sample of 21 firms from the Compustat data base.32 Tables 4a and 4b below detail the gross receipts and net income of these firms for the period 1990-1993. Information for 1994 generally was not available. The assignment of firm financial data to a specific industry may create a more encompassing definition than one might wish to employ. The commercial aviation industry includes passenger and freight services provided by fixed-wing aircraft as well as helicopter services. To draw a distinction between these different subsets of the industry, Tables 4a and 4b report data from a subset of 12 firms that are primarily engaged in passenger service, as well as industry totals.33 Table 4a.-Sales as Reported on Financial Statements of 12 Air Transport Firms 1990-1993 Source: Joint Committee on Taxation staff tabulations from Compustat data base. Table 4b.-Net Income as Reported on Financial Statements of 12 Air Transport Firms 1990-1993 - 3,122 - 1,916 - 4,913 1,917 - 5,032 1,869 Air passenger transport .. Source: Joint Committee on Taxation staff tabulations from Compustat data base. No firm conclusions can be drawn from the data in Tables 4a and 4b because of the small and incomplete sample of firms.34 Never 32 Compustat is a financial data service of Standard and Poors. It maintains publicly available financial information on most public companies and private companies that have publicly traded securities. The Compustat data are from corporate financial reports (i.e., the information the firms report to stock and bond holders) and, consequently, the information may not match information reported on tax returns. Financial information for 1994 was not generally available. The 21 firms are: Airtran Corporation; Alaska Air Group Incorporated; America West Airlines Incorporated; American Airlines Incorporated; Atlantic Southeast Airlines; Big Sky Transportation; CCAir Incorporated; Comair Holdings Incorporated; Conquest Airlines; Continental Airlines Incorporated; Delta Air Lines Incorporated; HAL Incorporated, Mesa Airlines Incorporated; Metro Airlines Incorporated; Northwest Airlines Corporation; Reno Air Incorporated; Skywest Incorporated; Southwest Airlines; Trans World Airlines; US Air Incorporated; and United Air Lines Incorporated. The sample is non-random. These firms were chosen because data on sales and income generally were available for the period 1990-1993. The staff of the Joint Committee on Taxation does not necessarily consider these firms as representative of the commercial aviation industry. 33 The 12 firms are: Alaska Airgroup Incorporated; America West Airlines Incorporated; American Airlines Incorporated; Continental Airlines Incorporated; Delta Air Lines Incorporated; Metro Airlines Incorporated; Northwest Airlines Corporation; Reno Air Incorporated; Southwest Airlines; Trans World Airlines; U.S. Air Incorporated; and United Air Lines Incorporated. 34 For example, the apparent return to reported profitability of the air passenger sector in 1993 is due to one firm reporting unusually large profits in 1993 after reporting unusually large losses in 1990. theless, these tables do document the relatively stagnate sales and substantial losses that preceded the congressional debate over the fuels tax exemption. The data also suggest that since that debate sales revenue has grown and a number of firms have generated positive profits. In fact, independent financial analysts estimate that the industry might currently be profitable. The Value Line Investment Survey writes that "[a]irline traffic rose just over 5 percent in 1994, and the upward trend looks like it will continue this year [1995]. Business was up more than 7 percent in January... By our estimates, the Air Transport group came very close to being in the black in 1994.... For this year [1995],... we think substantial profits are likely." 35 These observations may suggest that the conditions that led the Congress to enact an exemption from the transportation fuels tax may no longer exist. On the other hand, a return to profitability does not necessarily imply that the commercial aviation industry is in robust financial health. If the industry were profitable in 1994, it would be the first such year since the late 1980s. Moreover, current levels of profitability may not be particularly attractive to investors. Many observers continue to believe that airlines will need substantial investment funds to make necessary equipment acquisitions to modernize their fleets. With regard to the issue of ultimate tax burden, it has been long understood that individuals who are liable for making payments of tax to the government may not be the ones burdened by a tax. Instead, the incidence of a tax will depend upon the conditions of supply and demand in the affected markets. Market forces often shift the burden of a tax from the individual assigned the liability for payment to another party through price changes. Those parties who have the smallest change in behavior in response to a tax change generally will bear the largest part of the burden of that change. The transportation fuels tax is imposed on the vendor to the transportation industry, not directly on the industry. Depending on relative market conditions for all of the fuels and other products sold by the direct taxpayers, the tax may not be fully passed on to purchasers of any given fuel. Similarly, even if some or all of the tax is found to be passed on to transportation providers, relative market conditions within the commercial aviation industry and with competing transportation modes will determine whether the tax burden remains with the airlines or is passed on to the consuming public. Because fuel market conditions change frequently, even seasonally, predicting with assurance the ultimate burden of this tax is problematic. The present exclusion for commercial aviation might induce some consumers of transportation services to substitute air transportation for the other modes of transportation.36 As a result, the exemption from the transportation fuels tax should increase the demand for commercial aviation services. Whether any increase in demand for commercial aviation services increases the profits of existing service providers depends upon the competitive conditions in 35 "Air Transport Industry," The Value Line Investment Survey, March 24, 1995, p. 251. 36 Public transportation also is exempt from the transportation fuels tax. Hence, consumers might also substitute public transportation for the taxed modes of transportation. the industry. Where there is competition among service providers, any increase in demand generally would be met by increased load factors on scheduled flights or the addition of more scheduled flights. Price increases that are unrelated to the cost of providing air transportation services would not be expected, because competitors would always have the incentive to undercut their rivals. Increased load factors could increase profits of existing service providers in competitive markets. Such an increase in profits might induce expansion of service in such markets by either existing service providers or new service providers. Similarly, in air transportation service markets without substantial competition, an increase in demand could enable a service provider to increase its profitability by increasing prices. In the longer run, an increase in profitability might induce another service provider to enter the market and cause prices to drop through increased competition. Whether such increases in profits induce new entrants or expanded service by existing providers depends upon the potential profits that can be earned by providing air transportation services relative to other opportunities in the economy. The third issue, potential for inefficiencies in the transportation sector, depends on relative market competition among transportation modes. In certain cases, commercial aviation competes with highway, rail, and waterborne movements. Because the tax exemption lowers relative aviation costs, it could increase demand for commercial aviation services. More generally, any such increase due to a tax exemption for one mode of transportation distorts consumer choice and creates inefficiencies in the transportation system. Such distortions may, however, be motivated by other public policy goals, such as a perceived need to ensure an economically viable air transportation system. Some have suggested that the transportation fuels tax exemption for commercial aviation might be justified by the fact that commercial aviation is subject to other excise taxes on transportation of persons and property and the international departure tax. They argue that exemption from the transportation fuels tax keeps the total burden on the aviation sector from being markedly higher than that on competing modes of transport. Critics of this view note that these other excise taxes generally finance programs of dedicated trust funds that provide benefits to air transportation service providers and customers. For example, these taxes provide dedicated funds for airport modernization and air safety. Further, trucks, autos, buses, and certain shipping are also subject to dedicated excise taxes that finance trust fund expenditure programs. B. Tax Provisions Scheduled for May 10 Hearing 1. Tax credit for research and experimental expenditures (sec. 41 of the Code) General rule Present Law Section 41 of the Internal Revenue Code provides for a research tax credit equal to 20 percent of the amount by which a taxpayer's qualified research expenditures for a taxable year exceed its base amount for that year. The research tax credit is scheduled to expire such that it will not apply to amounts paid or incurred after June 30, 1995. A 20-percent research tax credit also applies to the excess of (1) 100 percent of corporate cash expenditures (including grants or contributions) paid for basic research conducted by universities (and certain nonprofit scientific research organizations) over (2) the sum of (a) the greater of two minimum basic research floors plus (b) an amount reflecting any decrease in nonresearch giving to universities by the corporation as compared to such giving during a fixed-base period, as adjusted for inflation. This separate credit computation is commonly referred to as the "university basic research credit" (see sec. 41(e)). Computation of allowable credit Except for certain university basic research payments made by corporations, the research tax credit applies only to the extent that the taxpayer's qualified research expenditures for the current taxable year exceed its base amount. The base amount for the current year generally is computed by multiplying the taxpayer's "fixedbase percentage" by the average amount of the taxpayer's gross receipts for the four preceding years. If a taxpayer both incurred qualified research expenditures and had gross receipts during each of at least three years from 1984 through 1988, then its "fixed-base percentage" is the ratio that its total qualified research expenditures for the 1984-1988 period bears to its total gross receipts for that period (subject to a maximum ratio of .16). All other taxpayers (so-called "start-up firms") are assigned a fixed-base percentage of .03.37 37 The Omnibus Budget Reconciliation Act of 1993 included a special rule designed to gradually recompute a start-up firm's fixed-base percentage based on its actual research experience. Under this special rule, a start-up firm (i.e., any taxpayer that did not have gross receipts in at least three years during the 1984-1988 period) will be assigned a fixed base percentage of .03 for each of its first five taxable years after 1993 in which it incurs qualified research expenditures. In the event that the research credit is extended beyond the scheduled June 30, 1995 expiration date, a start-up firm's fixed-base percentage for its sixth through tenth taxable years after 1993 in which it incurs qualified research expenditures will be a phased-in ratio based on its actual research experience. For all subsequent taxable years, the taxpayer's fixed-base perContinued In computing the credit, a taxpayer's base amount may not be less than 50 percent of its current-year qualified research expenditures. To prevent artificial increases in research expenditures by shifting expenditures among commonly controlled or otherwise related entities, research expenditures and gross receipts of the taxpayer are aggregated with research expenditures and gross receipts of certain related persons for purposes of computing any allowable credit (sec. 41(f)(1)). Special rules apply for computing the credit when a major portion of a business changes hands, under which qualified research expenditures and gross receipts for periods prior to the change or ownership of a trade or business are treated as transferred with the trade or business that gave rise to those expenditures and receipts for purposes of recomputing a taxpayer's fixed-base percentage (sec. 41(f)(3)). Eligible expenditures Qualified research expenditures eligible for the research tax credit consist of: (1) "in-house" expenses of the taxpayer for wages and supplies attributable to qualified research; (2) certain time-sharing costs for computer use in qualified research; and (3) 65 percent of amounts paid by the taxpayer for qualified research conducted on the taxpayer's behalf (so-called "contract research expenses"). To be eligible for the credit, the research must not only satisfy the requirements of present-law section 174 but must be undertaken for the purpose of discovering information that is technological in nature, the application of which is intended to be useful in the development of a new or improved business component of the taxpayer, and must pertain to functional aspects, performance, reliability, or quality of a business component. Research does not qualify for the credit if substantially all of the activities relate to style, taste, cosmetic, or seasonal design factors (sec. 41(d)(3)). In addition, research does not qualify for the credit if conducted after the beginning of commercial production of the business component, if related to the adaptation of an existing business component to a particular customer's requirements, if related to the duplication of an existing business component from a physical examination of the component itself or certain other information, or if related to certain efficiency surveys, market research or development, or routine quality control (sec. 41(d)(4)). Expenditures attributable to research that is conducted outside the United States do not enter into the credit computation. In addition, the credit is not available for research in the social sciences, arts, or humanities, nor is it available for research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity). Relation to deduction Deductions for expenditures allowed to a taxpayer under section 174 (or any other section) are reduced by an amount equal to 100 percent of the taxpayer's research tax credit determined for the centage will be its actual ratio of qualified research expenditures to gross receipts for any five years selected by the taxpayer from its fifth through tenth taxable years (sec. 41(c)(3)(B)). |