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The investment tax credit: a new - but not-so-new - idea.

President-elect Bill Clinton has promised to bring new ideas to Washington. However, a centerpiece of his economic plan is one of the oldest tax ideas--the investment tax credit (ITC). In his book, Putting People First, Clinton advocates "a targeted ITC to encourage investment in the new plants and productive equipment in the United States (so) that we can compete in the global economy."

The ITC, first introduced by the Kennedy administration in 1961, is part of Clinton's prescription for jump-starting the stagnant economy. At a press conference soon after the 1992 presidential election, President-elect Clinton announced the implementation of the ITC would create half a million jobs during the first year it was in effect.

There is little question that the level of business investment in new factories, machinery, computers, oil rigs (and all the other things that add to the productive capacity of the country) has been stagnant for more than a decade. Net investment as a portion of the entire economy is lower in the United States than in any of the other 23 countries in the Organization for Economic Cooperation and Development.

Although it remains unclear whether an ITC would actually boost investment levels, there is growing consensus that it will be part of a Clinton economic recovery program. Clinton advisors are wrestling with the form, the timing mechanism and the cost of the ITC.

The argument over the form of the ITC remains a political firecracker. Clinton's advisers have to decide whether the credits should be temporary or permanent, universal or targeted, on all investment or a limited percentage. Exactly how the next administration's ITCs might be shaped is still under discussion by the Clinton transition team, but their inclusion in his promised 100-day economic action program is almost certain. As one executive stated, "|T~hat's the cutting edge: to come up with a new type of mouse trap."

Tens of billions of dollars hang in the balance depending upon the time frame established for businesses to take the ITC on the investments they make. So high are the hopes of business executives for new tax breaks that there is widespread suspicion that many investments are now being delayed in anticipation of the introduction of ITCs. A plunge of 24.9% in machine tool orders between September and October was partly attributed to this wait-and-see attitude in the nation's boardrooms. Presently, the mere mention of ITCs is doing more harm than good to the economy, because businesses are holding off buying equipment in the hopes of receiving the ITC.

Additionally, businesses are concerned over whether the ITC will cover all investments or just increases over previous investments. Businesses are also concerned about the range of products and situations the ITC may cover--anything from furniture, machine tools and desk computers to environmental equipment, oil pipelines and airplanes. Moreover, most forms of an ITC would be fiscally expensive and could force tough decisions in other spending and tax areas simply to keep the deficit from getting much larger.

According to various tax and budget analysts, an ITC could cost anywhere from $5 billion to $30 billion, depending on the overall form. To offset the lost revenue, a 1% across-the-board tax increase would be necessary. Economists believe the ITC is needed to boost sagging levels of investment in the U.S. by businesses and individuals. They also argue the ITC would promote the long-term buildup of the nation's capital base, a key element in the Clinton's administration desire to revitalize and modernize the U.S. economy. In addition, economists theorize that without the higher levels of investment today, tomorrow's economy could be smaller.

In each of the last three decades, business investment growth has slowed. During the 1960s, the total level of non-residential fixed investment grew 68.5% after adjusting for inflation. During the 1970s, it grew by 49.5% and in the 1980s it grew by only 27.9%.

In 1961, President John F. Kennedy proposed an "incremental" tax credit to stimulate the economy that would give benefits only to businesses that increased their investments. In 1962, Congress passed a broader version that gave a 7% tax credit for any new business investment. In other words, if a company invested $1 million in 1962, it could take $70,000 off its tax bill. The ITC came off the top of depreciation for whatever equipment businesses would purchase. However, the ITC was limited. It depended on the type of investment and how long the piece of equipment lasted and it could not exceed 25% of a company's total tax bill.

Since 1962, various tax bills have included some partial form of an ITC. However, the ITC was repealed as part of the Tax Reform Act of 1986. The essence of the Act was to lower personal and business income tax rates in exchange for closing dozens of tax loopholes. The repeal of the ITC provided $143 billion in added revenue, one of the largest revenue-raising components in the 1986 tax package.

Presently, some tax attorneys and budget analysts are concerned that a new ITC would help unravel the 1986 tax reform bill. Some feel that unless there is a specific plan to restore a higher business income tax, the only accomplishment of a new ITC would be to reduce the taxes paid by businesses.

Key Clinton economic advisers, including Robert J. Shapiro of the Progressive Policy Institute and Lawrence H. Summers, chief economist of the World Bank, have praised a tax credit that would only reward increases in investment. For example, a tax credit covering 10% of the cost of a piece of equipment might be given to any investment over 80% of the previous year's investment level. If a company invested $1 million in 1992, any investment over $800,000 would qualify for the 10% tax credit the following year. In other words, if the company invested $1.5 million in 1993, $700,000 of that would qualify for the tax credit and would slice $70,000 off the company's 1993 tax bill. More importantly, an ITC of this sort is estimated to reduce the cost of capital by 11%, the real incentive to investment.

The incremental tax credit provides almost as much incentive to businesses at a fraction of the cost, which may be a significant advantage for Clinton, who will be dealing with a deprived government budget. On the other hand, the argument against implementing an incremental tax credit is that it rewards companies that have failed to make investments in the past, because it is easier for them to show improvement. Companies that have been aggressive investors would receive fewer benefits. However, those economists who support an incremental tax credit believe that a broader tax credit would reward investment that would occur anyway and that the real rewards for companies that invest heavily would come in the marketplace.

The good news is that Clinton has a smart and capable team of economic advisers, fully aware of the dimensions of the various arguments. Despite the uncertainty about how Clinton's ITC proposal will be structured--in terms of form, timing mechanism and cost--most economists agree that it is one of the very few tax breaks that will pay for itself. Even though businesses may be holding back their investments this year, waiting for some form of an ITC, Clinton has resisted the notion of coming up with a "cure-all" economic ITC.
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Title Annotation:Capitol Corridors
Author:Krasney, Jeffrey L.
Publication:The National Public Accountant
Date:Feb 1, 1993
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