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120 IRET Congressional Advisory 1 (2001)

handle is hein.taxfoundation/iretcgadv0117 and id is 1 raw text is: October 17, 2001 No. 120 WHAT SHOULD WE DO ABOUT THE ECONOMY? The current economic slowdown is due to a plunge in business fixed investment, not a drop in consumer spending. It should be dealt with by reducing taxes at the margin on The tax cuts business investment, saving, for growth in and work. It can't be cured by the same as t tax rebates or other cash good for the windfalls handed out to that reduce ta consumers or by government pi spending. The tax cuts that nduction oj would be good for growth in the near term are the same as those that would be good for the long term - cuts that reduce tax disincentives to the production of additional goods and services. The best way to boost investment and growth is to accelerate or otherwise enhance capital consumption (depreciation) allowances and to eliminate the corporate AMT. Of lesser impact would be a cut in the corporate tax rate. On the individual side, the best change would be to accelerate the phased- in tax rate reductions in the 2001 Tax Act (and eliminate the individual AMT so everyone would gain from the lower tax rates). The tax code punishes investment. There are two large anti-investment biases in the tax code. One is the corporate tax, which falls more heavily on the that I the, hose long disih C' adc, earnings of capital and other assets (patents, other intellectual property, managerial talent, brand name recognition, etc.) used by corporations than on the earnings of similar resources used by non-corporate businesses. The other major anti-investment bias is imposed by the tax depreciation rules (capital consumption allowances) affecting all depreciable property used by corporate and non-corporate businesses. Income is revenue less expenses incurred in earning the revenue. Businesses may claim labor costs and outlays for electricity, rent, materials, interest, and state and local taxes as business expenses in the year they are paid. They get to deduct 100 cents on the dollar, the full real value of their costs. But outlays for depreciable property - plant, equipment and structures - may not be expensed when incurred. They must be strung out over many years, losing the time value of money and getting clipped by inflation. (See chart on page vould be good 2.) In present value, the near term are deductions fall far short of the that would be full up-front cost of the assets, term - cuts overstating business income centives to the and inflating income tax tional goods liability. The after-tax income from investment is depressed, and so is capital formation. The biggest losers are workers. With less capital to work with, they are less productive, and their wages, which reflect productivity, are depressed. Correcting the under-depreciation of capital outlays is one of the most powerful incentives Congress could give for investment spending. Consider a business that buys a machine for $100 in 2001. Suppose it expects the machine to generate an additional $120 in revenue in present value over the life of the asset after all other costs are deducted. The real profit on the investment is $20 in present value ($120-$100), and, at a 35% tax rate, the company should owe the government $7 in tax (in present value), for an after-tax return of $13 or 13%. But the government does not allow an Institute for Research on the Economics of Taxation IRET is a non-profit, tax exempt 501(c)(3) economic policy research and educational organization devoted to inorming the public about policies that will promote economic growth and efficient operation of the free market economy. 1730 K Street, N., Suite 910, Washington, D.C. 20006 Voice 202-463-1400 * Fax 202-463-6199 0 Internet www.iret.org

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