sisted on methods which would not cos thuge amounts of revenue . At the time(1961 and 1962) the President was op -posed to substantial tax reduction as ameans of stimulating the economy . Theinvestment tax credit was granted i nconjunction- with a series of revenue -raising measures . It sought to encourag eactions which through history have beenassociated with high rates of economi cgrowth . Although direct cause-and-ef-feet may be uncertain, the performanc eof the economy since 1962 has been con-sistent with the hopes a< advocates of th ecredit .

When first enacted in 1962, the invest-ment tax credit required that the basi sof property eligible for the investor. en tcredit be reduced by the amount of th ecredit for the purpose of depreciation .In other words, for an asset costing $10 0and eligible for an investment credit o f$7, the basis had to be reduced from $10 0to $93 . This basis adjustment require-ment was repealed in 19F4, since it wa sfound that the reduction of the basis t owhich depreciation write-offs could beapplied actually reduced the incentiv eeffect of the investment tax credit .

Business leaders in 1961 and 1962

showed little enthusiasm for the invest-ment tax credit . They doubted that i twould be of lasting benefit and woul dhave preferred to get relaxation of Treas -ury restrictions on deduction of depreci-ation . Although businessmen generall yplaced high priority on improving rule sregarding depreciation, the Investmen ttax credt as passed often went markedl yfurther in increasing the rate of retur non ne\v investment than would resul tfrom substantial relation of depreciation

deduction allowances . As pointed out bythe Machinery and Allied Products In-stitute, the 7 percent tax credit is equiv-alent to an initial write-off of deprecia-tion of about 25 percent, higher than i sgenerally possible under even acceler-ated depreciation . 10 For equipment o faverage service-life expectancy, an in -vestment credit of 7 percent improvesthe after-tax equity return by about one -seventh or 15 percent .

.C he investment credit grants an out-

right tax reduction, over and above al ldepreciation allowances, whereas aspeed-up in depreciation allowancespostpones the due date for the investo r'stax liability if earnings are realized. Thetax postponement does raise the rate ofreturn, but the benefit in most cases isappreciably less than undE r the credit .

The investment credit of 7 percent i snot only effective in raising profitability ;it has other advantages as well . As al-ready noted, it is a tax offset, not a de-duction which might be treated as a nexpense in computing income . Thecredit, therefore, will not be treated i nbusiness records as a cost of operation asare increased write-offs under acceler-ated depreciation . Thus, as comparedwith accelerated depreciation an advan-tage claimed for the credit is that i tavoids any upward distortion of the cost son which a firm will base its pricing an dother decisions." This feature of thecredit may be of positive significancewhen one goal of national policy is tokeep the price level from rising (for do-Inestic reasons as well as ability to com-pete internationally) .

Proponents of the investment credi tbelieve that it has less tendency than

10, George Terborgh, New Investment Incentives (Washington, D .C . ; Machinery and Allied Products Institute ,1962) p . 12 .

11 . Accelerated depreciation alters the timing and not the total deducted ; the alleged cost-raising tendency o ftite early years of life of an asset will presumably be olTset by a cost-reducing result later .

17

special depI'eciation pI'ovisions to coIl -fuse the problem of stilnUlating invest -Illent with that of pI'operly (lefinin gtaxable income. In arriving at taxableiIlcome, depI'eciation Constitutes a cost .The amount deducted depends on themethod of depreciation and the depreci-able lives of the assets ; both of these aresubject to differences of opinion . SpecialdepI'eciation provisioIls to encourage in -vestment can interfere with accurat eestimating of cost and earnings. The in-vestment credit does not have to affec tproceduI'es of coIllputing depreciationand taxable incoIlle .

Even though the investment tax credi thad been presented as a permanent fea-ture of the tax stI'ucture, inflationarypressuI'es in 1966 led the Johnson Ad -ministration to propose, and CoI1gI'ess toenact, a suspension of the credit for th eperiod October 1, 1966, to January, 1 ,1968 . The suspension did apparentl ycause a decline of capital outlays, thoug hanalysts are by no means sure whethe rthe amounts were I11iIloI' of somewhatgreateI'; most business iIvestment plan sare not chaIlged on shoI't notice . But thedrop in business investment was largeenough to induce tile Adinfinstration torestore the credit as of March 9, 1967,almost 10 months befoI'e tile suspperiod had been scheduled to end . 12 TheRestoration Act of 1967 increased theamount of tax credit above the $25,000limit from 25 to 50 percent of the eligiblecI'edit for an), giveIl year .

Treasury assuI'ances when askitlg fo rsuspension of the investment tax credi tiN 1966, and the imexpectedly quick re-storation in the spring of 1967, worked t ogenerate more \Widely and firlilly til ebelief that the investment tax credit had

become a permaneIlt featuI'e of our ta xsystem . However, President Nixon ini1pril 1969 asked Congress to repeal i tpermaIlently. This proposal was couple dwith a request that the 10 percent taxsuI'chaI'ge exteIlsion be shorter than ha dbeen indicated earlier and that the rat efoI' a filial six months be 5 percent .

With respect to the investment credit ,the President said ; "This subsidy to busi-ness investIllent Ilo longeI' has pI'iorit yover other pI'essiIlg national needs . . . .While a vigorous pace of capital forma-tion will continue to be needed, nationa lprioI'ities now requre that we give atten-tion to the need for general tax relief, 1 3

The PresideIt also indicated that newproposals would be presented later .

Repeal of the investment tax credit i sestimated to pI'ovide the Federal goverIl -nient with additional revenues — an dbusiness with tax burdens — of $3 billiona year .

Tax Credits Used by States

An examination of state income ta xstructure's reveals that states which lev ythe tax permit a wide vaI'iety of credits ,CeI'tain types of tax credits appear i nseveral states, such as credits given forpersons aged 65 or over, for the blind, o rfor student dependents . Others are notyttite so coninion, such as those allowe dfor supporting a mentally retarded chil dat home, foI' C'011tI'iblltiolls to politica lpaI'ties oI' certified educational institu -tiolls, oI' for income received for servic eill the armed forces of the United States ,Thell, too, one or two income tax credit sare father uncommon, such as the cIedi tOklahoma alloys for the cost of con-structing a radiation fallout shelter or

12 . A further modification alloWCd the eredit to aphlk to property which \kw, ordered during the suxpensiotlperiod but acquired or built on or after May 24, 1967 ,

13, WeAly Compilation of Pre .tidentiul Documents, Vol . 5, No . 17, April Zit, 1969, p . 580 ,

18

that given by Louisiana to taxpayers wh ohave lost one or more limbs. Severa lstates allow some form of tax credit orexemption for the encouragement ofpollution control .

For computing taxable income, mos tstates follow the Federal precedent an dpermit a personal exemption deduction .Several states, however, allow the deduc-tion to take the form of a credit agains ttax in lieu of, or in addition to, the ex-emption deduction from income . Theuse of credits instead of exemptions re -sults from the desire to give a certainamount of tax benefit to those with lowerincomes and no more to persons wit hlarger incomes which are subject t ohigher tax rates . The credit offers a bene-fit which is the same for all taxpayers ,whereas tax relief produced by a deduc-tion from income varies with the mar-ginal tax rate . New York gives a taxcredit of $25 for married couples and $1 0for single taxpayers in addition to per-sonal exemptions . Arkansas, California,

Kentucky, Minnesota, and Wisconsingrant a tax credit to be deducted Chroctl yfrom the state tax liability .

In recent years certain states have al -lowed credits against their income taxe sfor sales and property taxes paid . Indi-ana, for example, allows a credit of $ 8per dependent for sales taxes paid o nfood and prescription drugs . Since thesales tax rate is 2 percent, the credit off -sets full sales tax on $400 of purchases .Colorado and Nebraska have a similarprovision, although the amount of thei rcredit is $7 per person; and the credit i sfor sales taxes paid on food purchasesonly . These credits offset part of th esales tax burden on the poor .

At least four states grant residents ameasure of property tax relief by permit-ting income tax credits for property ta xpaid. These are Michigan, Minnesota ,Maryland, and Wisconsin . In Minnesotaand Wisconsin the credit is granted onl yto those age 65 or over .

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Proposed Tax Credits for Stat eand Local Taxes

One of the most widely discussed ta xcredit proposals of recent years aims t ogive states and localities moI'e revenue ,or to enable them to raise more revenue ,by allowing taxpayers to offset a portio nof their Federal income tax liability bycredits for state and local taxes . Some ofthese tax credit proposals have been ad-vanced in part as a means of dealin gwith a potential Federal budget surplusin a way that will relieve pressures o nstate finances . To date, of course, sub-stantial increases in Federal expendi-tures for both defense and civilian pur-poses have matched rising revenues ; nolarge budget surplus has yet appeared .

Nevertheless, proposals for credits forstate taxes have continued to receiv esupport . l One argument sees them as apossible alternative to some present Fed -eral gI'ant-in-aid programs . Grants-in-aidare generally earmarked for one or an -other function and are spent under Fed-eral direction . The proposed tax credit s— if implemented 1)y actions of states t oraise, their own taxes at Federal ex-pense, i .e., to absorb a credit — \voul dgive fuller discretion to state and loca lauthorities to use the funds as they wish .

The different tax credit proposals cal lfor a credit of part of a taxpayer's local

or state income tax, or perhaps sales tax ,against the Federal tax liability, Basic -ally, tax credits in the proposed for mwould allow the deduction of one ta x( that of the state) from another (that ofthe Fe ,leral government) . State and lo -cal taxing units would then be in a posi -

tion to "pick up" some of the [former]Federal tax by incorporating a similartax in their own systems . Most of theseproposals, however, include restriction sthat would limit the amount of tax off-setting that could take place . Several re-strictive formulas have been described . 2

1. Proportio ial tax credits . The tax-payer would be allowed to credi t(that is deduct) a specified percent -age of his state tax against his Fed-eral tax liability .

3 . Graduated tax credits . These woulddivide state tax liabilities into brack-ets and allow the deduction of differ-ing portions of each ; for example, xpercent of the first $100 of tax, y per -cent of the second $100, and z per -cent of the remaindeI', Regressivecredits (x > y > z) include flat-sumallowances as a special case . Progres-sive credits (x < y C z) are similarin their effects on distribution of bur -den to deductions from income whe nthe tax rate is progressive .

I . To some extent the case for granting a credit against Federal taxes for taxes Ixaid to state-local government sapplits with equal validity to credits against state taxes for taxes paid to local governments . Some observer sin fact advocate the latter type of credit as a means of encouraging initiative and responsibility at the loca llevel, in preference to equivalents in grants-in aid or direct spending by higher levels of government .

2 . George F, Break . 'T'ax Coordination, In U .S . C'om,vrecs . Joint Economic Committee, ti'tbcommittee on i. isca lPolicy, Revenue Sharing and its Alternatives ; What Future for Fiscal Fe(leralisnt? (Washington, D .C . : U .S .Government Printing Office, 1967) p, 1172 ,

oo

3, Unlimited credits subject to a pro -portional ceilhig . The taxpaye rwould be allowed to deduct all of hi sstate tax but only lip to x percent o fhis total Federal tax liability ,

4 . Utilintited credits subject to a gradu-ated cei,li►lg, State income taxeswould be fully credited against theFederal individual income tax up to ,perhaps, 20 percent of the first $200of liability, 10 percent of the next$300, and 1 percent of the remainder .

The an7ount of money that would b emade available to the state under an yof these plans would depend on theterms involved and state respoIlses . Pres -ently, 13 states do not impose personalincome taxes at all . 3 The tax credi tscheme's would be coercive, in that allstates that do not now have the type o ftax allowed as a credit, such as a persona lincome tax, would be virtually com-pelled to introduce it . Otherwise, thei rresidents Nvould pay more Federal ta xthan people in states with the credit .States already having the tax qualifyin gfor credit could use it more intensivelythan at present; they could get more stat erevenue is the Federal burden decline dbecause of the credit ,

The credit could be devised to provid eit strong, and perhaps irresistible, incen-tive to all states not having a persona lincome tax to adopt one . They could do

so up to the amount of any ceiling (an dallowing for differences in detail) with -out adding-any cost at all to their owntaxpayers, or rather little, above theamount previously paid in taxes . ' Suchcredit, then, could bring important finan -cial aid to some state and local govern-ments . Whether other states would bene -fit appreciably by boosting existing taxe sis less clear . Some advocates wish to usethe credit to force all states to adoptpersonal income taxes . Other plan swould allow credit for sales and prop-erty taxes, thus leaving states free t oframe-' their own tax structures ,

Tax Credits as Alternatives toFederal Grants

Tax credits are one of a number ofproposals which have been put forwar deitheI' as supplements to, or substitutesfor, present Federal grant programs, aswell as to aid states in raising more rev-enue themselves, Grants may distribut eas much as $25 billion to state and localgovernments in fiscal 1970 . Alternativeswhich have been under debate woul daccomplish various combinations of ob-jectives . To attempt to compa I'e differentpossible tax credits with such other alter -natives as unconditional grants an dforms of "tax sharing" — i .e., giving thestates a larger stare in present FedeI 'alrevenues from income taxes — Would g obeyond the scope of this report . 5

3. Excluding New Hampshire, Rhode Island, and Tennessee, which tax only dividends and interest, and Ne wJersey, which levies its tax only an New Jersey—New York commuters' earnings, Two states have no incom etax at all, but local incorne taxes arc used extensively (onio and 1 1 cnnsyivam .r) ,

4. The Committee for Economic Development advocates the adoption of a Federal income tax credit in it sReport, A Fiscal Progrom for a Balanced Federalism, a Statement on National Policy (New York : Jun e19(7) .5, see Tax Foundation, Inc ., Creative Federalist' and Priorities in Public Progrants (New York : 1968), andAdvisory Commission or, Intergovernmental Relations, Fiaral Balance ill 0141 .4trrericwtr Fed(INII S) 'V(IM(Washington, D .C . : 1967, Vol, 1, and C . Lowell Harriss, Federal Revenue Sharing : A New Proposal (NewYork : Tax Foundation, inc ., 1969),

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IV.

The Monev Cost of Credits and Other"Tax Expenditures" '

Special tax provisions take malty dif-ferent foI. 111s . Under sollle, eel - twill typesof inconle are excluded froth the ta xbase, c.g., interest on state and loca lgovernment bonds, half of realized long-terIll capital gains, social security bene -fits for the aged, and some employe rpaylllents of fringe benefits, such as hos-pitalization, surgical, and group life in -surance preiniunis . Other tax provisionstake the forni of deductions for certai npersonal outlays - charitable contrlhu-tioIls, medical expeIses, and interes tpaylllents .

Still other special provisions allo\v de-ductions for business expenditures inexcess of actual cost (sonic percentage

depletion and had debt reserves) or per-mit deductions without adding th e\vorth of the hetlefit for \which the cost sare actually occurred, e .g., sonic agri-cultural expenses, research and devel -Oplllent Outlays, and sollle costs ofexploration and discovery of natural re -sources . The costs of these special ta xprovisions are difficult to estimate ; tra-ditionally, they are not entered in th eFederal budget, since they bring iIl Itorevenue and require no disbursemen tby the Treasury. Professor Stanley S .Survey, Nvhen Assistant Secretary of th eTreasury, terined these revenue effect s"tax expenditures ." If these special ta xprovisions could be grouped in eus-tornary budgetary categories -- assis-

I . The discussion in this section deals chiefly with income taxes . To a varying degree this discussion also applie sto estate, gift, payroll, excise, and property taxes .

Table 2"Tax Expenditures" and Regular Spending by Functio n

Fiscal Years 1968-1970(Billions)

Tax expendituresa Regular spendin gFunction 1968

1969 1970 1968

1969 1970

National defense $ 0.5

$ 0.6 $ 0.6 $80 .5

$81 .0 $81 . 5International affairs 0.4

0 .4 0.5 4.6

3 .9 3 . 7Agriculture and agricultural resources 0.9

1 .0 1 .0 5.9

5 .4 5 . 2Natural resources 1 .6

1 .7 1 .7 1 .7

119 11 9Commerce and transportation 7.8

9 .2 9 .7 8.0

8 .1 9 . 0Community development and housing 4 .0

4 .7 5 .2 4.1

2 .3 2 . 8Health and welfare 15.6

18 .0 19 .5 43.5

48.9 55.0Education and manpower 0 .7

0 .8 019 7.0

7 .2 7 . 9Veterans benefits and services 0.6

0 .6 0.7 6 .8

7 .7 7 . 8

a . Loss in Federal tax revenue through special tax provisions . Not Included are the foreign tax credit ,estate tax credit, and the unemployment insurance credit .

Source ; Treasury Department .

Table 3Credits Against Federal Income Taxe s

Income Years 1962-196 6(Millions)

Corporation Individua l

Investment Foreign Investment Foreign Retirement Dividend sYeara tax credite tax credit tax credit tax credit income tax receive d

1962 $ 834 $1,564 $119 $32 $116 $29 11963 1,106 1,915 159 n .a . 136 3181964 1,319 2,270 172 46 12 11965 1,716 &- . .. 16 206 59 110 —1966 2,019 n.a . 234 68 120 —

a. For most corporations the fiscal year corresponds to the calendar year .b. Excluding Investment tax credit claimed by small business .c. Preliminary .Source : Statistics of Income, Treasury Department .

tance to business, natural r( sours( -s, agri-culture, aid to the elderly, medica lassistance, and so on—the amounts coul dbe compared with cash outlays of th emore familiar type .

To show the Federal tax revenue "lost"through different special tax provisions ,the Treasury Department in 1968 pre -pared estimates giving a functiona lbreakdown of the money amounts in-volved (Table 2) .

The estimated total of such "tax ex-penditures" for fiscal year 1970 is in theneighborhood of $40 billion . Critics offigures such as these say that they reflectan underlying philosophy — one not ad-mitted openly—that government in somepervading sense owns, or has first claimto everyone 's income; that what it doesnot take is left as an act of grace .Whether or not this criticism of the "taxexpenditure" approacl) is valid, the de-cision not to take something from peopl eis not quite the same as collecting dollar sand then paying them out .

The recent Treasury study als oemphasized that getting a true andcomplete picture of the Federal govern-ment's impact on the economy is impos -sible as long as "tax expenditures " arenot included in the analysis . The variou sfeatures which lead to these "tax expen-ditures" have effects which include manyalterations of actions . Individuals and')usinesses change their behavior as aresult of the opportunities to reduce tax .But our knowledge of the many result sremains incomplete .

As to the money cost of present taxcredits, Table 3 provides a detailedbt oakdown .

In 1964, the total foreign tax credi tclaimed by corporations and individual stogether amounted to $2,316 million.The investment tax credit, by compari-son, amounted to $1,490 million in 1964 ,but it is estimated to be around $3 bil-lion for fiscal 19 ,. .`J and perhaps nearlyas much as that for foreign income tax .

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V.

Proposals for New Use of Credit sWelfare programs for the needy, med-

ical care for the poor, and education hav etraditionally been considered state andlocal responsibilities though in recen tyears the financing of these functions b yFederal funds has increased. Pressurefor more Federal action has also grown .Some specific proposals would make us eof tax credits .

The population shif t of the last thre edecades has seen the growth in metro-politan regions of areas having little tax -paying ability relative to the expense sof welfare, schools, and other govern -mental programs. The amount neede dto meet the full public service costs hasgenerally outstripped the revenu esources available . Federal grant pro-grams and direct spending have in -creased year after year in the effort t oassist states and localities . However,welfare spending, whether by Federal ,state, or local governments, is said tohave yielded unsatisfactory results ,partly because its attack on the sourceof the problems has been deficient. Wel-fare needs of most metropolitan area shave grown to a ditllension that has ren-dered them a matter of national concern .Faster progress in dealing with hard-core economic distress, it is said, require smore participation by business, and ta xcredits can help .

American business has not, of course,remained insensitive to these problems .A conference sponsored by the Nationa lIndustrial Conference Board in January

1968 provided vauable proof of some im -pressive pilot programs in the field oflow-cost housing, job training for thehard-core unemployed, and business-sponsored aid to basic education .

An outstanding initiative in this fiel dled to the creation of the National Alli-ance of Businessmen (NAB) in 1968 .This organization aims to encourageprivate industry in the 50 largest citie sto place 500,000 disadvantaged peopl ein jobs by June 30, 1971. The Federa lgovernment, through the job Opportu-nities in the Business Sector (JOBS )program, reimburses employers for theadded costs of hiring and training th edisadvantaged. JOBS is currently plac-ing people in private industry for train-ing and employment at the rate of 20,000per month, and reached its interim goa lof 100,000 some months ahead of sched-ule. In 1970, the Federal contributionwill be double that of 1969, with $420million in budget authority to under-write 140,000 training opportunities .Other manpower programs conducte djointly with the private sector are th eindustry incentive portion of the Officefor Economic Opportunity (OEO) "Spe-cial Impact Program " and the LaborDepartment 's on-the-job training pro-grain .

In the field of low-income housing, a1967 pledge by life insurance companiesof $1 billion toward the redevelopmentof urban ghetto areas is an outstanding ,but not a unique, example of an initiativ e

24

by the private sector to help case socia land economic problems . No special taxincentive is connected with this pledge .The life insurance companies made an -other $1 billion available in April 1969for the same purpose .

The concern with social problems wa srevealed in a 1969 article in Fortitne . lInterviews with business leaders showe dthat next to ending the war in Vietna mand the control of inflation, business ex-pects the Nixon administration to chan-nel a far greater share of the nation' sresources into solving the myriad prob-lems of the cities and the poor .

Tax Credits to Achieve NonrevenueOb jecti-ves

The belief that private enterprise —not only government—should be in-volved in solving the nation's economic ,and also the related social problems hasthe support of President Nixon . His ap-proach, as reflected during the cam-paign, would be to offer .tax and creditincentives to corporations and individ-uals for rebuilding city slums, locatingplants in "ghett o " areas, and training th ehard-core unemployed .

Under this approach Federal tax bur -dens would be reduced for those whoqualify for new types of tax credits .Those who make special effort to hel pin solving problems of special impor -tance could thus retain a larger portionof their income after tax . Such reductionof the prospective income tax burdenfollows the logic of the long-standin gAmerican belief that money devoted t oagreed upon social purposes should beuntaxed .

Secretary of the Treasury Kennedy

recently noted the Administration 's in-terest in the use of tax credits to meetsocial problems . He stated, "The Treas-ury is examining closely some of themore promising approaches recom-mended by the President's Task Forceon Taxation. We sliall proceed withthese studies as rapidly as possible ."2

Tax credit proposals range over a widevariety of goals, reaching from specifi csocial or economic problems (e .g., ruraland urban job incentives and slum hous -ing) to programs of general interest suchas pollution control facilities and ex-penses of higher education .

Several tax credit proposals were se-lected for brief discussion and summaryin the appendix of this report . Theyillustrate the aims and particular pro -visions included in specific tax credi tproposals . The bills discussed represen tproposals in specific areas ; but this se-lection gives no indication of the rang eof areas for which tax credits have bee nproposed.

It should be clear that all tax creditsare subject to restrictions and condition sto carry out the specific aims of eachproposal ,

For example, the granting of the in -vestment tax credit is limited to "quali-fied" investments in productive capita lfacilities with a life expectancy of a tleast four years . Excluded from the taxcredit were : property used to furnishlodging (e .g., hotels) ; property used bytax-exempt organizations, and by gov-ernmental units ; livestock ; and propertyused outside the United States. Usedproperty was only partially eligible fo rthe credit . The credit was limited to7 percent of investment expenditure s

L Allen T . Demaree, "What Business Wants from President Nixon," Fortune, Vol . LXXIX, No . 2, Februar y1969, pp . 84-97 .

2 . Treasury Department Release, February 7, 1969 .

25

and could be applied in full only agains ttax liability up to $25,000 . (It coul dZipply against it limited perceiilage—alfirst 25, then 50, percent—of tax liabilityin excess of $25,000.) In no case couldthe credit exceed the total tax burden .Any investment tax credit which canno tbe used in a specific taxable year be -cause of this limitation can he carrie dback for use to each of the three preced -ing taxable years and carried forwardsimilarly to any of the following five tax -Ale years .

The declared aim of the investmen ttax credit was to offer an incentive t obusiness for inN -cstinents in tangibleI)ropert\' tliat \\'ould further expansionand modernization of production facili-

ties . The forementioned regulations andcontrols are designed to aid the achieve -inent of these objectives .

Similar restrictions are part of th ecurrent tax credit proposals presently inCongress . Restrictions and controls gen-erally include guidelines as to the tim eperiod for which such credits are to b egranted, the amount of credit, and thespecific conditions and eligibility re-quirements for the recipient of a credit .Tax credits should thus not be thoughtof as easy and generous give-away pro -grams of Federal funds. On the con-trary, tax credit legislation is generall yaccompanied by stringent regulation sthat aim at the achievement of theagreed upon objectives .

J„

vieMerits and Demerits of Tax Credit s

Tax credits can be used to offer incen -tives to the private sector of the econom yto help in achieving our national goals .Past experiences, however limited, ten dto justify support for serious considera-tion of tax credit legislation in the con -text of current economic and socialproblems.

An evaluation of the merits and de -merits of tax credit legislation poses aparticularly difficult problem . Some ofthe earlier tax credits have either lostmuch of their importance or have beenrevoked altogether, and only a limitednumber of tax credits are still in effecttoday .

Arguments in Support of Tax Credits

The value and effectiveness of taxcredit legislation cannot be estimated fo rtax credits in general . What is meaning-ful is an evaluation of specific tax creditlegislation in the context of the need sand requirements when such legislatio nis enacted . The main criteria for evalua-tion should be the effectiveness of suc hlegislation and the flexibility with whic hit responds to changing needs and pri-orities. While testing the effect of suchtax incentives is particularly difficult ,tax credit legislation has been slow t orespond to newly arising priorities . Thisdiscussion suggests that tax credits ca neffectively be used for non-revenuegoals, dependent on stringent control sthat nevertheless permit adaptability t ochanging needs . The presence of regu-

lations that combine such safeguardswith flexibility seems to justify a positiveview on the potentials of tax credit leg-islation .

Advocates of tax credits believe thatgreater use of tax incentives offers ameans of promoting the national inter -est. They will often point to WesternEuropean countries which reportedlyused tax incentives successfully to stimu -late economic recovery and growth afte rWorld War II .

Proponents also argue that in th epresence of persistent urban and ruralpoverty, approaches to solutions whichuse tax inducements warrant more atten-tion. Tax credits are an alternative toother measures, including d irect govern-ment outlays. Credits encourage the pri-vate sector to become involved in differ -ent programs, e .g., to give job trainingand employment to the undereducated,especially to those who make up muchof the hard-core unemployment in areasthat lack an adequate economic struc-ture . These are also areas with high wel-fare needs . A more active involvement ofbusiness would, hopefully, bring moreuse of dynamic approaches, and moreimagination and initiative, in dealin gwith problems of poverty that to dat ehave not been solved by our highly pros -perous economy or by the various at -tempts made through government .

One argument favoring tax credits isthat they interfere less with busines s

27

decisions than do direct outlay program sof loans by government . 1'XI)C II(litUITS ,obwiouslw, are subject to annual budg-etary SC'I•lltill\' and to uncertainty abou tthe amounts to be available or the condi-tions to be attached . The possibility o fbudget cuts is always real . Federal loanprograms are also subject to substantia lchange front year to year . Tax credits ,once enacted, Inight be 111ore sheltere dfrom annual review by Congress, Conse -(illclltly, businesses and others iIlvolvedcould rely with greater certainty onthese tax credits than upon the avail-al)ility of lo\w-illterest goveI'nment loansOr diI'ect government expenditures. I nterms oft pI'actical reality tax cI'edits alsohave impressive appeal in that they offe rscope for gI'eat flexibilit y in maIlageria ldecision-Illaking, depending, of course ,oil the detail of regulations and condi-tions attached to each specific tax credi tlaw, in general, expenditure and loa nprogI•ains are almost certaiIl to impos e11101•(' eoIlfining constraints on initiative ,adaptutioll to diversity, and progressiv eresponse to both success and failure tha tcan be expected \with tax credits ,

Tlie champions of tax credits argu ethat even though in some cases tax cred-its lllay be less efficient than a direct('Xpc'nditure pI'ogI 'am, tax incentiveshave at least one great advantage ; theyfrra11t more freedom to the coIllpaIly o riii(lividual in the use of knowledge abou tconditions of the particular time, place ,and combiIlation of circumstances andin the choice of ways and means to dea lwith each problem.

It could also be argued that the invest-i1leIlt incentive route eIlcourages th eprivate sectoi, to participate in desiredactivities in a wa\ which keeps it mor edirectly in contact \with pIivate con -

sumer ruarkets, as distinguished front

public expenditure programs in whic hthe pI'ivate sector delivers to governmen tprocurement authorities ,

Arguments Against Tax CreditsIn cLtiite ofthe strong support given

to tax credits for nonrevenue goals, man yobservers view such legislation critically .

Sinne critics argue that tax credits doconstitute a form of "tax expenditure"

and should therefore be subject to fre -(fllellt Congressional scrutiny . If not,how can proper priorities be maintaine din in ecoIlomy of endless chaIlgesl? More -over, experience with the investment taxcredit shows that certainty cannot b ecounted upon . The absence of govern-ment control over details, which has pos-itive value in providing freedom andflexibility, troubles some observers . Can-not civil servants exert constructive in-fluence if only by speeding use of th ebenefits of experience, good and bad ,I'esultiIlg fronn projects in many places ?

It would certainly be fallacious tothink of tax credits or other tax incen -tiv ;,6 aS S1I11ple, automatic, aIld Self -eni ', )rcing solutions for any big proble mof s( Ciety . On the coIltrary, ally tax iI1 -

cc ritive legislatioIl is likely to encounterdifficulties which are inherent in th especific chaI'acteristics of the pI'obleIll athand. Tax cI'edits of even massive siz ewill not train or educate, build housing ,or reduce pollution . Heal limitations ofhuman effort and ability, of productiv ecapacity and market oI'ganization, wil linevitably keep accomplishments belo waspirations ,

As for effectiveness, a tax credit, lik eit deduction allowance, is not useful a tall when there is no tax liability, e .g . ,where there is no taxable incon1c . AII dthe effectiveIless of a tax credit depend supon both the amount of incentive of-

28

fered and the ability of the taxpayer toact in the ways desired, Anything whichreduces the tax payable enhances th eability of the taxpayer by leaving himwith more dollars and thus greater ca-pacity to find the funds needed to fi-nance the activity. When there is no ta xliability, however, the credit will notrelease funds to permit a business t opay for some program .' In such cases anexpenditure by government promises tobe more effective than a tax credit .

The differences among tax credits —dividend credit, retirement income, for-eign, estate tax, unemployment insur-ance, investment—make generalization ssomewhat hazardous . A tax credit de -signed to remedy an inequity might b ecriticized if the inequity which is to beremedied is thought to be unreal (e.g, ,the dividend credit) . Other tax credits ,such as the unemployment insurance taxcredit, are subject to the criticism tha tpolitical considerations have taken prior-ity over economic considerations . Somegenera' points can be made here .

Skeptics about the true contributio nof a tax credit, or any tax incentivemeasure, emphasize this point : The neteffect may be much less than appear sbecause a good deal would have beendone even in the absence of the credit .How could one possibly set up a tax (o rexpenditure) incentive system whic hwould give the benefit for only whatwould not be done otherwise? Can any-one predict with confident assurancehow much would be done without th etax credit? Rarely, if ever. It will cer-tainly be hard, probably impossible, t ojudge how much any sacrifice of revenu eactually produces, i .e., results that wouldnot have occurred otherwise . The cost of

the additional result may be low, rea-sonable, high, or exorbitant .

Tax credits are not shown as outlaysin the Federal budget, whereas direc tgovernment expenditure programs, be-ing recorded, are subject to scrutiny b yCongress in the annual appropriation sprocess. Most tax expenditures are some -what hidden, and their total cost unti lrecently remained unknown . Tax credits .however, have been identifiable, aftersome lag, in published statistics of taxa-tion; but little or no effort has been mad eto measure the results against the rev-enue loss . New programs along the linesof any of the four described above wouldraise serious problems of comparin gcosts and benefits .

Chairman Wilbur C. Mills of theHouse Committee on Ways and 'dean shas pointed out that the use of tax in-centives and other tax expenditures lead sto a tax base erosion and undercuts con-trol over government expenditures . Ilesees tax credits as a device for "bac kdoor spending ."

. . the grant of tax credits has pre-cisely the same effect on the budget a san outright expenditure. The only dif-ference is they appear as a negativ ereceipt rather than as expenditure .The grant of the additional tax credit sincreases the size of the budget defici tjust as surely as an additional expendi-ture. That is why I refer to the taxcredits as back door spending ."

He goes on, " . . . The increase inexpenditure for the particular purpos ethat results fI'om a tax credit could beachieved at a much lower cost . . . if theadditional investment lverc financodthrough direct expenditures, The ex -

1 . The carryback and the carry forward can make a tax credit available in years in which there ate no net earn-ings—but only if there had been profit in other years,

29

penditures could more readily b echanneled only to those who woul duut otherwise undertake the activity ."'

The 1968 Treasury study of the cost o f"tax expenditures " establishes a proce-dure for disclosure on a regular basis .To include these "tax expenditures "along with the annual direct outlays an dnet lending programs grouped by func-tions would permit periodic review an dencourage revision to take account o fchanges in objectives . Tax credits inparticular would no longer be so nearl yhidden costs, and their cost-benefit rela -

2 . Congressional Record, December 13, 1967, p . H-16890,

tionships could be estimated more ade-quately .

Benefits, of course, may be difficult toidentify and measure . Some may de-velop only gradually. The adoption o fclew tax credit incentive plans will ini-tially result in a loss of Federal revenueas taxpayers take advantage of them .Yet even revenue results may be positiv eif, as supporters hope, the credits doeffectively generate better economicgrowth and a faster rise in tax paymentsthan would otherwise occur . This happyresult will not, of course, become a real -ity merely because it is a possibility .

30

SummaryRecent discussions suggest that in -

creasing attention will be given to taxcredits to help in dealing with socia land economic problems . A tax credit i san allowance that can be directly offse tagainst the tax liability of an individua lor business, in contrast to a tax deduc-tion, which is subtracted from gross in-come before tax. A tax credit is therebylikely to have an appreciable "incentiveeffect ."

Government expenditure and loanprograms have long been used as a majo rweapon for dealing with welfare prob-lems . Federal grants and direct outlay shave increased year after year in theeffort to assist states and localities . Wel-fare spending, whether by Federal, state ,or local governments, however, is saidto have yielded unsatisfactory results ,partly because its attack on the sourc eof the problems has been deficient . Newtypes of tax credits, aimed at greaterparticipation by business, have bee nproposed as an aid to the solution ofsuch problems .

Tax credits have been used in thi scountry to a limited extent by differentlevels of government. The principal taxcredit measures used on the Federa llevel are of two major types : (1) thosedesigned to remedy a real or imaginedhorizontal inequity, such as the dividendcredit, the retirement income credit, an dthe foreign tax credit; and (2) credit saimed at encouraging certain action swhich presumably would not occur i nthe absence of the credit . Credits of thesecond type influence the allocation ofresources by in effect creating a horizon-

tal inequity. Within this second categorya further distinction can be made be-tween (a) credits designed to alter th ebehavior of government units ; and (b )those which would modify the behavio rof individuals or businesses, e .g., theinvestment tax credit. Interest currentlycenters on credits which fall in the cate-gory "2-b ."

Tax credit proposals presently underdiscussion rest on the belief that busi-ness, and not government alone, shoul dbe involved in solving the nation 's eco-nomic and related social problems .President Nixon has given support tothis principle. His approach, as reflecte dduring the campaign, would be to offe rtax and credit incentives to corporation sand individuals for rebuilding cityslums, locating plants in "ghetto" areas,and training the hard-core unemployed .Numerous proposals have been intro-duced in Congress to achieve these anda variety of other goals .

Tax credits should not be thought ofas easy and generous give-away pro-grams of Federal funds, or as simple ,automatic, and self-enforcing solution sfor any big social problem. On the con-trary, tax credit legislation is generall yaccompanied by stringent controls an dregulations that aim at the achievemen tof agreed upon objectives . It should als obe expected that any such legislationwould be exposed to difficulties whic hare inherent in the specific character ofthe problems to be solved .

The experience with earlier tax credit sgives only limited insight into the value

31

and effectiveness of any newly enacte dtax crec+it measure . No general evalua -tion ofd tax credits can be made here ,what is required is an evaluation ofspecific tax credit proposals in the con -text of the needs and requirement spresent at the time such proposals ar econsidered. Nevertheless, some majorarguments for and against the extende duse of tax credits are presented.

Great uncertainty exists in evaluatingthe probable effectiveness of tax credit sin attracting more industry into suc hproblem areas as job training for th eundereducated, the establishment o fplants in "ghetto" areas, and improvin gthe duality of housing for low-incomegroups. Taxes would be only one o fmany factors to be considered by busi-

ness . Greater importance would attac hto the normal determinants of busines sdecisions on such matters--access t omarkets, availability and cost of labor ,transportation costs, water and fuel sup -plies, availability of raw materials, theduality of public services, and so on .The importance of tax credits woul dvary with each particular problem an dfrom one industry to another . For somepossible programs the degree of capita lintensity would make some difference .

Earlier experiences with the tax credi tdevice were on the whole different i ntheir objective from the tax credit pro-posals presently under discussion . Theeffectiveness of tax credits with regar dto present day social and economic prob -lems, therefore, remains to be tested .

3?

AppendixTAX CREDIT PROPOSALS IN CONGRESS

The Rural Job Development Act (S .15)

The bill was introduced in January 1909 b ySenator Pearson and others . It provides incometax benefits for employers operating certai nindustrial or commercial enterprises in ruraljob development areas .

The Secretary of Agriculture is directed tocertify as eligible for benefits certain newfacilities or new parts of facilities which meetspecified requirements, includin g

(1) The creation of new, full-time jobs fo rat least ten persons ;

(2) Employment of persons in at least 5 0percent of the Jobs who reside withi nthe rural job ~evelopnient area, wh ohave served at least one year on activ eduty in the Armed Forces, or who havebeen enrolled at least one year in th ejob Corps ;

(3) Employment of persons in at least 3 3percent of the jobs who are heads offamilies whose income was less tha n$3,000 in the year immediately preced-ing employment, or persons describe din (2) .

The Secretary is authorized to require certi-fied businesses to file reports, and to give crim-inal sanctions for filing false reports .

The Act would offer an income tax credit forinvestment in certified depreciable property i nrural job development areas . The amount ofcredit for the year would be 7 percent of thequalified expenditures Made in real property ,or 14 percent of the qualified expenditures i npersonal property as defined, limited to th etaxpayer 's liability for the year, Carrybaek fin dcarryover are provided for the credit in excessof the deduction . The Act provides for tax in -creases to recapture credit if property fo rwhich credits were allowed is disposed of undercertain circuinstarces within 10 years in th ecase of real property , or 4 years for persona lproperty, t

The Secretaries of Labor and of 11ealth ,Education, and Welfare would be authorized to

provide training programs and training allow-ances for low-income individuals in rural jo bdevelopment areas who are unemployed andwho are to be employed by a person operatin ga business certified under this Act . Appropria-tions of $20,000,000 for fiscal 1909 and o fsuch amounts as may be necessary would b eauthorized .

The Secretary of Agriculture is charged tocollect, analyze, and publish economic data f uthe information and guidance of businessme nseeking to establish job creating enterprises i nrural job development areas . The Bill author-izes $250,000 for this purpose . It also calls fo rthe creation of a National Public Advisor yCommittee on Rural Industrialization, to b ecomposed of twenty-five members appointe dby the Secretary of Agieulture to assist in atd-irinistering this . .pct . The Secretary is directe dto snake an annual report to Congress concern-ing ;,i., operations under this Act .

The declared aittts are to use the human an dnatural resources of rural America more fullyand effectively, to slow the migration fromrural areas due to the lack of economic oppor-tunity, and to reduce population pressures i nurban centers resulting from such migration .

The Human Investment Act(S.1167, H.8824)

Senator Prouty introduced this Bill in Febru-ary 1909 in the Senate, and Representativ eSteiger in the House ,

A tax credit would be given for employeetraining expenses up to a total of $25,000 peremployer each year plus 50 percent of the taxliability in excess of $25,000, If training ex-penses exceed these limits, unused credits ma yhe carried back three yeaI's and forward seven ,Wages and salaries of apprentices, employee senrolled in on-the-job training prograuts, an demployees who are participating in certai ncooperative educational progratus are consid-ered to be emplo yee training expenses ,

1, The Act would also provide new and more generous depreciation deductions for property of the type fo rwhich credits are allowed i,nd for carryover as a dCductiun of net operating losses of rcrtfflCd bu .rinesscs ,The Act would also permit an additional (special) deduction of 50 percent of the compensation paid durin gthe taxable year to employees fit certified facilities who conform to the residence, Armed ForcCS, or JobCorps service provisions, or to the low-income descriptions set forth in the certification requirements .

33

Certain kinds of training are Uxcludc(l, fo r

example, those not withiIl the United States .

Tuition and fees paid raider employee trainin g

programs are excluded from the gross income

of the recipieIlt individual for Federal ta x

purposes .

By allowing a credit against income tax to

employers for the expenses of job training pro -

grams, this Bill would provide ail incentive t o

business to "invest" more in the improvemen t

of hunlaIl I'esources, hiring, trainiIg, and em-

ploying presently unemployed workers lackin g

needed job skills . This would encourage th e

upgrading of job skills and the creation of new

and better job opportunities for workers pres-ently employed or unemployed . Training woul d

be provided close to the job by ail employer

whose interest would presumably be in devel-oping a better work force . One of the presen t

obstacles would be reduced, namely the fear

that much of a company 's spending might b e

lost as workers left for other employers . The

tax credit would reduce the net cost to th e

company. And from the national point of view,

the worth of such "tax expenditures" would

not depend on where the person worked even-tually .

The Urban Employment OpportunitiesDevelopment Act (H.138I )

This Bill was introduced by Representativ e

Turney in the house early in 1969 . It calls fo r

an income tax credit and other benefits to b egiven to taxpayers operating certain cortuucr-

cial and industrial facilities iI1 urban poverty

areas .

The credit against tax would be i percent o f

expenditures made :

(1) For the manufacture, production, con-struction, purchase, or irtlproventent o freal or personal property ; and

(2) During the tell year period beginningwith the date oil which the taxpayer' seligibility for the program is established .

The amount of credit is limited to tile a1 llOU ll tof the tax liability for each year but with carry -

back and carryoveI' of unused credits for three

and ten years respectively .

Tax liability would be increased — credi t

givell earlier recovered —when the property for

which the credit was granted is disposed o f

under certain circumstances within ten years

(for real property) and four years (for per-

sonal property) of the date of the qualifie d

expenditures . Recapture would also be re-quired upon termination by the Secretary of

Housing and Urban Development of the tax-

payer's eligibility .

The Act would provide new regulations fo r

depreciation deductions for property of the

same type for which credits are allovved unde r

this Act, and for carryover as a deduction of

net operating losses for businesses eligible fo r

the tax benefits of this Act .

The Act would lis p, allow an additional spe-

cial deduction of 25 percent of the compensa-

tion paid during the taxable year to specifie d

employees .

Termination of the eligibility of the taxpay-ing facility under this Bill would increase th e

gross income for the taxable year in which th e

termination occurred by the amount of the de-ductions for employee compensation allowe d

in such taxable year and the two precedin g

taxable years .

The Act would authorize the Secretaries o f

Labor and of Health, Education, and Welfar e

to provide training programs and training al-lowances for low-income individuals in urban

poverty areas who are uIemployed and are t o

be employed by a person operating au indus-trial or commercial enterprise certified as eli-

gible for the benefits of this Act . The Bill call s

for appropriations of $20,000,000 for the firs t

fiscal year and of such amouIlts as may be nec -

essary thereafter . 2

(1) Written Ilotice from the governing bod yof the city in which the poverty area i slocated tfiat it wishes to participate i nthe programs of this Act for the crea-tion of new employmeIlt opportunities ;

(2) Approval by such governing body or anagency designated by it of the enter -prise applying for certification ;

(3) Determination by the Secretary of HUDthat the expected ht'llefits to e►nploy-ment and other aspects of the welfar eof the area warrant the granting of th eincome tax incentives provided by thisAct ; and

( 4) Agreement by the applicant to the rule sprescribed by this Act or by the Secre -

2 . These conditions are also stipulated in Pearson's rural job development bill described above .

34

tary of 11UD, including ,in agreemeIl tto provide jobs for at least fifty full-tin u v

cmploycc :; w1lo, prior to cml;lo mcut ,Were low-income individuals and eitherresided in the poverty area for the pre -VIOIIS SIX 111011t1IS 01' Were unetuployed ,

The Act would require that SUCll jobs be po-

sitions which slid not exist prior to the time o f

requesting ceI'tification . The Act would requir e

the agency which approves the enterprise t o

carry out a I'e'locatlon program for individuals ,

businesses, and nonprofit organizations dis-

placed by the enterprise, in accordance wit hcertain guidelines included in the Act .

The Bill also sets up partial criteria for ter -initiation of the certificate by the Secretary o f

11UD. All certificates of eligibility Would have

to be issued within tell year's of eIlactment . 'I'll(!Secretary of 11UD would be authorized to re -quire the filing of periodic reports by enter -

prises certified under this Act ; the filing of falsereports would be Subject to criminal sanctions .

The purpose is to reduce urban poverty an dthe social, physical, aIld psychological ills as-

sociated with it . Tax credits for private indus-try would create incentives to provide addi-tional employment opportunities and thus bell-efit the residents of urban poverty areas .

Tax Credits for Expenses of Highe rEducation

Different plans to give tax relief to familie s

with college expenses have been introduced i n

Congress in recent years, One proposed b y

Senator A. Ribicoff, and endorsed by Sl'VCI'al l

other Senators, illustrates the general feature sof this possible use of the tax credit .

Parents paying their children's college bill s

Would receive credits . .gainst iIlcome tax. Tax

credits would also be given to working student s

whose own incomes arc high enough to pro -

duce a tax liability and to married Student s

whose wives of husbaIlds make eIlough to pa y

income tax . Moreover, persons and organiza-

tions paying the tuition of individual need y

students would be granted a credit agains ttheir tax liability .

The aniouIlt of credit would depend oil th etotal outlay for education per student . The

maximum credit would be $325 for in outlayof $1,500 or more . The plan would also scal edown the credit when the annual family in -

come exceeds $15,000 so that the bulk of bell-efitS would go to those with low and middle -incomes . Yet there would be help for luiddle-and upper-middle income groups for whom

taxes arc Iligh and college expenses a difficultburden .

The bill proposes a rlulxilnLUU tax credit O f'$325 per Student, The credit would be com-puted on the basis of 100 percent of the firs t$200 of qualifying expenditures for tuition ,fees, and books; 25 percent of the next $300 ,and 5 percent of the SubSCC;ucnt $1,000. Nocredit would be allowed for student costs abov e

1,500 .

The available credit would begin to bephased out when the taxpayer 's adjusted gros sincome reached $15,000, One full credit wouldbe phased out at Well $10,000 level abov e$15,000 . A family paying the expenses of onecollege-age child would be entitled to sonictux credit up to all incolnc level of $25,000 .Similarly, a taxpayer with income abov e$35,000 could obtain a credit only if he weresupporting three or more Students. Thus theeffect of the credit would be adjusted accord-ing to tale CCOIIOI11iC Cir' CLIIIIStances of the tax -payer .

The aid Would go to iIldividilals rather tha nto the institutions as such; this future wouldget around possible difficulties of providin gFederal funds to private and church-supporte d

C011egeS and LuliversiticS- Some university ad -

ministrators have not welcomed the tax credit ,preferring plans which would channel mone yto the colleges . The outlays which would qual-

ify would not be limited to tuition ; students i ntux-supported, low-tuition, colleges would b eable to get credits as large as those of person sin private institutions .

The Kennedy and Johnson Administration sopposed ally tax credit for college expenses .Objections arise out of belief that the pla nwould benefit sonic people whose after-tux in -

comes could cover college expenses withou tundue sacrifice while doing little for sonic ofthe poor. People with a sulall income tax lia-bility could claim only a small amount o fcredit. Supporters of the credit argue that it sbenefits for the huge majority of families shoul dbe the deciding factor, not the Special condi-

tions of the relative few at the tipper and lowe rextremes of the income distribution, The ob-jection with greatest influence grows out of theSOtll'ee of the greatest appeal : the annual Cos tof Senator R1bicoff's plan llas been estimate d-it about $1,5 billion, Such revenue loss seem sto rule out early adoption, even though th ep-lplllarity of this tax credit may be widel ybased in influential Segulents of the population ,

35