obsolete. When the sewing machine was invented 150 years ago, all the old spinning jennies used to make clothing became obsolete.
Changes in the capital consumption allowance can sometimes help to confirm leading economic signals, but it is a lagging indicator in practice.
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