Any question about the size of the tax cut business will be getting in this year's tax bill has vanished.
The House Ways and Means Committee last week approved a Democratic alternative every bit as generous toward business as that proposed by President Reagan. Both plans would cut business taxes by about $40 billion in 1985, with the business share of all federal taxes, including Social Security, falling from about 11 percent this year to 7 percent.
The committee action represented a remarkable political turnabout for the Democrats, who traditionally have been reluctant to reduce business taxes by large amounts. Only Rep. Charles B. Rangel (D-N.Y.) commented on the shift in the tax burden from business to individuals -- and he voted for it, too.
Now the argument turns not on how much it cut but rather which approach -- the administration's huge increase in depreciation allowances or the Democrats' combination of corporate income tax rate cuts and immediate write-offs of investments in equipment -- will do more to spur capital spending and improve economic growth.
The administration rejected the Democratic plan out of hand, with Treasury Secretary Donald T. Regan calling it "a last-minute, scattershot scheme which falls short of addressing the economic needs of the country." President Reagan's version, he maintained, tied tax relief to "job-creating investments that help modernize American industry."
Regan's view, which found echoes among Republicans on Ways and Means, was disputed by a number of economists concerned that the tax cuts should provide incentives generally for more investment and not favor one type of investment over another. The administration's proposal, they say, plays favorites.
The theoretical ideal for a tax system, in the eyes of an economist, is one that is neutral. In such a system, the collection of the tax does not distort private choice made in the marketplace. That way, the tax system allows resources -- capital, labor and land -- to be used in the most efficient way possible, the way dictated by market forces rather than taxes.
Of course, the ideal does not exist and rarely is even approached. Members of Congress seldom are satisfied with general measures to enhance economic activity.Instead, they prefer highly targeted measures.
Thus, last week in ranking Ways and Means Republican, Rep. Barber Conable of New York, complained that cutting corporate income tax rates would mean higher after-tax profits and increased pressure for higher dividend payouts. If companies succumbed to that pressure, they would have less money to reinvest. The administration bill, on the other hand, would increase depreciation allowances, which are a cost, and therefore reduce reported profits. But at the same time, the companies would still have the cash from those allowances for reinvestment, Conable argued.
Conable's analysis, however, suggests that investment decisions are made without regard to the level of after-tax income that an investment will produce over the course of its useful life. It also ignores the possibility that an increase in dividends itself might lead to higher stock prices, new stock issues and, ultimately, more funds being made available for investment.
The important point to most economists is reducing the total tax burden on capital, whether that burden falls at the corporate or the stockholder level or on the owners of capital loaned to corporations to finance investment.
Assistant Treasury Secretary John Chapaton had a different reason to reject the Democratic alternative, which ultimately would allow businesses to "expense," or write off investments in equipment in a single year rather than depreciate them over several years. Because it would be phased in, Chapaton said, that in the early years the "present value" of the depreciation allowances under the administration's 10-5-3 bill would be greater for companies making investments in equipment than the partial expensing allowed during the phase-in of the Democrats' plan.
By present value, Chapaton meant the value in the year an asset is purchased, not only of that year's depreciation allowance, but of the entire stream of allowances for future years, with the future allowances discounted because they will not be received until later. Under expensing, by definition, there are no such allowances for future years.
However, since assets purchased in the next two or three years still would be producing income after the corporate cuts become effective, those rate cuts, too, would affect present value calculations. The staff of the Joint Committee on Taxation is working this weekend to sort out these issues.
Beyond the phase-in period, though, Chapaton and just about everyone else agree expensing would be a far simpler approach than any type of depreciation. It also would be considerably closer to the ideal of neutrality than would be 10-5-3.
Under the administration's approach, all equipment -- except some long-lived public utility equipment, which also is treated differently in the Democratic plan -- would be written off in five years. This represents a much greater increase in depreciation allowances for assets that last longer in use than for those with short lives. In some instances even, this is a longer, not a shorter period than now is permitted.
But the point is that some industries would do better than others because of the nature of their assets. And, above all, capital intensive industries would benefit more than other industries.
Economist Dale Jorgenson presented a plea last week on behalf of more than 100 well-known economists that a more nearly neutral plan be adopted. The group endorsed a scheme worked, out by Jorgenson and a colleague, which was similar to but less generous than the Democrats' full first-year expensing plan.
The economists' believe that the greatest benefits will flow from a given level of investment only if market forces dictate to which industries new resources will flow.
Ironically, the Democrats tacked a provision on to their bill that, as one Republican noted, violated neutralty in extreme fashion. Not content to cut taxes in the future, they also proposed retroactively to cut taxes for companies in six "distressed" industries -- airlines, automobile manufacturing, mining, paper, railroads and steel -- by allowing them to receive $3.3 billion worth of unused investment tax credits from prior years.