Time for an Investment Tax Credit?

Greg Mankiw has 9 reasons on why an investment tax credit (ITC) is a good idea. The one that I think will resonate most with people is number 7,

7. So much for theory, but would it work? The cash-for-clunkers program is thought by many to have promoted, or at least accelerated, car purchases. An ITC would be similar, but it would apply to business investment rather than personal cars. Instead of targeting a very narrow, politically favored industry, it encourages investment broadly. It should have positive effects on aggregate demand in the short run and positive effects on aggregate supply in the medium and longer run.

My big complaint about cash-for-clunkers was that it mere shifted forward car purchases. It was not likely to stimulate new car purchases for people who already had a car they were happy with. At best it moved forward sales that were going to happen in the coming months.

We’d see the same thing with investment goods, but unlike cars investment is something that is productive.

Another aspect of the problem with investment that I think is not getting much attention is covered by this part,

Part of the reason is that the policy environment seems adverse to business. I am referring here to a group of policies that include higher minimum wages, the seeming retreat from free trade, proposed mandates to provide employees health insurance, higher prospective energy costs from climate change regulation, and the likelihood of higher future tax rates resulting from the huge fiscal imbalance we are now experiencing. All of these factors have worked in concert to depress business investment.

Most of these are seen as major policy goals by the Obama Administration. When the economy was strong these goals were not unreasonable. At least they are consistent with goals of past Democratic party candidates and presidents. However, the economy is not strong. Fostering an environment for robust economic growth should have been President Obama’s primary concern. Granted, failure to implement campaign promises would leave him vulnerable to attack by Republicans, but the rejoinder to such attacks is obvious: The economy was in the midst of a very bad recession, yes I put a hold on my stated policy goals as the facts on the ground changed. How do you argue with that? Its simple, straight forward, and sensible.

Mankiw also links to the WSJ article by Hal Varian. The opening lines are very good, IMO.

These days it seems like it is our patriotic duty to consume more. And if we don’t choose to spend more money ourselves, the government will do it for us.

But wait a minute. Isn’t it excessive spending that got us into this mess in the first place? Spending more now seems like drinking Scotch to cure a hangover.

This is a point that my co-blogger Dave Schuler has brought up a few times. GDP is comprised, roughly, of 70%+ consumer spending. And that part of our problem was that such a level of consumer spending was because of the run up in housing prices and easy credit. Now we have neither so how can we maintain such consumption expenditures let alone increase them?

So we need to see the recovery start somewhere else. We can’t expect it in personal consumption expenditures such as retail sales. Real estate and construction are pretty much out for who knows how long. Why not investment spending?

In the modern economy, there are four sources of demand (consumption, investment, government and exports) and two sources of supply (domestic production and imports). When a component of demand declines, supply will ultimately have to decline as well.

In the case of the U.S. economy now, the double-whammy of wealth shocks from the real-estate bubble and the stock-market crash has made consumers understandably cautious. Quite sensibly they want to consume less and save more.

In an ideal world, an increase in savings would automatically lead to an increase in investment. When consumers put more of their money in their savings accounts, the funds would be lent out to finance the production of factories, machines, computers and other forms of physical capital. These capital investments make more consumption possible in the future which is, after all, why people choose to save.

It is not just investment in physical capital that matters. Savings can also be recycled as student loans, which allow for the accumulation of human capital by increasing the supply of doctors, engineers and skilled workers of all kinds.

Unfortunately, savings are currently not getting translated into investment for three reasons. First, one of the largest categories of physical capital is real estate, and we have already overinvested in that area. Second, businesses are reluctant to invest in new plant and equipment due to the weakening economy. Third, the sorry condition of bank balance sheets has made them reluctant to lend. The net result is that money is piling up in ultrasafe assets like Treasury bills, without being invested in ways that would build a more productive economy.

[…]

That brings us to government expenditure, which is getting most of the press. The danger with this form of stimulus is twofold: First, it takes too long for the government spending to kick in, and second, spending may easily focus on pork-barrel projects that have little inherent value.

If we are going to have another round of stimulus I think it could be done much worse than implementing an investment tax credit. Yes its tossing a bone to corporate America (big and small), but here’s a hint for all of you who don’t like this: corporate America is who employs most of the people in the U.S.

FILED UNDER: Barack Obama, Economics and Business, Government, Politicians, US Politics, , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Ugh says:

    Yes, let’s go back to the b.s. leasing tax shelters of the 1970s, hooray!

  2. Steve Plunk says:

    I’m having a NSS moment here. I’m sure Steve V. feels the same.

    I would argue business went into safe mode when it appeared Obama would win the election. I mean really, the guy brags about destroying an entire industry (coal) so how do we think he feels about business in general and do we think his policies would be rational? The guy is a menace to business large and small. With control of Congress in the hands of Pelosi and Reid the writing was on the wall.

    So a more than a year on we see exactly what we expected. An investment tax credit might help but the wolves are still waiting to prey upon us. Higher taxes, health care mandates, more regulation, a crappy energy policy, the list goes on. If Republicans retake the House we might see business invest more immediately after breathing a great sigh of relief.

    Throw in a payroll tax holiday that would immediately help along with that tax credit and then get out of the way. Jobs would come back rather quickly.

  3. sam says:

    I would argue business went into safe mode when it appeared Obama would win the election.

    Oh, would that be on the occasion of the first Palin interview? Snark aside (well, not really), are you asking us to believe that “business” up until “it appeared that Obama would win the election” thought things were just peachy? Seriously? That’s just dumb.

    As for the ITC , that’s not a bad idea (if properly fashioned to avoid the stuff Ugh mentioned). But, this:

    [Government] spending may easily focus on pork-barrel projects that have little inherent value

    is really question-begging, right? At least Keynesians would say so.

    But the political problem I see with the ITC, because this is true: “it’s tossing a bone to corporate America (big and small)”, is that the ITC is open to the “same old tax cuts for the rich bullshit” charge…and whether you like it or not, that criticism has some traction, especially after the bailouts, etc. The ITC sounds like a good idea, but it’ll take some persuasion to get it across to a skeptical public.

  4. Steve Plunk says:

    Sam, Things were not peachy but having a business hater move into the oval office makes them less peachy. That’s not dumb by any measure.

    Many have pointed out the government spending has turned into little more than payoffs for support and I would agree with that. Tax cuts and credits offer little opportunity for graft so the government class doesn’t like them.

    After the failure of the stimulus I expect the public to support both investment tax credits and a payroll tax holiday.

  5. sam says:

    Ah, Christ, Steve P, stop consulting your glands when you formulate an answer — “Business-hater”. Do you have any, any evidence at all the he “hates business”? About as much as someone would have for the proposition that you hate poor people because of your policy preferences.

    After the failure of the stimulus I expect the public to support both investment tax credits and a payroll tax holiday.

    Why don’t you check back in with us after your tour of the outer planets?

  6. Duracomm says:

    Sam,

    Obama may not hate business but his proposals and the economic uncertainty they create makes it harder for businesses to justify making investments to expand.

    Decisions like the one below are being made across all business sectors. The cumulative negative impact on the economy is considerable.

    Why My Business Has Ceased Investing

    The business I own has been growing at about 10% a year for the last five years. In each of the last 3 years, we have invested an average of a half million dollars in new facilities. In the past five years I have added over a hundred new positions in the company.

    This year we will add ZERO.

    But I just cannot put up any more capital in this environment. If I make an investment, how much will the government let me keep?

    How much are taxes going up (because they certainly are going up)? Inflation simply must be around the corner given the monetary policy this country is pursuing — so will my business be able to raise prices fast enough to keep up with inflation in my inputs?

    The legislative risks we face are tremendous. My two highest costs are labor (50% of revenues) and fuel and electricity (about 10% of revenues). Thus, nearly 2/3 of my costs are going to be increased by the current health care bill and cap-and-trade bill. The only question is how much.

  7. sam says:

    On the other hand:

    During the first half of this year, the investment component of GDP declined at a stunning 38% annual rate. Since the investment share of GDP was then about 14%, this implosion accounted for minus 5.4 percentage points of GDP growth. But since overall GDP declined “only” 3.6% in those two quarters, the rest of GDP (the 86%) actually rose. It was a small but real reason for optimism in a stormy sea.

    Then came the third quarter. Like a woozy prizefighter lifting himself off the canvas, the battered investment component of GDP managed to rise (at an 11% annual rate), which added 1.3 points to GDP growth rather than subtracting 5.4 points.

    The Case for Optimism on the Economy, Robert S. Blinder, writing on the WSJ site.

    So I guess not everyone is saying, “Woe is me.”

  8. anjin-san says:

    Do you have any, any evidence at all the he “hates business”?

    Well, Glenn Beck says so, and that is pretty much a holy writ to “conservatives”.

  9. Brett says:

    One question about business spending – would it ultimately have to have greater consumer spending to be viable in the long-term? I mean, simply pouring more capital into companies doesn’t change the fact that these companies generally need more customers.

  10. Steve Verdon says:

    Sam,

    I don’t know where Blinder is getting his data, but according to the BEA non-residential investment has declined every quarter since Qtr 2 2008. And total private investment in the 3rd quarter of 2009 went up by only 8.4% with most of that due to residential investment–the home buying tax credit? My numbers are from the BEA.

    Granted PCE went up too, but that is likely due to cash for clunkers a one time effect. In other words, much of the recent increases have been due to policy gimmicks. Will it be enough to keep the ball rolling? I’m skeptical.

    Brett,

    Yes. If we hold all other variables constant, then increased capital investment (plant and equipment) will result in increased output. That would also translate into lower real prices. To the extent that labor and capital are compliments it could also increase employment.

  11. Bill H says:

    I have a business where shipments have declined 43% in the past three years and no forecast that I can come up with sees any significant improvement for at least three more years. I have two plants sitting idle and one operating at 60% capacity. The government is adding to my employment costs by forcing me to provide health insurance for my employees; something I dropped last year because I could no longer afford it. Please tell me why I am going to invest in anything. Please tell me why investment is even on my list of things to think about. Please tell me haw saddling myself with a long term debt for new equipment in return for a one-time credit on taxes that I’m not paying right now because my income is negative makes any sense to me.

    An investment tax credit helps business that are presently growing and presently profitable and paying taxes. It is as useful as a screen door in a submarine to businnesses that need help; that are below capacity and are not making money.

    So by all means, lets do the typical government thing of “helping” those who don’t need help and ignoring those who do.

  12. anjin-san says:

    The government is adding to my employment costs by forcing me to provide health insurance for my employees

    How exactly is the government forcing you to do this and how large is the HR hit you have taken?

  13. Duracomm says:

    anjin-san said,

    How exactly is the government forcing you to do this and how large is the HR hit you have taken?

    Businesses have to forecast what the future economic environment is going to be. The more uncertain or negative the future economic environment looks the less likely business is to hire or expand.

    The democrats are diligently working on getting health care reform passed.

    The uncertainty over what is going to be passed is the first huge disincentive to hiring and expanding.

    The costs the proposed bills impose on business (especially small business) is the second big disincentive to hiring or expanding.

    A Total Crock

    I am only now getting through the 1500 pages of this bill (putting me ahead of Ms. Pelosi in reading it, I am sure),

    but the last House bill would have been a disaster for my company, increasing taxes on wages by up to 8% and imposing a record-keeping burden that was just horrific.

  14. Steve Plunk says:

    Sam, Your personal insults expose your lack of logical argument.

    Anjin-san, Falsely associating me with Beck is another weak excuse for debate.

    Liberals need to accept the fact this President and most Democrats see business as a necessary evil. They want to tax business as much as possible without killing the golden goose.

  15. Drew says:

    “are you asking us to believe that “business” up until “it appeared that Obama would win the election” thought things were just peachy? Seriously? That’s just dumb.”

    The only thing dumb is your predicate. You said “peachy.” Not anyone else.

    You can stay in denial, but as a general proposition business owners have gone into their turtle shells due to their views on the current President and Congress.

  16. anjin-san says:

    The government is adding to my employment costs by forcing me to provide health insurance for my employees

    Bill is clearly speaking in the present tense about something that MIGHT happen. Certainly business owners need to try and read the tea leaves to create strategy, but that is not what he is saying here. It sounds kind of like he is, you know, lying.

    So put up or shut up Bill, how is government forcing you, today, to provide health insurance?

    as a general proposition business owners have gone into their turtle shells due to their views on the current President and Congress.

    At best, a raging generalization. At worst, nonsense. Businesses turned of the spending tap before Obama won the election. There is a lot of fear out there, and a great deal of it came from watching the air go out of some major players because they were uncapitalized and could no longer get credit. Businesses that have cash are sitting on it.

    This trend started under Bush. Stop blaming the damage control team because the ship took a bunch of torpedo hits while your captain had his thumb up his ass…