Clinton’s Investment Tax Credit Stirs Debate : Economy: Kennedy tried the same stimulus in 1962. But advocates and critics of the new plan line up to argue its merits.

A young Democratic President, troubled by a sluggish economy and a skeptical business community, proposes a new tax incentive designed to boost private sector spending and win the hearts and minds of corporate America.

Bill Clinton in 1993? No, it was John F. Kennedy nearly a generation ago.

History, in fact, seems to be repeating itself as President-elect Clinton proposes a new investment tax credit to stimulate the economy, a recipe first tried by Kennedy in 1962 after his credibility was marred by a feud with the steel industry and a drop in the stock market.

Kennedy’s investment tax credit marked a “major shift by the Democrats toward a pro-business stance,” said Kim McQuaid, a professor of history at Lake Erie College. Clinton, who described himself to voters as a new kind of Democrat, “also wants to buy credibility with business” by reviving the investment tax credit, McQuaid said.

In his first post-election press conference on Thursday, Clinton said a new investment tax credit would be one of the pillars of the economic recovery program he plans to unveil shortly after taking office. He said a private study projects that an investment tax credit could create 500,000 jobs during the first year it is in effect.

But as with many issues in economics, the efficacy of the investment tax credit cannot be proven absolutely. Advocates say it is a powerful stimulus for business activity. Critics counter that it is little more than a gift to firms that would have spent the money anyway.

The investment tax credit has been added and removed from the U.S. Tax Code several times since Kennedy’s Administration. The most recent version was taken off the books with the 1986 Tax Reform Act, which eliminated many deductions, credits and assorted loopholes.

Many corporate economists agree with Clinton that a new investment tax credit is just what is needed to awaken a sluggish business environment.

“This is a program that makes sense in the long run because it’s going to increase capital and increase wages,” said Joel Prakken, a vice president at Laurence H. Meyer & Associates, a St. Louis consulting firm that recently prepared an analysis of investment tax credits for Clinton. “We’re looking for this thing to really stimulate a lot of growth.”

Like previous proposals, Clinton’s plan is aimed at encouraging capital spending by reducing the income taxes of companies that invest in new equipment. Although the details have not been worked out, companies might be allowed to reduce their tax bill by an amount equal to perhaps 10% of the purchase price of eligible equipment.

The theory behind such tax credits is that they tempt companies to spend more on new equipment than they would have otherwise or to accelerate purchases that might have been deferred. That, in turn, boosts sales and job growth for equipment manufacturers, giving the economy a short-term stimulus. It also contributes to long-term productivity growth by replacing old, obsolete equipment with new, more efficient products.

A traditional investment tax credit would provide the biggest benefits to capital-intensive manufacturing concerns that need to purchase machines, computers or other business equipment and would prove less useful to service firms that tend to increase efficiency by other means.

So far, Clinton has not disclosed whether he favors a universal credit that would apply to all firms and all kinds of equipment, or a more targeted credit aimed at selected industries or firms or certain types of equipment. Another way to target a credit is to limit it to investments that exceed average purchases in previous years.

For corporate managers, the bottom line is that a tax credit reduces the net cost of equipment and machinery. If a new computer costs $100 and the credit is 10%, the company’s tax bill is reduced by $10. That has the same impact as if the computer’s original price was $90.

As a method of stimulating economic activity, “it’s better than other tax cuts, because you can only take advantage of it if you invest,” said Gordon Richards, chief economist at the National Assn. of Manufacturers. A universal 10% credit will generate an additional $120 billion in economic activity over five years, Richards said.

Another strong endorsement is offered by Charles F. Larson, executive director of the Industrial Research Institute in Washington. “I think the investment tax credit would be a good incentive,” Larson said. “Capital spending is very important.” Larson also wants Clinton to improve the investment climate by pressuring newly cautious banks and thrifts to make more business loans.

In its study, the Meyer firm assumed a 10% investment tax credit would apply to any capital equipment expenditures in excess of 80% of the amount spent in 1992. Prakken speculated that about 85% of American businesses might qualify for the credit. He estimated that the U.S. Treasury would lose as much as $12 billion in tax revenue during the first two years, assuming no additional economic activity.

“But that’s not what will happen in the real world,” Prakken said, because the stimulus to business would create enough new jobs and income to recover just about all the lost revenue. “There is very little risk with investment tax credits,” he contended.

A strongly contrary view is offered by Alan Auerbach, an economics professor on leave from the University of Pennsylvania. Auerbach said a credit “runs the risk of destabilizing the economy” by creating unintended inflationary pressures. Experts disagree whether the economy has begun to recover or is still weakening, he said, making it difficult to time the introduction of a stimulative credit.

Auerbach and fellow economist Lawrence Summers, who studied the use of the credits between 1972 and 1976, concluded that the tax break did not increase total business investment over that period. Instead, they said, it merely altered the timing of purchases that would have been made anyway and had an impact on the kind of equipment purchased.

Citizens for Tax Justice, a liberal public interest research group, is equally dubious. Its director, Robert S. McIntyre, recently wrote that the record of investment tax incentives in helping the nation recover from the recession of the early 1980s “was a sorry one.” McIntyre said that total business investment, after adjustment for inflation, grew only 1.9% from 1981 to 1986 and that “investment in industrial factories and equipment actually fell.”

Clinton is firmly committed to enactment of a new investment tax credit, but has not yet clarified whether it will be available to all takers or limited in scope.

“If you just do it across the board, then large, established businesses may be given a windfall for something they would do anyway,” said Floyd Williams, tax counsel for the Tax Foundation, a Washington research group.

But a narrowly focused tax credit available only to selected industries blessed by the Clinton Administration would “contaminate” the value of the credit, said Lawrence Hunter, chief economist at the U.S. Chamber of Commerce.

“The best way is to make it permanent, broad and universal,” he said.