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Business Taxes, Capital Costs, and Competitiveness

A monograph published July 1990 by the ACCF Center for Policy Research.

Preface

Concern about the effect of U.S. tax and environmental policies on U.S. capital costs and American industry's competitiveness at home and abroad led the American Council for Capital Formation Center for Policy Research to sponsor a special project in 1990 on "Tax and Environmental Policies & U.S. Capital Costs." This monograph reports on the proceedings of the first of the three special project symposiums, "Business Taxes, Capital Costs, and Competitiveness," held in Washington, D.C. on May 1, 1990.

To address the subject of "Business Taxes, Capital Costs, and Competitiveness," a distinguished panel of four tax-policy experts was assembled. New research by Stanford University professor and ACCF Center for Policy Research director John Shoven, commissioned specially for the symposium, served as the focal point for the discussion. Commenting on Dr. Shoven's study were the Honorable Sidney L. Jones, assistant secretary of the Treasury for economic policy; Dr. Alan Auerbach, professor of economics, University of Pennsylvania; and Dr. Kenneth McLennan, president, Manufacturers' Alliance for Productivity and Innovation.

The ACCF Center for Policy Research extends its thanks to these experts for their contribution to this successful event. Sincere gratitude is also expressed to those groups that are so generously supporting the 1990 special project on "Tax and Environmental Policies & U.S. Capital Costs": American Business Conference; American Petroleum Institute; BankAmerica Foundation; Chemical Manufacturers Association; Clean Air Working Group; Exxon Company, USA; General Electric Company; The Henley League, Ltd.; Manufacturers Alliance for Productivity and Innovation; National Venture Capital Association; Shell Oil Company; Thermo Electron Corporation; and Weyerhaeuser Company.

A second symposium, entitled "Environmental Policy and the Cost of Capital," was held on June 11. A third symposium in the special project series, "Trends in U.S. Investment: Impact on Productivity, Competitiveness, and Growth," will be held in November. The American Council for Capital Formation Center for Policy Research will publish a monograph in conjunction with each of these events.

Introduction

From the standpoint of capital formation, U.S. tax policy in the 1980s gets mixed reviews. Early in the decade, the 1981 Economic Recovery Tax Act provided the United States with one of the world's most competitive capital cost recovery systems, along with other incentives for saving and investment including a significant capital gains differential for individuals and corporations. This system was all but destroyed, however, by the tax bills of 1982 and 1984 and, especially, by the Tax Reform Act of 1986. The Congressional Research Service has estimated that together these measures raised the capital cost of investing in productive equipment by 90 percent, when measured in terms of the pretax rate of return that investors require to commit their funds.

Many experts believe that we should examine the impact of tax policy on U.S. capital costs because U.S. investment spending is among the lowest of the major industrial countries and, since the passage of the 1986 tax act, has not been as buoyant as in the early part of the expansion that began in late 1982. Productive investment in the United States is already lagging relative to our competitors. Investment per worker in Japan, for example, is twice as high as in the United States, and Japan now invests more in dollar terms in plant and equipment than we do-even though its gross national product is only a little more than one-half of ours.

The capital cost of investment in productive equipment is especially important to competitiveness. The United States is a high-wage economy that can compete successfully in international markets only if it sustains a high rate of productivity growth, or output per unit of input. To this end, heavy investment in modern, state-of-the-art machinery and equipment is essential.

Changes in tax policy are needed to reduce the high cost of capital for U.S. business and thereby foster productive investment to help ensure strong and sustained economic growth. It is our hope that this monograph will provide important guidance as policy analysts focus on this critical issue.

Charls E. Walker, Chairman

Mark Bloomfield, President

Margo Thorning, Director of Research