S. Christian Statement to the U.S. House of Representatives
Committee on Ways and Means on Tax Reform and the U.S. Manufacturing
July 26, 2012
By Ernest S. Christian
WRITTEN STATEMENT SUBMITTED FOR CONSIDERATION
TO: COMMITTEE ON WAYS AND MEANS U.S. HOUSE OF REPRESENTATIVES
HEARING ON TAX REFORM AND THE U.S.
HEARING DATE: JULY 19, 2012
SUBMITTED BY: ERNEST S. CHRISTIAN
ON HIS OWN BEHALF AS A FORMER DEPUTY
ASSISTANT SECRETARY AND TAX LEGISLATIVE COUNSEL OF THE TREASURY
1155 23rd Street, NW
Washington, DC 20037
PO Box 57232
Washington, DC 20037
(202) 659-1407 email@example.com
JULY 26, 2012
ERNEST S. CHRISTIAN
WRITTEN STATEMENT SUBMITTED FOR CONSIDERATION
TO COMMITTEE ON WAYS AND MEANS U.S. HOUSE OF REPRESENTATIVES
HEARING ON TAX REFORM AND THE U.S.
Hearing Date: July 19, 2012
My name is Ernest S. Christian. I am pleased to submit on
my own behalf this written statement about the dynamic role
of lower tax rates and improved capital cost recovery allowances
in economic growth -- with special emphasis today on manufacturing.
I am a former Treasury tax official and, in and out of government,
have been a tax lawyer in Washington, DC since the early 1960s.
At present, I am a co-chairman of the Center for Strategic
Tax Reform (CSTR), a role that I share with several former
members of this Committee. CSTR is a nonprofit §501(c)(6)
organization that Dr. Murray Weidenbaum, former Chairman of
the President's Council of Economic Advisors, and I formed
over 20 years ago to promote pro-growth tax reform. The views
expressed here are solely my own.
During the 1970s, I served as both the Deputy Assistant
Secretary and Tax Legislative Counsel of the Treasury Department,
where I designed and drafted the Asset Depreciation Range
System (ADR) of depreciation enacted in 1971. That tax reform
measure continued the essential acceleration of depreciation
allowances that began in the Kennedy administration. During
the Reagan administration, I assisted with further reforms,
including lower tax rates and designing the present capital
cost recovery system known as MACRS and its predecessor --
Changes in tax rates and capital cost recovery allowances
both have profound effects -- for good or ill -- on manufacturing's
key role in job creation. On the positive side, to maintain
and expand manufacturing and manufacturing jobs, and for the
overall health of the U.S. economy, the Congress should reduce
the corporate tax rate and make permanent either 50 percent
or 100 percent first-year expensing of business capital equipment.
That should be followed with tax reforms that better enable
businesses to export goods and compete directly in foreign
On the negative side, the worst thing Congress could do
is, with one hand, cut nominal or statutory tax rates, and
with the other, reduce capital recovery allowances from their
already inadequate levels. This would increase the effective
tax rate for many manufacturers and others -- and would increase
the "tax cost" of job-creating investment all across the U.S.
economy. The tax code should not drive more manufacturers
Ever since the Kennedy administration in the 1960s, tax
reformers who have focused on economic growth have sought
not just to lower tax rates, but also to accelerate depreciation
allowances so as to alleviate the long-standing tax bias against
job-producing "capital-intensive" businesses. It would be
a tragedy if, because of budget pressures outside the jurisdiction
of this Committee, the Congress were to reverse the course
of tax reform and start back down the road of making manufacturing
in the U.S. even more tax-expensive and less productive.
I applaud this Committee's focus on the need to remove tax
impediments to economic growth. And I agree especially with
Chairman Camp's emphasis on the need both to lower the tax
rate and to have a correct tax base to which that rate is
applied. If the Congress were to go in the wrong direction
on either of these elements of the tax code, we would end
up with a system that further retards economic growth and
the true cause of tax reform could be set back for decades.
My purpose is to assist in the Chairman's effort to keep
tax reform on the right path toward producing highly positive
economic results. This can be accomplished by making first-year
expensing permanent and phasing in a major reduction in the
corporate tax rate in a way that maximizes the bang-for-the-buck
from these two components of fundamental tax reform.
Phase-In of Pro-Growth Tax Reform That Works
Alex Brill, a former Policy Director and Chief Economist
of this Committee, recently suggested that 50 percent first-year
expensing be made permanent and that a corporate rate cut
be phased in. (See "A Pro-Growth, Progressive, and Practical
Proposal to Cut Business Tax Rates," AEI Tax Policy Outlook
No. 1, January 2012.)
Following up on that, I have worked with Gary Robbins, formerly
a Treasury Department tax economist and now president of Fiscal
Associates, to formulate a specific proposal and to quantify
its revenue consequences (both static and dynamic) as well
as its all-important growth effects.
Our proposal is permanent 50% first-year expensing for all
businesses and a phased-in reduction of the corporate tax
rate to 25%. The results are illustrated in Table I below.
Table I - One Percentage Point Per-Year
Corporate Rate Cut plus 50% Expensing for All Businesses
Note: All dollar amounts are in billions
of dollars. The column "Static Cost of Rate Cut" shows the
cost of changing the corporate rate to the rate indicated
in the "Corporate Rate Cut" column from 35 percent without
50% Expensing. The "Static Cost of 50% Expensing plus MACRS"
shows the effect of 50% Expensing without a change in the
corporate rate. The "Combined Static Cost" column is not equal
to the sum of the two prior columns because it accounts for
interactions between the parts of the plan. Additional GDP
results in additional federal receipts. That is the difference
between the combined static and dynamic cost of the plan.
The "% Reflow" is the ratio of the additional receipts to
the "Combined Static Cost."
Note: For this purpose, MACRS includes
other cost recovery provisions that under present law remain
in effect in 2013 and thereafter. So-called "bonus depreciation",
a temporary provision which expires, is replaced by the more
correctly denominated 50% expensing rule which works in essentially
the same way except that it is a permanent part of the law.
Table I tells us many important things. The static "cost"
of rate reduction builds up over time, but the static cost
of 50% expensing declines rapidly and is nearly gone after
10 years. The combined annual static cost of these two reform
components is on average about $100 billion per year -- essentially
equal to the annual cut in spending beginning in 2013 that
is required by the Budget Control Act of 2011. Those who are
concerned about the potential negative impact of spending
cuts on our fragile economy might welcome the significant
tax cuts in 2013 - 2015 as shown by Table I.
Indeed, the most powerful part of the story is in the last
two columns of Table I which illustrate the highly efficient,
large bang-for-the-buck growth effects of combining rate reduction
and expensing. The dynamic cost is only $353 billion over
10 years and the boost to GDP is a whopping 1.8% or, in dollar
terms, roughly $3,599 billion -- thereby providing a 10-to-1
return ($3,599 divided by $353). Moreover, even the 10-year
$1,057.8 billion static cost (for those who prefer old-fashioned
accounting) is only 29% of the $3,599 billion of induced GDP
growth -- thereby providing almost a 3.5-to-1 return.
Given the current fragile condition of the economy, fine-spun
arguments about the distinction between dynamic and static
scoring are largely irrelevant. Absent a powerful pro-growth
tax cut, and sensible long-term reductions in spending, it
is highly likely that we face a 4% economic decline starting
in the first quarter of 2013 according to the Congressional
Budget Office (CBO). Keep in mind that compared to where we
would have been if GDP had returned to its historic trend
of 3.2% per year growth, we are already $2 trillion in the
hole (i.e., GDP is that amount smaller than it should be this
It is in this context that the pro-growth tax cut in Table
I is almost "free" in the sense that if we don't do it, the
economy and revenue will continue to muddle along at a subpar
or worse rate. CBO's current-law forecast shows the result
of accepting this low level of recovery and growth as the
"new normal." By the end of the budget window, in 2022, GDP
will be 16.5% below its 50-year trend level or $3.6 trillion
too low, or a $12,000 loss for every man, woman and child,
each and every year into the future.
The tax cut illustrated in Table I is especially powerful
and needed not just because it reduces the corporate rate.
Indeed, most of its strong boost to economic growth comes
(a) from moving closer to the free-market neutrality of full
expensing and farther away from the distortive, efficiency-reducing
effects of the "winners and losers" class lives that underlie
the MACRS system; and (b) because the 50% expensing rule applies
to capital investments made by unincorporated businesses as
well as in the case of corporations.
Although not discussed in detail here, we have analyzed
and would also recommend a proposal that reduces tax rates
for unincorporated businesses as well as corporations. When
combined with first-year expensing for all businesses, that
approach would produce an even more powerful boost to economic
Important Perspectives on Tax Reform
Nominal vs. Real Tax Rates
Alan Viard, a Resident Scholar at the American Enterprise
Institute, recently reiterated the perils of tax changes that
reduce the nominal statutory rate, but ignore the effective
rate of tax. (See "The Benefits and Limitations of Income
Tax Reform," AEI Tax Policy Outlook No. 2, September 2011.)
When the nominal rate is cut, but deductions are denied, and
the tax base is therefore changed, the effective rate of tax
may go up or down or remain the same.
Suffice it to say that if the corporate tax rate were to
be cut and depreciation deductions for new purchases of capital
equipment were reduced, the effective rate of tax (Note) for
job-creating companies that are purchasing a lot of new capital
equipment would go up, but would go down for those that are
not, and would remain about the same for those in the middle.
Chris Edwards at the Cato Institute has correctly pointed
out that when Canada cut its corporate tax rate from 29 percent
to 15 percent over the last decade, the reforms did not broaden
the tax base in anti-growth ways such as by reducing depreciation
allowances. In addition, recent research by Douglas Holtz-Eakin
and Ike Brannon at the American Action Forum reveals that
of 96 corporate rate cuts of one percentage point or more
among OECD countries since the year 2000, only 25 were paid
for with some other tax increase.
The "Economic Efficiency" Notion
The notion that lowering the business rate while cutting
back depreciation to the vastly disparate "class lives" would
introduce efficiency gains for the economy is wrong. It assumes
that the existing class lives are accurate, closely matching
the ever-changing, almost impossible to quantify decay rates
for innumerable kinds of business assets across various industries.
They aren't -- and here I speak from experience, having been
at the Treasury Department in the period 1971-1975, where
I was responsible for updating and rearranging the class lives,
often using data that was even then out of date.
Despite the best efforts of many people in the 1970s, including
those in the Treasury Department's then, but now disbanded,
Office of Industrial Economics, the task proved to be impossible
-- and still is. Therefore, the class lives in the old ADR
system -- and as now carried forward into MACRS -- are at
best only rough approximations and make arbitrary distinctions
that have become more distortive with the passage of time.
Consequently, if present capital cost recovery allowances
were, for example, to be cut back to the class life system,
disparities in depreciation rates would tend to be magnified
and, instead of economic inefficiencies being reduced, they
would be increased.
Neither MACRS nor Expensing Is a Loophole?
There are loopholes in the Internal Revenue Code -- hundreds
of them, in fact, but allowing a business to deduct when incurred
(or soon thereafter through MACRS) the costs of the tools
that it puts in the hands of its workers is not one of those
loopholes. Allowing expensing is not a subsidy like allowing
a business to deduct the cost of healthcare benefits that
are not included in employees' income. The costs of a machine
tool, a forklift, a rolling mill in a steel plant, the components
of a refinery and so forth are in all cases just as much an
expense of doing business as the wages of the employees who
operate the equipment.
Expensing the cost of capital investments produces the correct
measure of income when the goal is to avoid double taxing
investment. Double taxation occurs under a depreciation regime
because deductions are allowed only over a period of years
-- and, as a result, the present value of the deductions is
always less than the actual expense incurred. Thus, because
only a partial deduction is allowed, the equipment is partially
double taxed, with the severity of the penalty being proportionately
greater the longer the so-called "class life" arbitrarily
assigned to the item of capital equipment. As the Treasury
Department recognized in its 1984 tax reform proposal ("Tax
Reform for Fairness, Simplicity, and Economic Growth: The
Treasury Department Report to the President, November 1984"),
if deductions for capital cost recovery are deferred and devalued,
the face amount of deductions should be increased to start
with in order to avoid double taxation. It is far simpler
to allow first-year expensing.
When Economy Slows Congress Improves Capital
Typically, when the economy slows, one of the first things
almost every administration and Congress has done is to improve
capital cost recovery by enacting an investment credit, a
more accelerated cost recovery system, and/or allowing for
partial or full expensing of the costs of the tools and equipment
necessary for economic growth and job creation. It would be
counterproductive and wrong for Congress in the current extraordinarily
difficult economic circumstances to move in the opposite direction.
Tax Reform Requires Lower Rates and a Movement
Since the 1960s, tax reform has been about lowering the
tax rate and correcting the tax base to assure that there
are no incorrect omissions from the tax base and that nothing
is included in the tax base twice and double taxed. For a
long time, the most obvious example of double taxation was
the corporate income tax itself. Because the same dollar of
earnings is taxed both to the corporation and its shareholders,
tax reformers sought to integrate the two taxes. The effort
partially succeeded in many foreign countries, but not here.
In recent years, the two-layers-of-tax problem has been alleviated
somewhat by the soon expiring lower tax on dividends and by
increased use of "pass-through" entities. But the more damaging
double taxation from the failure of the tax code to allow
for first-year expensing continues. The problem should be
fixed, not made worse.
It may be appropriate to "capitalize and depreciate" capital
equipment costs for the purpose of financial accounting, but
when done for the entirely different purpose of imposing a
tax, the result is to discriminate against capital equipment,
which is the most critical component of economic growth and
Since the 1970s (the renowned Blueprints for Tax Reform
, for example) all the way up through Congressman Paul Ryan's
current-day Roadmap, tax reform proposals have provided for
the combination of lower rates and a movement toward expensing.
Here are a few examples: The National Commission on Economic
Growth and Tax Reform in 1996 ("The Kemp Commission"); The
President's Advisory Panel on Federal Tax Reform in 2005 (the
"Breaux-Mack Commission"); and The USA Tax -- the ground-breaking,
bipartisan proposal by then Senators Sam Nunn and Pete Domenici
(USA Tax Act of 1995, as introduced in S. 722 on April 25,
1995) and subsequently fully explained in "USA Tax System
-- Description and Explanation of the Unlimited Savings Allowance
Income Tax System," Tax Notes Special Supplement
, Mar. 10, 1995, pp. 1481-1575.
Summation and Conclusion
The intellectual and moral integrity of tax reform lies
in its dedication to economic growth -- the real kind that
arises from allowing the free market to function properly
within a tax code that has low rates and an evenhanded, non-distortive
tax code that is as close as possible to full first-year expensing.
It is improbable that the Congress will be able to achieve
growth-oriented tax reform in a "revenue neutral" manner by
closing loopholes. There simply aren't enough of them to go
around -- and certainly neither expensing nor MACRS is a loophole.
The bottom line choice is either to cut spending enough to
pay for all or part of the tax cut that is inherent in true
tax reform -- or to bite the bullet and enact a net tax cut.
Either one will boost economic growth substantially and make
all Americans better off. America is in an emergency situation
that requires extraordinary measures. The question of whether
and when the tax cut will "pay for itself", in terms of enhanced
revenue to the federal government, is not the point. More
jobs, economic growth and making more Americans better off
is what the exercise of government is all about. The tax cut
I am suggesting is one that jumpstarts economic activity in
the short term and moves us when fully phased in to a far
more efficient and growth-oriented tax code over the long
term -- and that's an ideal tax reform.