from Social Policy, September/October 1973, pp. 44-45. ROBERT EISNER Men and Machines and Taxes POLICY PROPOSALS Four billion dollars a year! That is what the U.S. Treasury can expect to lose in presumably needed tax revenues as a result of the investment tax credit. This provision, designed ostensibly to encourage capital expenditures, reduces business taxes by up to 7 percent of the amount of purchases of new machinery or equipment. By contrast business taxes are generally increased by 5.85 percent of all wages, the employer contribution of the payroll tax. Why should business get a special tax break when it buys new machinery and equipment? Some say that such purchases contribute to economic growth. But if they do, that is, if a $100 machine will, with proper discounting for the future, produce more than $100 in extra output or cost savings, any profit-seeking firm should be expected to install the new ROBERT EISNER is Professor of Economics at Northwestern University. 44 equipment without special government encouragement. And if the $100 piece of machinery will only return $95, it does not contribute to economic growth to have the U.S. Treasury pay out an extra $7 to make the investment profitable. While in a free enterprise system businesses should be expected to acquire on their own an optimal amount of plant and equipment, economic growth might well be stimulated by government encouragement of other forms of investment that businesses cannot handle on their own. These include, in particular, Investment In human capital, training, know-how, and basic job skills, many of which can come only from experience. There are currently some million and a half persons from sixteen to twenty-one years of age listed as unemployed, over 12 percent of the 12 million persons in the civilian labor force. There are another 10 million not in the labor force, many of them because they have given up looking for jobs, which seem to be unavailable. And there are another half million youths listed as working part-time who are lookIng for full-time employment. Making Jobs available for young people is one of the greatest Investments we can make, for the investment is not only in them but In the economy and the nation. Despite repeated insistence by President Nixon and his administration that there will be no increase in taxes, Herbert Stein, Chairman of the President's Council of Economic Advisers, now suggests that higher taxes might prove desirable to combat inflation. He adds that one particularly appropriate Increase might be a suspension of the investment tax credit. By suspending the credit, we might encourage businesses to postpone expenditures for new equipment, thus reducing the boom In business investment which has contributed substantially to the high demand we associate with Inflation. Yet to the extent that this suspension were successful, it would keep output of business equipment below what it would otherwise be and thus reduce employment in the capital goods industries—this with 5 SOCIAL POLICY percent of the total labor force and 12 percent of youths still unemployed. Ironically, when the investment tax credit was reincarnated in 1971, it was dubbed in best Madison Avenue fashion, ■ "job development credit." Many of us were skeptical then, but it is true that tax Increases, or other tight fiscal and monetary measures aimed at reducing inflation, run the serious risk of raising unemployment. Yet there is a change we can effect in the tax structure or tax mix that would reduce the rates of inflation and unemployment and contribute to economic growth. I propose a tax package that would include suspension of the investment tax credit along with suspension (if not permanent repeal) of part of the payroll or employment tax on all workers up to the age of twenty-one. This will reduce Infla drawal of the Investment tax credit by cutting corporate after-tax earnings would reduce the boon of lightly taxed capital gains enjoyed most by the rich. Suspension of the investment tax credit could be expected to cause some cooling of the economy by reducing demand for capital equipment. But the effects would be slow, and since much equipment is produced in oligopolistic industries where prices are notoriously rigid in a downward direction, we might well fear more unemployment than reduction in prices. This could be counterbalanced by elimination of the employer portion of the payroll tax for employees up to twentyone years of age. As far as that applies to the 6 million currently working full-time, It would mean a reduction of over 5 percent in labor costs. That in turn should reduce prices. But what is more, em that 6 million full-time and 4 million parttime employees sixteen to twenty-one years of age are earning $50 billion per year in covered employment, the employer portion of the payroll tax amounts to $3 billion. It may be objected that a special incentive to hire youths will result in less employment for adults. This is hardly likely. While there might be some "substitution effect" in the economists' jargon, the expansion effect of added employment should considerably outweigh It. A more serious objection might be that the 5.85 percent reduction in labor costs (more precisely, 5.85 divided by 105.85, or 5.53 percent) would not be enough either to Induce significant additional hiring of young workers or to have much effect on prices. The answer to this might be to offer employers still further incentives to "While in a free enterprise system businesses should be expected to acquire on their own an optimal amount of plant and equipment, economic growth might well be stimulated by government encouragement of other forms of investment that businesses cannot handle on their own." tion while keeping to the targets of full employment and economic growth. The proposal has much to commend it in terms of equity. The total payroll tax now amounts to 11.7 percent of employee incomes up to $10,800. According to President Nixon's budget, it will account for 29 cents of every dollar of federal tax revenues, second only to the personal income tax in the aggregate and far in excess of the 14 percent of tax revenues now accounted for by corporations. Yet it is a highly regressive tax with no deductions or exemptions and with smaller proportions of income taken the more income exceeds the $10,800 limit. Thus for an individual with an income of $100,000 the maximum payroll tax of $1,263.60 is only 1.25 percent rather than the 11.7 percent for those with incomes up to $10,800. To redress the balance, with SEPTEMBER/OCTOBER 1973 ployers would have an incentive to hire additional teen-agers and those twenty and twenty-one years of age and to give full-time jobs to many now working only part-time. The gains from such increased employment of youth are likely to be lasting. Employers are frequently understandably reluctant to hire young people without experience and training. Risks are considerable and if new employees work out there is no guarantee that they will remain long with the employers who invest in their first job. Yet that first job, before the frustration of idleness has wreaked its toll, may be critical to estab-. lishment of lifelong skills and the work ethic. In terms of magnitudes, this switch in taxes is entirely feasible. We may estimate the investment tax credit as approaching $4 billion in 1973. If we assume hire youths, such as crediting them with the 5.85 percent that they contribute for employees. In the interest of increasing employment generally and lowering prices, one might extend the reduction or elimination of taxes beyond those under twenty-two years of age, for example, by applying to the payroll tax the $750 personal exemption in the individual income tax. But whatever the limitations of my proposal, eliminating the employer payroll tax for youths as we suspend the Investment tax credit would clearly be a step in the right direction. It would help to reduce unemployment and the rate of Inflation. And it would halt unjustified government intervention to encourage investment in machines while reducing government discouragement of investment in man. 45 54-397 O-75-4 Mr. EISNER. I would like to indicate certain basic principles that I think should guide us in terms of government policy, tax policy toward small business and indeed, toward the economy in general. I start from the premise that, unless there are reasons to indicate otherwise, there should essentially be a policy of nonintervention. This hardly means that the government will have nothing to do with what goes on. Indeed, as I proceed, I will indicate principles which will call for significant intervention, but intervention that does not interfere with the optimal allocation of resources and efficient operation of enterprises. The basic principles which would call for intervention in aid of small business or in aid of anybody else, or restricting anybody fall, I would think, into three categories. First we have the matter of imperfections in markets. Where there are imperfections in markets such that competition is not operating adequately, or there is inadequate access to capital funds, we may want to correct those imperfections or compensate for them. A second phenomenon calling for intervention involves what in economists' jargon is called externalities, that is, in the area even of perfect competition there may be things that an individual firm will do which involve costs or benefits to others than those who are involved in the transactions. The obvious case in point we are all familiar with now involves pollution. A firm producing competitively may find it best to burn a kind of coal or engage in a process which is cheaper for it, cheaper for the customer, but imposes costs elsewhere. However, there are also positive externalities; that is, a firm may, for example, by hiring youth, by training people, convey benefits to society for years and years to come by talking youngsters off the street, by building in them a kind of human capital that will enable them to be productive members of society for the rest of their lives. Now, a final basis for intervention might be, very frankly, that we want to redistribute, we want to take from some and give to others. I think if we keep these categories in mind, we will find on the one hand that many of the proposals, however well intentioned, that have been advanced in behalf of small business or anybody else, really fall to the ground with proper analysis, but other proposals come to the fore. Underlying this there has to be recognition of the simple truth, the aphorism that there is no free lunch-someone has to pay for it. That has to be immediately qualified by the recognition that when there is massive unemployment, as there is now, and there is a huge amount of capacity unused, there may be lunches waiting to be eaten. They are already there. There is no cost to eating them. Now, I can begin rather negatively by suggesting that a lot of the proposals in the way of encouragements to business capital expenditures in my opinion are very much misguided. They are misguided for large business, and misguided even more for small business. These are the whole variety of proposals, including a lot of policies we already have, and extensions of them for equipment tax credits, in which businesses are told if you spend money to buy eligible equipment, you get a tax break. Similarly, there are proposals for increasing depreciation allowances beyond true economic depreciation-again, there are tax advantages, giveaways, loopholes, tax expenditure-however you want to call it. There are other proposals in the way of changing capital gains taxation, already very liberal, already a very large loophole, in the direction of somehow giving favor to small businesses and to their owners. All of these proposals I consider incorrect-incorrect in terms of violating the basic principles I have enunciated, encouraging businesses to spend on things they would not otherwise spend, indeed distorting the economy. If we think about it quickly, take the equipment tax credit, misnamed the investment tax credit, that does not cover all investments, not even all business investments, more arrogantly and I think mischievously misnamed at times, the job development creditthere are far better ways of developing jobs. If anything, an equipment tax credit would, as compared to other stimulatory devices, tend to encourage expenditures on equipment as opposed to expenditures on people. Another objection to the equipment tax credit and the whole collection, really, of devices to encourage business spending on investment, is that it tends to be procyclical, rather than countercyclical. The higher the business investment, the higher equipment spending is, the more the tax break. The higher equipment spending is, the more we are in a boom. That is exactly when we do not want to give more in the way of tax breaks. On the other hand, in a recession where equipment spending is down, then the benefits would be less, and then, indeed, the stimulatory effects are likely to be less. I might add that my own research suggests that the benefits from these things usually are far less than the costs. We may find ourselves. giving away $5 billion in tax advantages to get $1 or $2 billion in increased investment spending. There is, however, a final note in regard to this that I might stress, of particular relevance in the case of small business. Subsidies for business investment tend to help those businesses that are most capital intensive. It is reasonably well known that this is not likely to be small business. The very nature of capital intensity, as such, is to require large businesses, large investment. It means then that the investment credits that we have or those proposed, the increases in them, would much more favor large business than small business. Figurately speaking, small business will be picking up the crumbs from the table. I hope then that I have made clear that this is an unfortunate intervention in the system, one which again is understandable, but one on which I think the Congress in an enlightned fashion should be vigilant. Everybody wants something for himself. Everybody can figure out a reason why a tax advantage to him will somehow help the country, help the economy, help economic growth, and these items actually become very attractive for any individual. Of course, it seems to make sense for the individual. But the classic argument for the equipment tax credit or investment credit is that it favors economic growth. There is first an issue to be raised as to whether Congress has any business biasing the economy in the direction of more or less economic growth. For a prosperous country, the free market decisions of how much we want to save or invest for growth might well be respected. Second, the notion that more machinery or more business investment stimulates growth is, after all, a notion which comes from a competitive economy, from the idea that business firms normally left to themselves will acquire equipment, will invest when it adds to their own profits, to productive capacity. That is well true when the Government does not intervene: but if the Government is giving, let us say, a 10-percent tax credit, what it means is that businesses that might contemplate a $100 million investment which would net them perhaps $95 million in increased productivity in the future, would now undertake that loss investment; such investment means $100 million will get you not more but less, $95 million, which they undertake because when they enter into their own calculus they recognize that the Government handout of another $10 million from a 10-percent credit will put them ahead. Now, as opposed to investment credits, there are ways to stimulate the economy to help small business and to be consistent with the principles that I have suggested. I think a major one here would be subsidizing investment in human capital. It is notorious in our system, since we are not a slave economy, that businesses really have no incentive other than good will to invest adequately in the human capital, in the training of people, the hiring of young, inexperienced workers, because they cannot own them. If you take a young kid of 17 or 18, a dropout from high school, or a recent graduate whose future is uncertain, and you hire him, in the first place it may be a bust and you have lost, and in the second place it may be a success and there is no way you can keep him or her from going elsewhere. Not that, of course, is a problem of all business. But I submit it is a problem of particular import for small business. With a large concern there may be much more in the way of longevity. People think of lifelong pensions and careers. Small businesses will tend to have a greater turnover. There is therefore more reason than ever to help small business in the hiring of people and the keeping of people. I would suggest that there may be some tendency for small businesses for a variety of reasons to pay low wages. There will therefore be arguments that the way to help small business would be to remove. the minimum wage law requirements. This is a path that I would not follow. However, let me come to a proposal that I would follow, that I think would help small business and would help the economy, and would involve investment in human capital-that is to have a true job development credit-not the misnamed one for equipment, but one which would subsidize businesses in the hiring of labor. That would be a very simple device. We, by this time, have an 11.7 percent tax on the hiring of labor-not a subsidy, not a credit, but a tax. Everytime an employer hires a worker, he has to in effect pay to Uncle Sam 5.85 percent which is pulled out of the employee's salary, and another 5.85 percent on top of that. An appropriate thing to do might be and you can work out the bookkeeping, the accounting, the legal niceties as you wish to have business excused or credited for some or all of these payments. The Government then would, perhaps out of general Treasury revenues or however it would do it, take over some portion of this 11.7 percent. Indeed, what I would suggest is that they pay all of it for those under 21. By doing that you would have a major subsidy, perhaps not adequate, but a significant step in that direction to businesses to hire the young, to give them |
