Why Stunt Our Growth?

April 23, 1962

To provide more incentive for capital investment, the Administration has proposed that businesses investing in productive equipment be granted a flat-rate tax credit of 8 percent of the amount of their investment in any year. In addition, the Treasury has begun to reduce its estimates of “useful lives” of property to permit business to take somewhat quicker depreciation allowances than before.

These are certainly steps in the right direction. A modification of the first proposal (a 7-percent tax credit) is embodied in the tax bill as it passed the House and is now before the Senate. But is this proposal excessively generous, as some senators think? Or is it insufficient? And is it better or worse than other proposals designed to attain the same result?

Careful estimates indicate that, as a result of inflation combined with a shortsighted past depreciation policy, about $100 billion of plant and equipment in this country is obsolete and in need of replacement. Other careful estimates hold that our underdepreciation of plant and equipment amounts to $5 billion to $8 billion a year. On this basis business is paying $2.5 billion to $4 billion more in annual taxes than it would with adequate depreciation.

OBSOLETE PLANTS

If these calculations are reasonable, then even if the Treasury was correct in its first estimate that its proposed 8-percent credit would mean a tax cut of $1.2 billion a year at the outset, the tax credit would still not enable industry to write off adequate depreciation.

But how does the proposed tax credit compare, in fairness or as an incentive to modernization and new investment, with the method generally used in Europe in recent years, of allowing faster depreciation write-offs or a bigger initial write-off?

The tax credit would no doubt provide some incentive to new investment. But compared, say, with allowing a bigger initial write-off, it would have disadvantages both for industry and for the government. It would favor the already prosperous and growing industries over the older or more depressed. It would favor investment in short-lived rather than in long-lived assets. It would be more expensive for the government, because it is a direct offset against a corporation’s tax and would not reduce subsequent depreciation allowances. George Terborgh of the Machinery and Allied Products Institute has calculated that it would require at least a 40 percent initial write-off to match an 8 percent tax credit in overall terms.

FOR FASTER WRITE-OFFS

If it is a choice of one or the other, therefore, allowing faster depreciation on write-offs or a big initial write-off seems fairer as between companies, more promising in the long run as investment incentive, and ultimately better for government revenues, than the proposed tax credit.

The advantage of allowing faster write-offs or a big initial write-off is that the government gets the money back. A corporation can never write off an asset for more than its total cost. If it is allowed to write off 40 percent of that cost the first year, it has only 60 percent left to write off in later years. Depreciation adjustments involve merely transfer of income from one year to another. Past insistence by the Treasury on slow depreciation over the so-called “useful life” of an asset has been not merely arbitrary but shortsighted.

The Treasury itself stands to gain from liberalized depreciation allowances. Maurice E. Peloubet, a certified public accountant, has persuasively argued for adoption of the Canadian method of capital allowances and for “reinvestment depreciation.” A Senate subcommittee recently concluded:

“Liberalized depreciation allowances would generate enough new taxable earnings among producers of capital goods to offset the tax loss from lower profits resulting from increased depreciation allowances. . . . It is doubtful that there would be any revenue loss in the second year after such liberalization, and perhaps none in the first. . . . The economic growth and resulting greater tax base under new depreciation policies should assure the Federal government of a long-term gain in revenue.”