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October
11, 2001, 8:00 a.m. |
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last November the National Bureau of Economic Research, official arbiters
of the business cycle, declared the U.S. economy has been in recession
since March. Until recently, conventional wisdom had it that the recovery
was already underway. The fourth quarter would not be as bad as people
thought and growth would turn positive in the first or second quarter
of 2002. Washington seemed to concur as pressure to pass an economic stimulus
package, so intense in September and October, subsided. Senator Ted Kennedy
last week even called for tax increases to fund more government spending.
The president specifically mentioned that he wanted a speedup in the marginal rate cuts passed earlier this year as well as tax relief for low- to moderate-income workers that may not have received a rebate check. To stimulate investment, Bush called for faster depreciation of capital expenditures and the elimination of the corporate alternative minimum tax (AMT).
In our September 27 column, we ranked generic tax-cut proposals in terms of how much each would add to gross domestic product per dollar of revenue cost. Although the specifics of the tax cuts remain to be worked out — and the devil is always in the details — the president’s selections could give the economy a needed boost. Let’s examine the individual components more closely.
FASTER
DEPRECIATION
Current law requires that most purchases of plant and equipment be written
off over a number of years. These depreciation deductions are set by law
and vary for different assets. For example, computers must be written
off over five years and most factory-floor machinery over seven years.
The longer the business is required to postpone the deduction, the less
the deduction is worth and the greater the tax cost associated with the
purchase.
Shortening tax lives by 20% for most equipment and expensing some high-tech assets would yield $9 in extra GDP per revenue dollar. The reason for the high payoff is that to receive the tax cut a business must purchase an asset, which constitutes new investment.
Total depreciation deductions would not increase, but would simply be moved closer to the time of purchase. As the chart below shows, the tax cut delivers its punch when the economy most needs it. Half the 10-year revenue cost for faster depreciation is concentrated in the first three years before trailing off.
What is more, by postponing deductions for capital purchases, government forces business to give it an interest-free loan. The fact that government can borrow at a lower rate than business further mutes the revenue loss relative to the gains to business. Shortening the life of a seven-year asset to five years would save business 40% more than it would cost government.
AMT
REPEAL
The alternative minimum tax (AMT) is supposed to make sure that individuals
and businesses pay their “fair share” of taxes. In fact, the AMT is an
expensive and inefficient way to deal with perceived or real equity problems
of the current income tax. The AMT raises marginal tax rates, particularly
on capital income, and has very high compliance costs. As serious as these
problems are, perhaps the biggest drawback in the current economic climate
is the fact that the AMT is procyclical. It hits hardest when the economy
is weakest. A repeal would yield $5.61 in added GDP for every dollar of
revenue cost.
ACCELERATING
RATE CUTS
Rebates
mailed out to taxpayers make up less than 10% of the $1.35 billion in
tax cuts enacted earlier this year. Reductions in existing marginal income
tax rates, elimination of the estate tax, and expansion of IRAs come later.
The rate cuts will lower marginal taxes on income from both capital and
labor. The IRA and estate tax provisions boost incentives to save and
invest. Speeding up the entire package of tax cuts would produce $2.52
in economic benefits for every dollar of revenue. Restricting the speed
up to the rate cuts would lower the payoff to $2.10.
RELIEF
FOR LOWER-INCOME TAXPAYERS
Many lower-income Americans already pay no federal income tax, which makes
payroll tax relief a likely choice to stimulate this group. Payroll tax
cuts, however, would generate the smallest economic payoff because labor
is nowhere near as responsive as capital to changes in its return after
taxes. A 0.7% reduction in the Social Security and Medicare rate for all
workers would yield an extra $0.70 in GDP per revenue dollar. Limiting
the relief to lower-wage workers further drops the economic payoff to
$0.23.
SETTING
THE STAGE
President Bush has called for the right stuff. Faster depreciation and
AMT repeal would turn around the year-long decline in investment. Speeding
up the rate cuts and lower payroll taxes would increase incentives to
work, save, and invest. Handled the right way, this mix of tax relief
could set the stage for a healthy recovery early next year.
EDITOR'S NOTE: Be sure to Join the Robbinses and IPI on October 16 for a congressional policy briefing on what should be done to stimulate the economy. Click here for details.
— Aldona and Gary Robbins operate Fiscal Associates, an economic consulting firm in Arlington, Va. Both are Senior Research Fellows with the Institute for Policy Innovation in Lewisville, Tex.