Missing the point - business tax reduction

National Review, Feb 20, 1995 by Ed Rubenstein

Tax cuts for business investment and capital gains? "The real problem," argues the New York Times, "is that these two ideas would harm the economy by steering some individuals toward worthless investments." Their inclusion in the GOP's Contract "fuels suspicion that its real motives lie elsewhere - perhaps lining the pockets of favored benefactors."

In the zero-sum world of Times editorials, more for the capitalist invariably means less for the worker. Fortunately, the real world isn't like that. Living standards of American workers rise or fall with the amount of capital their employers are able to invest in them. Tax the boss, and you tax the worker also.

In 1990 the average American manufacturing worker was supported by $98,598 worth of machinery, structures, and other capital, according to the Department of Commerce. In the oil and gas industry, capital investment was an astronomical $1,027,273 per worker. Service industries invested just $21,495 per worker.

Recent research by New York University professor Edward N. Wolff traces the stagnation in real wages to slower growth in capital investment per worker. From a peak of 2.0 per cent per year in the 1950s the growth rate of capital per worker slipped to 1.2 per cent per year in the period 1977-1992. We still have the largest base of capital invested per worker - and the average U.S. worker produces more, on average, than his foreign counterparts, according to Wolff. But our lead is shrinking.

Over the long haul, worker productivity - GDP per worker - is vital because it determines growth in wages and living standards. From 1950 to the early 1970s average annual productivity growth of 2.3 per cent per year helped put two cars in every suburban garage and instill confidence that the economic future would be still better. Since 1975 we've slowed to a crawl - 0.8 per cent per annum - while worker productivity in Europe and Japan has expanded at more than twice ours. The U.S. ranks dead last among industrial nations in the fraction of GDP devoted to investment. More ominously, since 1986 our investment rate has fallen.

U.S. tax policy explains much of this, and so the trend is unlikely to reverse itself without a policy change. Savings incentives were weakened when, as part of the 1986 Tax Act, IRAs were no longer deductible and capital-gains tax rates were raised. Since 1990, and particularly since 1993, marginal tax rates have been increased by more than 50 per cent at the top.

Although the 1986 act reduced corporate tax rates, it also lengthened the time over which capital expenses must be depreciated and terminated the investment tax credit. According to Arthur Andersen & Co., companies subject to the corporate Alternative Minimum Tax are currently allowed to deduct only 58 per cent of their investment expenses (on a present-value basis), as compared to 98 per cent under the pro-investment tax regime in effect from 1981 to 1985.

The Contract would resurrect many of the savings incentives lost since 1986. Wealthy families generate a disproportionate share of national savings, so the tax benefits are necessarily skewed: 30 per cent of the benefits would go to the 2 per cent of families earning more than $200,000 per year.

But as America ages, ordinary workers will be called upon to support a growing army of retirees. More capital will be the key to their economic survival.

       Still First, but for How Long?