But Any Loss Would Be High-Tech’s Gain : Changes May Be Harmful to Smokestack Industries

Times Staff Writer

For the nation’s once-mighty manufacturing sector, President Reagan’s proposal to overhaul the tax system appears likely to provide a small but unwelcome nudge in the wrong direction.

Most economists believe that it would be no more than a nudge. Even if Congress enacts Reagan’s package intact, they say, the economic landscape will not become littered with the carcasses of industrial giants laid low by the Internal Revenue Code.

But gloom is spreading through already gloomy smokestack America. The struggling auto industry would almost surely lose. So would the thriving defense industry. Steel might not--but only because tax changes cannot hurt it if it doesn’t make any profits.

Heavy industry’s loss, however, would be high-tech’s gain: Tax favors now showered on the Rust Belt would flow instead to Silicon Valley. And, true to Reagan’s dedication to “the age of the entrepreneur,” small manufacturers would gain advantages denied to their bigger competitors.


All such generalizations are fraught with risk. The nation’s manufacturing sector produced a staggering $1.5-trillion worth of goods last year, from jet airplanes to tiny computer chips, from sheet steel to Scotch tape, and the tax code is as complex and variegated as industry itself. It is also only one element--albeit an important one--in the maze of factors confronting the country’s industrial decision-makers.

“The tax factor is not a big deal in most decisions to invest,” said Brookings Institution economist Robert Z. Lawrence. “Tax is only one part of the cost of capital and one far less important than, say, interest rates.”

Interest rates, too, would feel the effects of the tax package--but just exactly how remains unclear. Some forecasters, including Chase Econometrics, predict that the tax plan would exert slight downward pressure, helping to offset the negative effects of other facets of the plan on the manufacturing sector’s ability to raise capital. Data Resources Inc., by contrast, sees an upward force that would compound the manufacturing sector’s miseries.

Thus, forecasting the interaction between tax codes and industry is as much fortune-telling as science.


Offsetting Effects

To make matters more difficult, many of Reagan’s tax provisions would have offsetting effects. Most clearly, the proposed reduction in the corporate tax rate would help, but the repeal of numerous corporate tax breaks would hurt.

“The impact of the plan is exceedingly variable, company to company,” said Paul R. Huard, vice president of the National Assn. of Manufacturers. Although General Motors has publicly favored the plan, he pointed out, Ford Motor Co. has criticized it sharply.

Not even high tech is uniformly bullish on tax reform. Ultimately, said Kenneth C.O. Hagerty, vice president of the American Electronics Assn., what’s bad for heavy industry is bad for high tech.


“They buy our stuff,” Hagerty said. “If they are hurt, we are, too. If they don’t buy, we don’t eat.”

This much seems sure: The tax plan would drive down corporate profits, at least in the short term. Chase Econometrics projects that after-tax corporate profits would plunge by nearly 30% next year under the Reagan tax plan; Data Resources Inc. sees depressed profits at least through 1995.

But what that would mean for manufacturing output remains problematical. Industrial production, according to Chase, would stagnate next year. But then, thanks to growing consumer demand spurred by individual tax cuts, it would exceed the level that it would reach in 1987 under current law.

Cut in Corporate Tax Rate


Of all the Reagan plan’s complex and intricate provisions, these are the ones that stand to have the most direct impact on the nation’s manufacturers:

--A reduction in the corporate tax rate, to a 33% maximum rate from 46%.

--Repeal of the investment tax credit, which allows businesses to subtract 6% to 10% of the cost of their investments from their tax liabilities.

--A retreat from the generous tax breaks enacted in 1981 for capital investment. Businesses would have to write off the cost of automobile purchases over four years instead of three, for example, and depreciation of factories would take 28 years instead of 18.


--Implementation of a temporary tax, to be phased out in 1989, on the profits that some businesses will reap during the next few years as a result of the 1981 tax breaks for capital investment. As one of its effects, those tax breaks allowed businesses to postpone some tax liabilities until 1986 or later, when tax rates would suddenly drop.

The proposed tax, designed to raise $57 billion during its three-year life, is intended to prevent corporations from reaping windfall profits from this double tax break.

Taxes Would Rise 25%

In 1986, those proposals would add up to an income tax increase of nearly 25% for business, and even more for the capital-intensive companies that stand to lose the most from the windfall tax and the loss of the investment tax credit and rapid depreciation. That has smokestack America up in arms.


“We have concluded this is an unfair distribution of the burden,” said Huard of the National Assn. of Manufacturers, which intends to aim its lobbying fire at the windfall tax. To Joseph A. Jeffrey, vice president and tax specialist with the American Mining Congress, it is “totally inequitable.”

An auto industry executive who asked not to be named protested the apparent preferential treatment for high-tech manufacturing and service industries. “You can’t run the whole country on information,” he said. “No economy will work if people are just taking in each other’s washing.”

The Brookings Institution’s Lawrence said: “We are hearing wails from industries that have had huge benefits in the recent past and are going to lose them. They see that they are going to be hit differently from other industries that didn’t have the benefits, they think their current cash flow will suffer and they moan.”

A surprisingly small amount of the moaning is coming from steel, that prototype of smokestack industries. James F. Collins, executive vice president of the American Iron and Steel Institute, said that even the windfall tax would raise no money from companies that show no profit.


No Taxes Paid by Steel

The steel industry as a whole, Collins said, will have to pay no taxes of any kind until it uses up about $4.1-billion worth of unused tax breaks that it has carried over from previous years. “That could be a very long time for us,” he said.

But the industry would still suffer indirect losses from the tax package because its customers in other industries--notably automobiles--would have less money to invest. If Congress enacts the windfall tax, said Donald W. McCambridge, tax analysis manager for Bethlehem Steel, “it would have a negative cash-flow impact on our customers.”

To the manufacturing sector as a whole, the other two most punitive measures in Reagan’s package--repeal of the investment tax credit and the proposed reduction in today’s accelerated depreciation of factories and equipment--appear far less threatening than the windfall tax.


Although the investment tax credit has been an enormous boon that will reduce corporate taxes by an expected $25 billion this year, business had expected it to fall victim to tax reform well before Reagan introduced his proposal.

And the new schedule for depreciating factories and equipment, although less generous than the system enacted in 1981, would add only an average of $2 billion a year to the nation’s corporate tax bill through 1990.

Improved Tax Deduction

McCambridge of Bethlehem Steel argues that, in the long run, the proposed depreciation system might even represent an improvement over the current one because it would allow businesses to claim tax deductions for the inflation-adjusted cost of their investments, not just for the actual cost.


And a study by the U.S. Chamber of Commerce suggests that the new depreciation schedule would drive up the cost of capital only marginally for some kinds of investment--and reduce it for other kinds. That is a far cry from the Treasury Department’s tax reform proposal of last November, which would have substantially curtailed the benefits on all forms of investment in factories and equipment.

One provision of Reagan’s tax package has drawn no criticism at all from business: the proposal that the corporate tax rate be reduced to 33% from 46%. But even this provision stands to aid the manufacturing sector less than the service sector because, thanks to the tax breaks that current law showers on manufacturers, service companies as a rule have been paying a higher effective tax rate.

Lower tax rates provide little benefit for such industrial giants as General Electric, Du Pont and Weyerhaeuser, which have paid no federal taxes at all in recent years. And they will provide scant comfort for Big Steel, which still has no profits to tax.

Light Industry to Gain


Light industry, by contrast, stands to gain more substantially from lower tax rates. Soap and cosmetic companies as a group have been paying more than 33% of their pretax income in federal income taxes, according to the congressional Joint Tax Committee, and the Reagan package would guarantee them a tax cut. Food processors, which have been paying nearly 33%, probably would come out ahead.

Likewise, compared with steel and automobiles manufacturers, light industry does not pour such massive sums of money into factories and equipment, and so it does not stand to lose as much from the proposed reduction in investment tax breaks.

Representatives of General Foods, 3M Co., Dart & Kraft Inc., Sara Lee Corp. and Procter & Gamble Co.--"the ones that can afford to have a choice,” as an auto company officer put it--appeared before the House Ways and Means Committee last week to praise Reagan’s tax proposal.

And, for the high-tech sector, tax reform actually could facilitate the raising of the venture capital that new companies need to grow and thrive. This is because Reagan’s plan would reduce the maximum tax rate on capital gains--profits from the sale of stocks, bonds and other assets--to 17.5% from 20%.


The already low tax rate on capital gains is thought to attract investors to high-risk but potentially high-growth companies in such fields as electronics and communications. So pleased is the American Electronics Assn. with the Reagan package that it is planning a nationwide series of meetings to promote it.

Defense Industry Penalties

Paradoxically for a President who has overseen the nation’s greatest peacetime military buildup, Reagan’s tax package actually would add special penalties for the defense industry on top of the punitive provisions that would apply to all manufacturers.

Companies fulfilling long-term contracts--defense firms do almost all of their business this way--may now take tax deductions up front for expected interest costs to be incurred over the life of the contract. Under the proposed reform, such expenses could be deducted only as they were incurred.


Even so, Raymond Garcia, director of legislative affairs for Rockwell International, manufacturer of the B-1 bomber, dismissed as “superficial” the conclusion that the tax plan would hit defense contractors unduly hard. The plan would have myriad effects, both direct and indirect, on so large a company as Rockwell, he said. “Parts of the economy may change, people’s behavior is going to change.”

For the nation’s manufacturing sector, Reagan’s tax plan promises another kind of uncertainty as well--uncertainty over the shape of the tax code in the years ahead. Its complicated provisions, already much changed from those the Treasury Department proposed to Reagan last November, may undergo another metamorphosis in Congress.

“What is this--the fourth major tax bill in five years?” wondered Abraham Schneier, tax coordinator for the National Federation of Independent Business. “It’s hard for any kind of business to make any kind of plan. I hope after this they’ll leave the tax code alone for a while.”