From KENNEDY
II. TAX INCENTIVE FOR MODERNIZATION AND EXPANSION
The history of our economy has been one of rising productivity, based on improvement in skills, advances in technology, and a growing supply of more efficient tools and equipment. This rise has been reflected in rising wages and standards of living for our workers, as well as a healthy rate of growth for the economy as a whole. It has also been the foundation of our leadership in world markets, even as we enjoyed the highest wage rates in the world.
Today, as we face serious pressure on our balance of payments position, we must give special attention to the modernization of our plant and equipment. Forced to reconstruct after wartime devastation, our friends abroad now possess a modern industrial system helping to make them formidable competitors in world markets. If our own goods are to compete with foreign goods in price and quality, both at home and abroad, we shall need the most efficient plant and equipment.
At the same time, to meet the needs of a growing population and labor force, and [p.292] to achieve a rising per capita income and employment level, we need a high and rising level of both private and public capital formation. In my preceding messages, I have proposed programs to meet some of our needs for such capital formation in the public area, including investment in intangible capital such as education and research, as well as investment in physical capital such as buildings and highways. I am now proposing additional incentives for the modernization and expansion of private plant and equipment.
Inevitably, capital expansion and modernization-now frequently under the of automation-alter established modes of production. Great benefits result and are distributed widely-but some hardships result as well. This places heavy responsibilities on public policy, not to retard modernization and capital expansion but to promote growth and ameliorate hardships when they do occur-to maintain a high level of demand and employment, so that those who are displaced will be reabsorbed quickly into new positions-and to assist in retraining and finding new jobs for such displaced workers. We are developing, through such measures as the Area Redevelopment Bill and a strengthened Employment Service, as well as assistance to the unemployed, the programs designed to achieve these objectives.
High capital formation can be sustained only by a high and rising level of demand for goods and service. Indeed, the investment incentive itself can contribute materially to achieving the prosperous economy under which this incentive will make its maximum contribution to economic growth. Rather than delaying its adoption until all excess capacity has disappeared and unemployment is low, we should take this step now to strengthen our anti-recession program, stimulate employment and increase our export markets.
Additional expenditures on plant and equipment will immediately create more jobs in the construction, lumber, steel, cement, machinery and other related capital goods industries. The staffing of these new plants-and filling the orders for new export markets-will require additional employees. The additional wages of these workers will help create still more jobs in consumer goods and service industries. The increase in jobs resulting from a full year's operation of such an incentive is estimated at about half a million.
Specifically, therefore, I recommend enactment of an investment tax incentive in the form of a tax credit of:
-15% of all new plant and equipment investment expenditures in excess of current depreciation allowances
-6% of such expenditures below this level but in excess of 50% of depreciation allowances; with
-10% on the first $5,000 of new investment as a minimum credit
This credit would be taken as an offset against the firm's tax liability, up to an overall limitation of 30% in the reduction of that liability in any one year. It would be separate from and in addition to depreciation of the eligible new investment at cost. It would be available to individually owned businesses a an overa1Ê"> well as corporate enterprises, and apply to eligible investment expenditures made after January 1 of this year. To remain a real incentive and make a maximum contribution to those areas of capital expansion and modernization where it is most needed, and to permit efficient administration, eligible investment expenditures would be limited to expenditures on new plant and equipment, on assets located in .the United States, and on assets with a life of [p.293] six years or more. Investments by public utilities other than transportation would be excluded, as would be investment in residential construction including apartments and hotels. Of the eligible firms, it is expected that many small firms would be able to take advantage of the minimum credit of 10% on the first $5000 of new investment which is designed to provide a helpful stimulus to the many small businesses in need of modernization. Other small firms, subject to a 30% tax rate, would strive to be eligible for the full 15% credit-the equivalent for such firms of a deduction from their gross income for tax purposes of 50% of the cost of new investment. Among the remaining firms, it is expected that a majority would be induced to make new investments in modern plant and equipment in excess of their depreciation in order to earn the 15% credit. New and growing firms would be particularly benefited. The 6% credit for those whose new investment expenditures fall between 50% and 100% of their depreciation allowances is designed to afford some substantial incentive to the depressed or hesitant firm which knows it cannot yet achieve the 15% credit. In arriving at this form of tax encouragement to investment, careful consideration was given to other alternatives. If the credit were given across-the-board to all new investment, a much larger revenue loss would result from those expenditures which would have been undertaken anyway or represent no new level of effort. Our objective is to provide the largest possible inducement to new investment which would not otherwise be undertaken. Thus the plan recommended above would involve the same revenue loss-approximately $1.7 billion-as only a 7 percent credit across-the-board to all new investment. The use of current depreciation allowances as the threshold above which the higher rate of credit would apply recommends itself for a number of reasons. Depreciation reflects the average level of investment over the past, but is a less restrictive and more stable test than the use of an average of investment expenditures for a period such as the preceding five years. In addition, the depreciation allowances themselves in effect supply tax-free funds for investment up to this level. We now propose a tax credit-which would help to secure funds needed for the additional investment beyond that level. The proposed credit, in terms of the revenue loss involved, will also be much more effective as an inducement to investment than an outright reduction in the rate of corporation income tax. Its benefits would be distributed more broadly, since the proposed credit will apply to individuals and partnerships as well as corporations. It will also be more effective as a direct incentive to corporate investment, and increase available funds more specifically in those corporations most likely to use them for additional investment. In short, whereas the credit will have the advantage of focusing on the profitability of new investment, much of the revenue loss under a general corporate rate reduction would be diverted into raising the profitability of old investment. It is true that this advantage of focusing entirely on new investment is shared by the alternative strongly urged by some-a tax change permitting more rapid depreciation of new assets (be it accelerated depreciation or an additional depreciation allowance for the first year). But the proposed investment credit would be superior, in my view, for a number of reasons. In the first place, the determination of the length of an asset's life and proper methods of depreciation have a normal and important function in determining [p.294] taxable income, wholly apart from any considerations of incentive; and they should not be altered or manipulated for other purposes that would interfere with this function. It may be that on examination some of the existing depreciation rules will be found to be outmoded and inequitable; but that is a question that should be separated from investment incentives. A review of these rules and methods is underway in the Treasury Department as a part of its overall tax reform study to determine whether changes are appropriate and, if so, what form they should take. Adoption of the proposed incentive credit would in no way foreclose later action on these aspects of depreciation. In the second place, an increase in tax depreciation tends to be recorded in the firm's accounts, thereby raising current costs and acting as a deterrent to price reduction. The proposed investment credit would not share this defect. Finally, it is clear that the tax credit would be more effective in inducing new investment for the same revenue loss. The entire credit would be reflected immediately in the increased funds available for investment without increasing the company's future tax liability. A speed-up in depreciation only postpones the timing of the tax liability on profits from the investment to a later date-an increase in profitability not comparable to that of an outright tax credit. Yet accelerated depreciation is much more costly in immediate revenues. For example, on an average investment, a tax credit of 15% would bring the same return to the firm as an additional first year depreciation of over 50% of the cost of the investment. Yet the immediate revenue loss to the Treasury from such additional depreciation would be twice as much, and would remain considerably higher for many years. The incentive to new investment our economy needs, and which this recommendation would provide at a revenue loss of $ 1.7 billion, could be supplied by an initial write-off only at an immediate cost of $3.4 billion. I believe this investment tax credit will become a useful and continuous part of our tax structure. But it will be a new venture and remain in need of review. Moreover, it may prove desirable for the Congress to modify the credit from time to time, so as to adapt it to the needs of a changing economy. I strongly urge its adoption in this session.
