May 14, 1993
"Investment Tax Credit Begins to Nod Off"
San Jose Mercury News
By Timothy Taylor
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OLD TAX breaks never die. Instead, they retreat to a catacomb, somewhere deep below Washington, and hibernate, awaiting a favorable change in the congressional climate. Ever since the investment tax credit was put to sleep by the Tax Reform Act of 1986, tax code naturalists have been waiting for it to put in a fresh appearance.

After all, a 7 percent investment tax credit had been enacted in 1962, suspended for six months in 1966, and then repealed in 1969. It awakened three years later in 1972 and grew to 10 percent in 1975, before its repeal in 1986. All along the winding road from longshot presidential hopeful to his State of the Union address in February, Bill Clinton promised to reawaken the investment tax credit. But now, as Congress rolls up its sleeves and prepares to massage Clinton's tax proposals, it appears likely that the investment tax credit will pull a Rip Van Winkle, and sleep awhile longer.

From the start, the notion of a tax break for investment was on a collision course with the goal of reducing the budget deficit. Re-establishing the 10 percent investment tax credit, 1986-style, would have cost about $40 billion per year -- obviously too big a splurge for a president who had promised to reduce the budget deficit.

So Clinton tried to stimulate investment on the cheap. His investment credit would have been 7 percent, not 10 percent. It would expire in two years (except for a continuing provision aimed at small firms). It would only apply to extra investment, above the level of investment in the late 1980s. It would only apply to spending on equipment and machinery, not buildings or structures.

With all of these provisions and a bit more fine print in place, the total cost of Clinton's investment tax credit was whittled down to $6 billion per year. But those methods of saving money soon became arguments against the credit itself.

For example, a temporary tax credit doesn't have a long-term effect on investment. Instead, it primarily encourages business to speed up investments that would have been made anyway.

Having an incremental tax credit, applying only to extra investment, meant that businesses which invested heavily in the late 1980s -- like the computer and semiconductor industry -- would not benefit as much from the tax break as industries that didn't invest much in the late 1980s. Such a credit rewards a lack of investment in the recent past.

While a tax break focused on equipment and machinery may please companies that invest heavily in such equipment, it offers little to companies that invest in research and development, or training of employees, or service- related businesses. In fact, such companies are likely to feel relatively disadvantaged by a tax credit aimed at others.

Finally, all the carefully drawn limitations are a red-flag challenge to tax lawyers and accountants. One can almost hear the tax sharks salivating as they consider ways of classifying everything from office furniture to delivery vans as "plant and equipment." The mind reels at the possibilities for collecting the tax break on total investment, instead of only additional investment, by setting up subsidiary firms that buy equipment, and then lease it to the owner company. In the last few years, total producer purchases of durable equipment have hovered at about $370 billion per year. After the limitations on the credit and the unavoidable game-playing with the tax code were taken into account, it's hard to believe that Clinton's version of the investment tax credit would have much altered that figure. Little wonder that business groups who are natural allies of an investment tax credit, like the National Association of Manufacturers and the American Council for Capital Formation, expressed no enthusiasm for this one.

Tax policy can have a substantial effect on investment, but it's only one of several important factors. The main argument against Clinton's investment tax credit wasn't its minimal effectiveness, but that it might distract from other determinants of investment, like the corporate tax rate, interest rates, and the availability of capital.

For example, even as Clinton offered business an investment tax credit, he proposed taking that money back by raising the corporate tax rate from 34 to 36 percent. With the investment tax break out of the picture, a lower increase in corporate taxes seems likely.

Over five years, the investment tax credit would have cost $30 billion. Putting that money toward deficit reduction will help make more money available for private investment, by reducing the level of government borrowing.

The promise of deficit reduction has also been helping to hold down the threat of renewed inflation, and thus helping long-term interest rates creep down. The drop in interest rates over the last few years has helped business to raise investment capital more cheaply, and its effects have surely been far more powerful than Clinton's watered-down investment tax credit could ever have been.

Raising the level of investment in machines, people, and technology is tremendously important to the long-term health of the U.S. economy, but Clinton's bargain basement investment tax credit wasn't the answer.

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