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1962, suspended for six months in 1966, and then repealed in 1969.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
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
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
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
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