THE HOUSE Democrats' alternative tax bill is clearly superior to the Reagan plan in, at least, its treatment of depreciation. Congress' choice in the weeks ahead is going to affect profoundly the way the American economy works. In a letter today, Rep. Cecil Heftel, a member of the Ways and Means Committee, sets out the reasoning behind the Democrats' formula.
The tax laws allow a business to deduct from its tasable income the depreciation of its equipment as the equipment wears out. But businesses complain bitterly that, because of high inflation, they are actually recovering much less than the original value of the money they invest. In a rough and very approximate attempt to compensate for inflation, the Reagan administration wants to push all types of equipment into three simple categories with arbitrarily shortened lives of 10, five and three years. That's the 10-5-3 plan, and it has serious flaws.
It will undercompensate business for inflation if the inflation rate rises, and it will overcompensate if the rate falls very far. This plan would have sharply different effects on different industries, and distort competition among them. In combination with the investment tax credit, for certain short-lived assets, it would give business back more than it invested -- that part was apparently not intentional -- and create yet another subsidy.
The Democratic alternative, in contrast, simply lets a business treat investment as an ordinary expense and deduct the full cost of new equipment immediately. Because investment in any year would be deducted from the same year's income, expensing is neutral in regard to inflation and in regard to different kinds of assets.
Both the Reagan plan and the Democrats' alternative would result in extremely large losses of revenue over the coming years. Either would represent a further severe erosion of the corporation tax, accelerating a process that has been going on for some three decades. The scale and speed of this erosion is now a closed question, since there the administration and the House Democrats agree. The only questions still open are the ways and means of going about it, and to the benefit of precisely which industries. Several other aspects of the Democrats' bill are pretty dubious. But on the central issue of depreciation, the choice is easy.