Economic Report of the President

correct some of the distortions in investment that accompany inflation.Under proposals for accelerated depreciation, the allowable depreciationon capital assets would be increased. This would permitfirms to write off their capital purchases faster. The changes wouldaffect two determinants of business investment. First, they would increasethe after-tax yield of capital investment, and thus its attractiveness.Second, they would increase business cash flow and therebysupply a portion of the funds needed to finance additional investment.Increases in the investment tax credit would have a similar impacton investment incentives. The investment tax credit reduces the purchaseprice of eligible equipment. It thus provides a direct incentiveby raising net return and by increasing after-tax cash flow.A reduction in corporate income tax rates, on the other hand, influencesinvestment by increasing after-tax profits. This tends to be aless effective stimulus to investment than either accelerated depreciationor increases in the investment tax credit because it has a smallerimpact on the net return from new purchases of capital assets. Inaddition, depreciation liberalization or an increased investment taxcredit are only available to a firm to the extent it invests, but a corporatetax reduction would be available whether investment is undertakenor not.The President's Economic Revitalization Program contains severalelements that would significantly improve the outlook for businessinvestment by offering direct incentives to invest in new plant andequipment as well as support for business cash flow. The two majorinvestment incentives in the program are expansion in the coverageof the investment tax credit and a simplified and liberalized form ofdepreciation allowances.The proposed changes in the investment tax credit would allowfirms to claim full credit for all equipment purchases, even shortlivedassets that currently are allowed only a portion of the tax credit.In addition, the investment tax credit would be made partiallyrefundable. Under the current law, the credit can be used to offsetthe first $25,000 of tax liabilities plus up to 70 percent (rising to 90percent by 1982) of liabilities in excess of $25,000. But the proposedchange would allow firms to claim 30 percent of the value of thecredit even if they had no tax liabilities for the year. In this way,firms with substantial investment needs but with little or no currentearnings would be supported in their efforts to rejuvenate andexpand their capital assets. Among these are both younger and smallerfirms that are just beginning to grow and larger industries undergoingtransition, such as autos and steel.75