The Democrats Drag An Old Nostrum Out Of The Attic

It's tanned. It's rested. It's ready. The investment tax credit, the Democrats' favorite business incentive, may be due for a comeback.

First enacted in 1962 as a way to prime the economic pump, the ITC has slipped in and out of the tax code seven times in the past 30 years (chart). It was most recently repealed in the 1986 Tax Reform Act, after critics charged that much of the $30 billion-a-year revenue loss went to subsidize investments that would have been made anyway. But business lobbyists, mindful of the credit's history, predicted it would return with the next recession.

They may have been just a few months off. Democratic Presidential hopefuls, including Arkansas Governor Bill Clinton, and congressional Democrats such as House Ways & Means Committee members Sander M. Levin of Michigan and Frank J. Guarini of New Jersey are backing a slimmed-down ITC. At the same time, Republicans such as Senate Finance Committee member William V. Roth Jr. of Delaware and some Bush Administration aides are exploring ways to resurrect the credit.

IFFY BILL. That's not to say that the unrestricted 10% ITC is coming back. That would now cost as much as $40 billion a year -- money that a deficit-strapped Congress is not about to lavish on business. Instead, lawmakers are considering two approaches. One would allow the credit only for investment above a company's historical levels. Another would limit it to the purchase of manufacturing equipment. The Levin-Guarini bill, for instance, would provide a 7.5% credit only for new investment in "property integral to the manufacture of tangible property." That would save the Treasury money by ruling out such things as cash registers but would also cost it some business support.

The measure is politically iffy because it pits the service companies against manufacturers. Just consider how it would treat computers and software: A manufacturer could take a write-off for buying workstations and a computer-aided design program, but an airline couldn't get a break for upgrading its reservations system. Service-related businesses and their suppliers are not likely to embrace a costly incentive that does them no good -- especially if the price is a rate hike or similar across-the-board levy to recapture lost revenues. But broadening the credit would be hugely expensive and invite abuses.

Backers of the credit are optimistic that it can be packaged with other incentives, should Congress and President Bush go for a big tax bill next year. One hope: a shotgun wedding of the investment credit and a capital-gains tax cut. Says Mark Bloomfield, president of the American Council for Capital Formation (ACCF), a probusiness lobby: "Perhaps capital gains will be the Republican growth initiative and ITC the Democratic." Such a package might be politically appealing. But will it work?

Economists, not surprisingly, are divided. Tax reformers argue that restoring the credit is another step toward undoing the 1986 act, which cut tax rates while reducing subsidies. If Congress wants to stimulate business, they say, the better approach is to cut corporate tax rates further. Let's say Congress wanted to give business a $10 billion tax break. It could either provide a limited credit or cut the corporate tax rate by three percentage points, to 31%. The reformers also argue that business investment in equipment actually increased after the credit was repealed in 1986, suggesting that optimism, not taxes, spurs new investment.

CENTRAL PLANNING? The reformers are also troubled by the idea of government getting back in the business of picking winners and losers. Says Charles McClure, a Hoover Institute economist who drafted the Reagan Administration's initial tax-reform plan: "It seems ironic that just as we are seeing the disastrous effects of politicians and bureaucrats engaging in central planning in Eastern Europe, people in Washington are trying to import the idea to the U.S."

Among those economists who believe there is a use for tax incentives, the ITC is preferred to other write-offs, including a capital-gains cut. Stanford University economist John B. Shoven, in a study done for the ACCF, reported that a 7.5% credit would reduce the cost of capital by 20% to 30%, while trimming the effective capital-gains tax rate to 20% from 28% would cut business' cost of capital by only 4.5%. "If one wants to lower the cost of capital for equipment investors," argues Shoven, "it would be hard to find a more effective option."

The idea of restoring the ITC is widely popular right now. Once the tax debate begins in earnest next year, however, the credit will have to compete with other subsidy schemes. Whether Congress will want to target such a costly incentive to the shrinking manufacturing segment of the U. S. economy remains to be seen. But given the credit's political resilience, it's tough to bet against it.

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