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.