Clinton likely to use tax credits to spur investment

WASHINGTON — WASHINGTON -- President-elect Bill Clinton is expected t use three letters -- ITC -- to persuade Maryland executive Loren Jensen and thousands of businessmen like him to put their money where it matters most to the economy, in job-creating investments in plants and equipment.

ITC stands for investment tax credits. They are central to the Clinton blueprint for invigorating the economy by promoting new, or accelerating existing, corporate spending.


Exactly how the next administration's ITCs might be shaped is still under discussion by the Clinton transition team, but their inclusion in his promised 100-day economic action program is almost certain. They are strongly favored by Lawrence Summers, chief economist with the World Bank and an influential economic adviser to Mr. Clinton.

Mr. Jensen is chairman and chief executive of EA Engineering, Science and Technology Inc., of Hunt Valley, an environmental engineering, monitoring and cleanup company with 700 employees nationwide.


An ITC would enable him, he said, to increase his spending on equipment next year after a "conservative" investment program of about $1 million this year, which was restrained in part by difficulty in obtaining bank loans because of the credit crunch.

"We would probably translate a tax credit directly into additional equipment purchases for sure," he said, adding: "We don't discard equipment. We add new pieces, and you have to add to the payroll to operate them." Mr. Jensen would like to see a tax credit for research and development as well as investment, saying: "If we could get restoration of R&D; credits . . . we would begin to stimulate more R&D; in our own laboratories."

Mr. Jensen said his company had used an earlier R&D; credit "very aggressively," and its abolition in the 1986 tax reform had "a very direct effect" on his ability to conduct in-house research.

"That's where the cutting edge, competitively speaking, is: to come up with a new type of mouse trap," he said.

So high are the hopes of business executives for new tax breaks that there is widespread suspicion that many investments are now being delayed in anticipation of the introduction of ITCs next year. A plunge of 24.9 percent from September to October in machine tool orders was partly attributed to this wait-and-see attitude in the nation's boardrooms.

"Just the mention of investment tax credits is doing more harm than good to the economy right now because businesses are holding off [buying equipment] in the hopes of getting that credit," said Paul Merski, of the independent Tax Foundation.

Mr. Clinton's advisers have to decide whether the credits should temporary or permanent, universal or targeted, on all investment or a limited percentage.

ITCs were first introduced by President John F. Kennedy in 1962 to stimulate the economy. They applied to all equipment but not to other assets, such as buildings and inventories. They were suspended in 1966 to slow down the economy but were quickly reintroduced in 1967.


The credits were permanently repealed in 1969 as contributing to inflation, and reintroduced as a stimulant in 1971. All this time, the tax credit was 7 percent. In 1975, it was raised to 10 percent and stayed there until the ITCs were abandoned as distorting investment and supply in 1986. Their removal also served Congress' attempt to bring corporate and individual tax rates more into line with each other.

If Mr. Clinton followed a traditional pattern of introducing a permanent ITC, this would promote the long-term buildup of the nation's capital base, a key element in the next administration's desire to revitalize and modernize the U.S. economy. But it could be expensive.

Temporary credits have the attraction of putting pressure on businesses to take advantage of them while they last. This is regarded as an effective way to accelerate investment plans that are already on the books as well as to spur new spending. A company planning to invest $5 million in new equipment in 1995 is likely to advance that spending if it is offered a tax credit that expires at the end of 1994.

Targeting the credits on certain types of equipment or industries would reduce the cost of the tax break and give a boost to selected parts of the economy. The downside is that targeting could distort investment patterns. Giving a break to all investments would be hugely expensive, adding to the deficit.

In his book, "Putting People First," Mr. Clinton advocates "a targeted investment tax credit to encourage investment in the new plants and productive equipment here at home that we need to compete in the global economy."

Sung Won Sohn, chief economist with Norwest Corp., agreed: "I feel this is really the most effective means of stimulating the economy right now. Our conclusion is that investment tax credits are probably 10 times as powerful as cuts in capital gains [tax] when it comes to stimulating actual investment."


An ITC on all investment outlays would be a windfall for business that the nation can hardly afford. Limiting the credits to a percentage of investments would encourage new investment, rather than reward existing plans. The idea would be to set a level of investment beyond which the credit would apply. The trick is to set a figure low enough for most companies to benefit but high enough to prevent a boondoggle. A frequently used vTC base figure is 80 percent of the previous year's investment outlays.

Example: A company that invested $1 million in 1992 would be eligible for a tax credit on any investments over $800,000 made in 1993. If it invested $1.5 million in 1993, $700,000 would qualify for the credit. If the credit was 10 percent, this would allow the company to deduct $70,000 from its tax liability. More important, an ITC of this sort is estimated to reduce the cost of capital by 11 percent, the real incentive to investment.

"It's a very, very generous tax break if you get a 10 percent credit," said Jane Gravelle, senior economist with the Congressional Research Service at the Library of Congress.

Lawrence Meyer, professor of economics at Washington University in St. Louis and a private economic consultant, has worked out that a likely Clinton permanent and incremental ITC would cost $4.5 billion, add 300,000 jobs in 1993 and increase economic growth by 0.5 percent.

"We are in a deficit-constrained world," he said. "We don't give money away any more. We have to structure incentives so we get the greatest bang for the buck, and that's what this game is all about."

Incremental credits, however, would be difficult to implement. They could invite sharp bookkeeping practices to make as many investments as possible appear to exceed the 80 percent base level. Commented a congressional staff economist: "Tax lawyers and accountants are probably smarter than anyone at Treasury or the IRS in making all kinds of investments look as though they come in over the base."


There is also the question of whether the economy, which appears to be strengthening on its own, will need the stimulus of an ITC next year.

"I think it's the wrong thing to do, for two reasons," said William A. Niskanen Jr., who was an economic adviser to President Ronald Reagan and is current chairman of the free-market CATO Institute. He expects to see an ITC in the Clinton economic program next month.

"One, it is not a desirable part of a long-run tax code; two, the

timing is wrong for a stimulus package."

But Mr. Clinton argues that an investment tax credit would be one of the speediest stimulative mechanisms available to activate the moribund job market and would increase the woefully low U.S. rate of investment.

"I think you can make the case for a temporary investment tax credit," said Jeff Faux, director of the labor-backed Economic Policy Institute. "I think it makes some sense, but I would not spend the Treasury's money on it from now until doomsday."


The link between industrial investment and economic growth has been traced as far back as the period of mechanization that produced the historic European boom in the 1760s. More recently, the business-funded American Council for Capital Formation (ACCF) has noted that introduction of previous investment tax credits in 1962, 1967, 1971 and an increase in the credit rate from 7 percent to 10 percent in 1975, all coincided with, and possibly helped produce, stronger economic growth. The last investment tax credit was abandoned in the 1986 tax reform.

According to the council, investment in producers' durable equipment grew at an annual 10.3 percent rate from 1982 to 1985, but slowed after the passage of the 1986 tax reform, bringing the 1986-1990 average down to 2.7 percent. The 1991-92 investment growth rate was 7.5 percent.

"You can't prove it, but a lot of [analytical] work shows investment would have been greater had we not removed the ITC and faster depreciation. You can make a pretty good case it has had that impact," said Margo Thorning, chief economist with the ACCF.

The council, which is lobbying the Clinton team and Congress for the ITC's reintroduction, said in a study paper: "Every time it has been turned on, good things have happened in the economy; when it has been turned off, bad things have happened."

David Wyss, economist at DRI/McGraw Hill, the Boston economic consulting and forecasting group, found that the sort of ITC Mr. Clinton is expected to introduce would produce $4 in new investment for every $1 of lost tax revenue. This would add $16 billion a year to the $380 billion annually invested in production equipment, an increase of just over 4 percent.

"It actually pays for itself," said Mr. Wyss. "The extra gross domestic product you get is enough to offset the tax loss. It's one of the very few tax breaks you can make pay for itself."