TABLE 5.-U.S. exports of capital equipment, 1962-65 and January-June 1965 and 1966

NOTE. Shifts in commodity classification in 1964 and 1965 disrupted comparability of data for some items.

Source: Department of Commerce.

TABLE 6.-U.S. imports of capital equipment, 1962-65 and January-June 1965

Action to restrain demand for machinery and equipment thus will have a favorable impact on the balance of payments by reducing the demand for imports and by helping to forestall the loss of export sales that will occur if the prices of capital goods continue to rise. In the short run, the favorable impact of this development will more than outweigh any adverse impact on the balance of payments attributable to a reduction in the rate of modernization of some sectors of U.S. industry.

The impact of this bill

This bill as a part of an overall program, including the reduction of at least $3 billion in Government expenditures, will help restrain inflationary pressures by suspending for 15 months the investment credit for machinery and equipment and accelerated depreciation on buildings. Suspension of accelerated depreciation on buildings whose construction is begun during the suspension period complements the suspension of the investment credit. Without overlapping, the two measures combine to apply fiscal restraint over a broad sector of the market for investment goods.

By increasing the cost of items ordered, acquired, or constructed during the suspension period, the bill will reduce the potential returns from prospective investments and will discourage marginal investments. This effect will be intensified by the fact that the investment credit will be available for machinery and equipment, ordered and acquired, or constructed after the suspension period. This effect is also intensified by the fact that accelerated depreciation will be available with respect to buildings whose construction is begun after December 31, 1967.

It is the impact on the rate of return on prospective investments rather than the revenue gain to the Government which is the most important feature of this bill from the standpoint of anti-inflationary fiscal policy. Orders for new machinery or equipment will be, and in some cases have already been, reduced relative to the large volume evident in recent months. The prompt reduction in orders will result in a decline in the size of producers' order backlogs. This will encourage producers to return to normal production schedules by reducing overtime; they will also reduce their orders for supplies and materials. These developments will lessen the pressures which have tended to produce inflationary price and wage increases in the machinery and equipment industry, commercial and industrial construction industry, and related industries.

Suspension of the investment credit increases the cost to business. firms of all goods which now qualify for the credit. This increase in cost ranges from 2.4 percent in the case of machinery and equipment with an expected useful life of 4 to 6 years to 7.5 percent in the case of machinery and equipment with an expected useful life of 8 years or more. With respect to buildings, the use of accelerated depreciation methods currently provides the owners of new buildings with a benefit equivalent to at least 4 percent of the cost of the building. It is particularly worth noting that these increases in cost are temporary and can be avoided by postponing orders until after the termination of the suspension period. The bill therefore offers businessmen a strong inducement to defer investment projects until after the suspension period is terminated.

S. Rept. 1724, 89-2- -3

The immediate effects on economic activity which stem from a reduction in orders of capital goods are of prime importance from the point of view of restraining inflationary developments. In appraising the bill, attention should therefore be focused primarily on these effects and not on the manner in which corporate tax liabilities will be affected by the suspension. The investment credit and accelerated depreciation deductions affect tax liabilities, as a rule, only after the economic activity resulting from the production of a machine or building has been completed.

The reduction in new orders for machinery, equipment, and buildings which will result from this bill will tend to moderate the expansion in plant and equipment expenditures, and by preventing excesses. will tend to forstall an economic downturn in the near future. Moreover, the bill is likely to have a sigificant impact in reducing the demand for credit by business, with the result that pressures on interest rates will be eased and more funds will become available to finance home mortgages. To the extent that the bill suceeds in preventing further increases in interest rates or in promoting a reduction in interest rates, business borrowers themselves will benefit. The reduction in interest costs to such borrowers will partially offset the effect of suspending the investment credit and accelerated depreciation with respect to buildings. By moderating the domestic demand for machinery and equipment, the bill will strengthen the balance of payments in the short run. In view of the relatively brief suspension period, over the long run the competitive position of U.S. exports will continue to benefit from the availability of the investment credit.

While the bill is expected to have a significant anti-inflationary effect, it will not be of such a magnitude as to incur the risk of promoting a recession. The bill will have a marginal effect on the economy but an effect which should direct it toward the path of full employment economic growth without price inflation.

If military requirements in southeast Asia should decrease before January 1, 1968, or if for some other reason it should become apparent that suspension of the investment credit and suspension of the use of the accelerated depreciation methods with respect to buildings are no longer necessary to restrain inflation, the Congress can promptly terminate the suspensions. The administration has also indicated that it would recommend terminating the suspension period before January 1, 1968, under such conditions.

Revenue effect

It is not clear how the suspensions of the investment credit and accelerated depreciation will change budget receipts. There would appear to be an increase in revenue, at a given level of investment. However, the suspension can be expected to reduce investment expenditures which will reduce incomes of some sellers of investment goods and thereby reduce revenues.

There is value in describing the hypothetical revenue effect of the bill, however, given the current level of investment expenditures. This, therefore, is only a description of the magnitude of the tax changes effected by this bill. The actual revenue effect will depend upon how business firms modify their investment plans in response to these suspensions.

It is estimated that suspension of the investment credit as provided in H.R. 17607 as amended by your committee will increase receipts. in the fiscal years 1967 through 1970 by $1,650 million (as contrasted to $1,950 million under the House bill). Of this total, about $300 million is expected to be received in the fiscal year 1967 and $700 million in the fiscal year 1968. The relaxation of the existing limits provided by this bill on the amount of investment credit which may be claimed in any one taxable year will partially offset the effect of suspending the credit as far as the fiscal years 1968 through 1970 are concerned. This provision will reduce tax receipts in those 3 fiscal years by $850 million. In the fiscal year 1968, the relaxation in the limitation will reduce receipts by $125 million, reducing the net effect of the investment credit provisions to an increase in receipts in that year of $575 million. Suspension of accelerated depreciation with respect to buildings costing $100,000 or more constructed during the suspension period will increase receipts during the fiscal years 1968 through 1970 by an estimated $95 million. The effect in the fiscal year 1968 of this latter provision will be an increase of $10 million.

III. GENERAL EXPLANATION

A. Suspension of the investment credit (sec. 1 of the bill and sec. 48 of the code)

1. Present law

Existing law provides a credit (code sec. 38) against tax liabilities with respect to "qualified investment." The credit, generally equal to 7 percent of qualified investment, may be taken with respect to investment in most types of tangible personal property and in certain limited types of real property where the property is used directly in manufacturing, production, transportation, etc. Qualified investment is investment in either new or, to a limited extent ($50,000), used property of the type referred to above with a useful life of 4 years or more. In the case of such property with an expected useful life of 4 to 6 years, qualified investment is limited to one-third of the investment in the property and in the case of such property with an expected useful life of 6 to 8 years, qualified investment is limited to two-thirds of the investment in the property. Qualified investment includes the entire investment in this property only if it has an expected useful life of 8 years or more. In the case of most public utility property the investment credit is limited, in effect, to 3 percent of qualified investment.

The amount of the 7 percent investment credit (or, where applicable, the 3 percent credit) which may be claimed in any one taxable year is limited to the tax liability of that year if the liability prior to the application of the credit does not exceed $25,000. If the tax liability, prior to the application of the credit, exceeds $25,000, the credit which may be claimed is limited to $25,000 plus an amount equal to 25 percent of the tax liability in excess of $25,000. Credits which are unused as a result of this limitation may be carried back to the 3 prior taxable years and, if not used up in this manner, carried forward to the succeeding 5 taxable years. In computing the applicable amount of a carryback or carryforward, the investment credit

remains subject to the limitation outlined above and any investment credit earned during the taxable year must be used before any applicable carryback or carryforward.

2. Explanatioin of provision in general

The bill temporarily suspends the investment credit. The suspension applies to otherwise qualified investment in—

(i) Property acquired during the suspension period;

(ii) Property ordered during the suspension period; and (iii) Property whose construction, reconstruction, or erection begins during the suspension period.

An exception (explained in part C below), is made with respect to property acquired or constructed pursuant to a contract binding on the taxpayer at the time the suspension became effective. An exception is also made for up to $25,000 of property ($15,000 under the House bill) ordered, acquired or constructed during the suspension period which would otherwise be classified as ineligible for the credit as the result of the suspension provided in this bill. The property covered by these exceptions will continue to be eligible for the investment credit.

The suspension period begins on October 10, 1966 (September 9 in the House bill), and ends on December 31, 1967.

The suspension is applied both on the basis of orders for property made during the suspension period, and also on the basis of the construction of property during the suspension period, to insure that the measure will achieve the objective of restraining inflation. If the suspension applied with respect to installations made during the suspension period it would have little or no impact on orders placed during the suspension period in cases in which delivery and installation would not take place until, or could be deferred to, 1968 or later years. In view of the current length of order backlogs in segments of the equipment industry and of the length of time required for the construction of large items of capital equipment, a suspension based on installations would, therefore, have relatively little effect on the volume of orders placed during the suspension period. Production is largely keyed to orders, not deliveries, so that a suspension based on installations would have relatively little impact on the current demand for resources.

The fact that the suspension of the credit applies to orders and commitments as well as construction does not, of course, imply any change in the basic operation of the investment credit. Taxpayers will continue to claim any amount of credit due them only after delivery or installation of the property.

As previously indicated, an exception to the general rule outlined above is available in the case of property acquired during the suspension period under the terms of a binding contract entered into by the taxpayer prior to the beginning of the suspension period. The investment credit will continue to apply to such property. An excep tion also applies to property constructed, reconstructed, or erected by the taxpayer if such construction, etc., was begun before the beginning of the suspension period. This exception to the general rule is required in fairness to taxpayers who were unaware of the forthcoming suspension of the credit at the time they entered into agreements