To Promote Growth

December 26, 1960

Last week I discussed here the need of tax reform to encourage increased corporate investment in the most modern plant and equipment in order to promote more rapid economic growth and to enable American industry to meet increasingly serious European competition. The most important tax reform in this connection would be to permit more rapid write-offs for depreciation of old equipment.

Suppose you are in the laundry business, and have invested $5,000 in machinery which has worn out or become obsolete in five years. If you have been allowed to deduct $1,000 a year for depreciation, and at the end of five years the new machines available to replace the old cost you no more, then you can have both the funds and the incentive to replace your old machinery with new. But suppose the government refuses to allow you to write off your old machines over five years, and says you can only do so over ten, fifteen, or even twenty years? Then you may not have the funds to reinvest at the end of five years, and you will certainly have less incentive to do so.

REPLACEMENT COSTS

Even if you are allowed to depreciate your old equipment over five years, or some similar short time, it is improbable, in a period of inflation, that you will be able to replace your worn-out or obsolete equipment at the same dollar cost. It will probably cost you more. That is why, in France today, the government not only allows rapid depreciation deductions against original cost, but revaluations of property to take into account higher costs of replacement as a result of inflation. A like reform here would certainly be desirable, but accelerated depreciation allowances would at least make it less urgent. In a “creeping” inflation, prices of equipment rise less over a short period than over a long one.

If accelerated depreciation has such obvious advantages, if it encourages greater production, lower costs, faster economic growth, why did our government adopt it only for defense industries in wartime? Why does it refuse to permit all industry to make regular use of it?

The stock argument against this has always been that the government would lose revenue. The objection is shortsighted. Perhaps there would be some loss of revenue in the first year or two, but it is difficult to see how there would be any over the long run. A corporation is allowed to deduct, in any case, no more than 100 percent of the amount it has invested in plant or equipment. If it has invested $1,000 in a given machine, and the government does not change the corporate income tax rate over the years, what difference does it make to its revenues whether the corporation deducts $50 a year depreciation over twenty years, or $200 a year over five years, or $500 the first year and diminishing amounts in succeeding years? Whatever the government loses in tax revenues in the early years it makes up in later years.

INVESTMENT STIMULATED

Of course if the corporation tax rate is lowered in later years, the corporations “gain” and the government “loses” by accelerated depreciation. But if (as has, alas, been more usual) the tax rate is raised rather than lowered in later years, the corporations lose and the government gains by accelerated depreciation.

The foregoing calculations ignore, however, an even more important factor. Accelerated depreciation stimulates investment in modernization and new plants. This modernization increases production, payrolls, and corporate earnings, and so increases tax revenues over the long run.

This has been dramatically shown in Canada, which has far more liberal depreciation allowances than we have. A study by Maurice E. Peloubet, a prominent accountant, has shown that whereas depreciation allowances taken by Canadian corporations in 1959 were more than five times what they were in 1946, corporate profits before deducting either depreciation or taxes had increased three times in the same period. As a result corporate income tax revenues increased nearly two and a half times.

A recent poll by the American Economic Foundation shows that seven out of every ten business and labor economists favor liberalized depreciation. The reform is long overdue.