One factor probably contributing to this increased understanding has been a comparison of savings and growth rates among various industrialized countries. As is noted in the following table, the economies of Japan, West Germany, Canada, and France have devoted significantly more gross domestic product to savings and investment than have the U.K. and United States, and these same economies have grown at a faster rate than those of the U.K. and United States. While there can be other circumstances influencing such relationships, the message should be clear-there is a direct relationship between the level of investment and the rate of economic growth. INVESTMENT AND ECONOMIC GROWTH: INTERNATIONAL COMPARISON (1960–74) As concern has grown over the rate of capital formation, various studies have provided quantitative estimates of capital needs for the next decade. The New York Stock Exchange, the General Electric Company, and Chase Econometric Associates have reported results of studies suggesting that there will be a significant gap between the level of investment the economy will need to achieve certain objectives and the level of total savings which can fund that investment. Forecasting such developments over a period of years is not a simple matter, and perhaps too much has been made of some attempts to provide specific dollar estimates. But the basic point remains that the known forecasts indicate there will be very substantial capital requirements in the coming decade-not only to keep up some semblance of economic growth, but to account for mandated environmental and personal safety standards and at least to get a start on energy self-sufficiency-and it is unlikely that those requirements can be met unless the general climate for capital formation is improved. II. TAX POLICY AND CAPITAL FORMATION Tax policy is a key factor affecting the level of capital formation in the private sector. While not the only factor, it can be critical at the margin and may well determine the success or failure of regaining a better productivity performance and achieving more satisfactory increases in real income for workers. This critical impact results from the effects tax policy has on available sources of capital. For industry, three sources are: (1) retained earnings, which are affected by the tax rates and depreciation system; (2) equity, which is impacted by the double taxation of dividends and the imposition of capital gains taxes; and (3) debt, which is also affected by the double taxation of dividends. Congress obviously faces difficult choices in reducing tax obstacles to capital formation, given the context of multibillion dollar federal budget deficits and the concern such deficits raise as inflationary potentials in the economy. The justification for reducing any taxes in periods of such substantial budget deficits is simply the fact that estimated direct revenue impacts do not reflect changes in economic activity which would follow basic tax changes. When a new investment is made and people are put back to work, or new jobs created, as a result of the tax changes recommended, the federal income tax base will grow. The revenue losses are then substantially or fully offset due to the feedback effects of the original tax reductions. In addition to the particular effects of specific tax policies, the general stability of tax law is a major concern. Uncertainty as to the favorable nature of the general tax climate can affect both the timing of new investments and even the decisions to make such investments at all. The investment tax credit is virtually the only tax provision enacted in the last twenty years which favorably affects the capital formation process. And it has been suspended, reinstated, repealed, reenacted, raised, and extended six times since its creation. If it were viewed as the capital recovery mechanism that it is, rather than as a fine-tuning device which can be turned on and off at will, its long-term impact probably would be even more favorable than has been the case. The planning of investment decisions, whether by corporations or individuals, would not be aided by recurring upheavals in tax policy, such as would occur, for example, if various so-called "tax expenditures" were to expire every five years. Such proposals are being discussed, and they pose a significant new threat to investment planning. III. PROPOSED TAX REFORMS There are a number of possible tax changes which would, to varying degrees, improve the climate for capital formation. Three are of particular interest, and the NAM strongly favors adoption of any of these proposals either alone or in combination. Tax Treatment of Dividends The economy has long endured the double taxation of dividends, first at the corporate level through the corporate income tax on earnings and then again at the shareholder level through the individual income tax on earnings paid out as dividends. Because of this long history, some claim it just doesn't matter. In fact, most efforts to enact relief from such double taxation have fallen largely on deaf ears. Even the very limited 4 percent credit for dividends received by individuals was repealed as part of the 1964 general tax reduction legislation. Industry believes that it does matter-that the apparent indifference has been a case of growing accustomed to a chronic pain. Perhaps this pain didn't become really noticeable until the equity and new issues markets collapsed in the 1970's. Nevertheless, the problem has been with us right along. One result of such double taxation has been to enhance the appeal of debt financing relative to equity because of the tax penalty imposed on dividends but not on interest. Another has been the diversion of some funds to other forms of investments where the pre-tax rates of return need not be so high as that necessary in industry which generally utilizes the corporate form. Industry's position with respect to double taxation should be clearly understood-double taxation of dividends is inequitable and economically undesirable, and it should be ended. There are collateral issues which are discussed below, but this general statement represents the policy position of the NAM. While an end to double taxation is desirab'e, Congress should be wary of packaged proposals which would result in a climate for capital formation worse than that which already exists. "Tradeoffs" for an end to double taxation have become the number-one topic of discussion, and herein lies the concern of the business community. The end to double taxation would be an equitable tax relief action and, taken alone, would be a net benefit to the capital formation process. But, when combined with repeal or restriction of existing provisions which mitigate the adverse effects of tax law on capital formation, the end of double taxation could produce an overall adverse impact. This would not be desirable. For example, if shareholders were allowed to take a tax credit for the corporate taxes already paid on their dividends but were taxable on 100 percent of the capital gains on sale of the stock, the impact might well be to discourage investment by individuals. From a different perspective, a shareholder credit having an estimated revenue loss of $10 billion, offset by a $5 billion revenue gain from other capital-related provisions, would produce a net benefit only if shareholders reinvested more than $5 billion of their tax savings. The NAM does not have a preference as to the method used to end double taxation. A shareholder credit attached to dividends or a corporate deduction for dividends paid are the two methods generally discussed, and either could produce desirable results. Whatever alternative is adopted, the fair and equitable ending of double taxation is the primary objective. Capital Recovery Allowances While double taxation impacts the creation of capital and the level and form of new investment, existing depreciation policy has a substantial adverse impact on maintaining the real value and usefulness of previously invested capital. When any business asset is purchased, capital is expended. In order to prevent taxing such capital when it is recovered during the sales of goods and services, the Code allows for the deduction of the cost of assets purchased. If this were not allowed, our capital base would be eaten away by taxes, and enormous amounts of new investment would be needed just to maintain the status quo. Unfortunately, the depreciation system now permitted by the Code sanctions a small-scale version of the same destructive process because it is based on the "useful life" concept rather than fast recovery of invested costs. The problem with the useful life concept is that its theoretical recovery of invested capital does not work in the real world of inflation and technological change. The longer the depreciable life assigned to an asset class, the more devastating the eroding effect of inflation on recovering real capital costs. This is particularly true with regard to manufacturing industries because the bulk of their assets have minimum depreciable lives of at least nine years. The principal result is a loss in value of real capital even though the historical dollars have been recovered. Therefore, a portion of the new capital formed each year must be used just to stay even in real terms. Another adverse result is the extent to which long recovery periods tie up capital which would be productively reinvested more quickly. The Revenue Act of 1971 introduced the Class Life System and ADR as revisions to depreciation policy. Coupled with accelerated accounting techniques, these reforms have increased somewhat the speed of cost recovery for companies which can handle their complexities. However, even these provisions remain tied to the useful life concept, and their purpose can be frustrated by the inability of many businesses-particularly small businesses-to adopt them. The NAM recommends a complete change in the capital recovery system in the Code through enactment of a capital recovery allowance system which would abandon the useful life approach. The system would include the following features: Machinery, equipment, and pollution-control facilities would be subject to an accelerated five-year writeoff; Industrial buildings used in the process of manufacturing, extraction, transportation, communication, etc., would be subject to an accelerated ten-year writeoff. No salvage values would be used; Taxpayers wou'd elect deductions of 0 percent to the maximum allowed for any year and, unused deductions would be carried forward indefinitely; The system would be applicable as costs are incurred; and A full-year convention could be applied for all costs. Rate Reduction The corporate rate structure itself continues to be a fundamental tax obstacle to productive investment. The maximum 48-percent rate applied to each dollar of income above $50,000 is a heavy drain on a firm's ability to generate new internal capital. The most recent across-the-board reduction in rates was in 1964. The 4 percentage point reduction enacted then probably would have been even larger if the investment credit had not been adopted only two years earlier. Since that time, only the temporary 1975 increase in the surtax exemption and rate cut for small business have been enacted. But even these rather limited reductions will expire at the end of 1978 unless further action is taken. A reduced rate of tax on corporate income would maximize the market system's allocation of funds to productive uses and, therefore, could he the most productive of real wage gains. The NAM supports an across-the-board reductions resulting in a single lower normal tax (currently 20 percent on the first $25,000 and 22 percent on the excess over $25,000), a lower surtax (currently 26 percent of income in excess of $50,000) and a permanent increase in the surtax exemption to at least $100,000. This rate package would reduce tax obstacles to corporate operations in general-whether capital or labor-intensive, large or small, new or mature in age—while giving relatively more boost to small and moderatesize businesses. Across-the-board rate reductions for individuals are a'so highly desirable. The 70 percent maximum rate on dividends, interest, and the included portion of capital gains is a burden on and deterrent to productive investment and should be reduced to the 50-percent maximum applicable to earned income. Reductions throughout the rate structure would result in more potential capital among all individuals and would be particularly appropriate for the hundreds of thousands of small businesses operated by sole proprietors and partners. While possibly not affecting investment decisions as directly as other proposals, rate reductions would be simple and easily understood and could be put in place immediately without any confusion as to new regulations, new qualifications, or campaigns to explain it. Such reductions would be a limited answer to the overall problem of correcting the tax system's bias against productive investment, but it would help and would not interfere with more basic reforms which could be instituted over a period of time. IV. CONCLUSION Any tax structure will remove funds from the private sector which could otherwise be invested to produce economic growth. Industry's concern over existing tax policy is that it goes beyond being a relatively neutral revenue-raising structure and, in fact, erects obstacles do the capital formation process; by creating a bias against savings and investment, tax policy inhibits economic growth. Imposing a penalty tax on dividend income, sanctioning the erosion of capital through useful life depreciation, taxing business and investment income at high rates-these and other features of tax law adversely affect the capital formation process which sustains the creation of new jobs, increased productivity, and real wage rates. Fundamental tax reforms such as the end to double taxation, a rapid capital recovery system, and sizable rate reductions wou'd enhance the prospects for continued growth for the U.S. economy, and they should be adopted. AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, SENATOR HARRY F. BYRD, Jr., DEAR SENATOR BYRD: Thank you for your letter of June 16, requesting our views on incentives for economic growth. We have pulled together comments on several important aspects of this subject, and several copies of our summary are enclosed. We commend you and your Subcommittee for your interest in this subject. The impact of our tax system on economic growth and capital formation is extremely important, and it is encouraging that many Congressional and Administration leaders have stated publicly the importance of capital formation to our economic well-being and to long range employment goals. Because of the relatively short time we have had to develop the views covered by the enclosed summary, we have for the most part relied on positions previously taken by the AICPA Tax Division in Congressional tax hearings. At the present time, we are considering other aspects of capital formation and basic tax reform problems, and we hope to have further input on these matters in the next few months. Although I know the record of these hearings ends on July 1, we would appreciate the opportunity to submit additional data to you at a later date. A new edition of the Federal Tax Division's "Recommended Tax Law Changes" will be distributed shortly to members of Congress. While these changes are primarily technical in nature, we believe that a number of them would have a positive effect on economic growth, and would welcome the opportunity to discuss such items with you or your staff. If we can assist you or your staff further in your considerations, we would of course be pleased to do so. In that regard, please feel free to phone Charles Lees, Chairman of our Legislative Affairs Subcommittee (212-758-9700), or me here in Washington (785-9510). Very truly yours, WILLIAM C. PENICK. DIVISION OF FEDERAL TAXATION OF THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS—CommENTS ON INCENTIVES FOR ECONOMIC GROWTH (Prepared for the Subcommittee on Taxation and Debt Management, July 1, 1977) TABLE OF CONTENTS A. Integration of Corporate-Shareholder Taxes. 1. Dividends paid or gross-up method. a. See the Tax Division's Statement of Tax Policy No. 3, "Elimination of the Double Tax on Dividends." 1 b. See excerpt from the Tax Division's Testimony before the Senate Finance Committee on HR 10612 on March 18, 1976. 2. Possible Impact of Integration on Subchapter C. a. Based on comments developed by the Tax Division's Task Force on Business Combinations. (Note: These comments have not been approved by the Executive Committee and therefore do not necessarily represent the official position of the Tax Division. 3. Potential problems in the determination of the rate of corporate tax to be imputed to shareholders if the gross-up method is selected. a. While the Tax Division has not extensively considered this area, the subcommittee should refer to the report on "Tax Policy and Capital Formation," prepared for the Ways and Means Task Force on Capital Formation, April 4, 1977.1 B. Importance of capital recovery systems—including investment tax credit and accelerated depreciation methods. C. Treatment of Capital Gains. 1. See the Tax Dixision's Statement of Tax Policy No. 1, "Taxation of Capital Gains." 1 2. Excerpt from testimony presented to the Ways and Means Committee on March 12, 1973. 3. Excerpt from testimony presented to the Senate Finance Committee on March 18, 1976. D. Impact of death taxes on the pool of capital flowing through estates. 1. Excerpt from testimony presented to the Ways and Means Committee on March 15, 1976. EXCERPT FROM THE TAX DIVISION'S TESTIMONY BEFORE THE SENATE FINANCE COMMITTEE, MARCH 18, 1976 ELIMINATION OF THE DOUBLE TAX ON DIVIDENDS The Institute believes that the present tax treatment of corporate-source income does not measure up to accepted standards of tax equity, and that such treatment inhibits the growth and development of not only the corporate sector but all phases of the U.S. economy. Furthermore, the double-taxation of corporate-source income has added to the complexity of tax law administration. And finally, since the incidence of the corporate income tax is unknown, the present system has hindered the Congress's ability to predict the effect of proposed legislation and to thereby design the legislation that most accurately and effectively accomplishes its social and economic purposes. We believe that some measure of integration of the corporate and individual income taxes would alleviate these problem areas. Based on our analysis of the various alternatives available, we urge the adoption of either a dividends-paid deduction for corporations or a "gross-up" method of calculation that wou'd allow a tax credit to shareholders for those taxes paid by the corporation which are attributable to the income distributed as dividends. Properly structured, either alternative would be feasible from an administrative standpoint and would correct many of the shortcomings of the current system of taxing corporate-source income. 1 These items were made a part of the official files of the committee. |