ECONOMIC

aspects of the tax system which impinge on investment and saving. This sectiondiscusses some of these features and suggests some possible changes thatmay be useful to stimulate additional capital formation and promote amore efficient use of available capital resources.INVESTMENT TAX CREDITThe investment tax credit (ITC) was first enacted in 1962 as part of theKennedy Administration's program to stimulate investment by increasingthe profitability of new equipment. Since then, the ITC has been revisedby a series of legislative actions and successively suspended, repealed, andreenacted. The ITC was permanently reinstated at a maximum 7 percentrate (4 percent for utilities) by the Revenue Act of 1971. The Tax ReductionAct of 1975 temporarily increased the maximum rate to 10 percent forall businesses, including utilities, during 1975 and 1976. The Tax ReformAct of 1976 subsequently extended the 10 percent rate through 1980, andthe President has proposed that it be made permanent.At present the law provides for a credit against current tax liabilities ofcorporate and noncorporate businesses, equal to 10 percent of the value ofqualified investments. Qualified investments are generally new depreciableassets used in production, excluding structures, with service lives of 3 years ormore. The credit is applied on a sliding scale in such a way that one-third ofthe full credit is allowed for assets with service lives of 3 or 4 years, twothirdsfor assets with service lives of 5 or 6 years, and the full credit forthose assets with service lives of 7 years or more. The ITC rates thus rangefrom 3/3 to 10 percent, depending on the life of the asset. The creditclaimed in any year cannot exceed a company's total tax liability for theyear, and the maximum credit that generally may be taken is $25,000, plus50 percent of the tax liability in excess of $25,000. Credits not usable in thecurrent year because of this limitation may be deducted against tax liabilities3 years back and 7 years forward on a first-in, first-out basis, that is,the oldest credits are used first. Under current law, the basis for calculatingdepreciation allowances on new equipment is not reduced by the amount ofthe credit. A provision requiring a basis adjustment was contained in theoriginal 1962 legislation, but it was subsequently repealed by the RevenueAct of 1964.The credit was restricted to equipment purchases because of the favorabletax treatment already accorded to structures under the rulesfor accelerated depreciation and for expensing of interest and taxes incurredduring the construction period. It was also felt that the most rapid gains inproductivity could be achieved by encouraging investment in new equipment.In addition, there was a fear that a credit on structures might becomea tax loophole for real estate speculation and the purchase of privateresidences.There is no general consensus about the precise impact of the ITC oninvestment spending. Nevertheless it does appear that past increases in163