Breakfast with Chris Walker on Capital Costs, August 1, 1989
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- Title (Dublin Core)
- Breakfast with Chris Walker on Capital Costs, August 1, 1989
- Date (Dublin Core)
- 1989-07-28
- Date Created (Dublin Core)
- 1989-07-28
- Congress (Dublin Core)
- 101st (1989-1991)
- Policy Area (Curation)
- Commerce
- Creator (Dublin Core)
- Dole, Robert J., 1923-2021
- Record Type (Dublin Core)
- attendance lists
- Rights (Dublin Core)
- http://rightsstatements.org/vocab/CNE/1.0/
- Language (Dublin Core)
- eng
- Collection Finding Aid (Dublin Core)
- https://dolearchivecollections.ku.edu/index.php?p=collections/findingaid&id=26&q=
- Physical Location (Dublin Core)
- Collection 007, Box 395, Folder 5
- Institution (Dublin Core)
- Robert J. Dole Institute of Politics, University of Kansas, Lawrence, KS
- Archival Collection (Dublin Core)
- Robert J. Dole Republican Leadership Collection, 1985-1996
- Full Text (Extract Text)
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(page 1)
MEMORANDUM FROM
CHARLS E. WALKER
DATE (handwritten) 7/28/89
(handwritten)
Dear Senator --
Here is some background material for our breakfast discussion on 8/1.
Charly
(page 2)
August 1, 1989 - 8:30 a.m. S-230
Breakfast Meeting
(handwritten check mark) Senator Dole
(handwritten check mark) Senator Simpson
(handwritten) 9:15 (text) Senator Boschwitz
(handwritten check mark) Senator Mack
(crossed out) Senator Domenici
*handwritten) Senator Grassley
(handwritten check mark) Charls Walker
(page 3)
August 1, 1989 - 8:30 a.m. S-230
Breakfast Meeting
(handwritten check mark) Senator Dole (handwritten) - oatmeal, bran muffins skim milk
(handwritten check mark) Senator Simpson (handwritten) lots of eggs and oatmeal apple juice english muff
(handwritten) 9:15 (text) Senator Boschwitz (handwritten) - standard breakfast w bacon
(handwritten check mark) Senator Mack (handwritten) - standard breakfast w bacon
(crossed out) Senator Domenici (handwritten) - standard breakfast w bacon
(handwritten) 6. Senator Grassley - standard breakfast w bacon
(handwritten check mark and "7.") Charles Walker (handwritten) - standard breakfast w bacon
(handwritten)
Coffee/ tea
extra muffins and biscuits
5 standard breakfast w bacon
1 oatmeal, bran muffin, skim milk
Danny (unintelligible) 9:30
Carolyn
338-1799
(end handwritten)
(page 4)
July 28, 1989
TO: SENATOR DOLE
FROM: JOYCE
RE: CHARLS WALKER BREAKFAST
The following Senators have accepted the invitation to breakfast with Mr. Walker on Tuesday, August 1 at 8:30:
(handwritten) 1. Dole - oatmeal, bran muffins, skim milk
(handwritten) 2. (text) Simpson
(handwritten) 3. (text) Boschwitz (handwritten) - standard breakfast with bacon
(handwritten) 4. (text) Mack (handwritten) - standard breakfast with bacon
(handwritten) 5. Domenici - standard breakfast with bacon
(text)
Senator Bond - Hastings
Senator Packwood - Speech
Senator Gramm - conflict
Senator Domenici - doctor appointment
(handwritten)
6. Charls Walker
299-5414
Symms - wcb NO
Grassley wcb OK
(unintelligible) wcb has another breakfast
(unintelligible) Rep.
(unintelligible) N.C.
phar form
2 (unintelligible) largest
met. (unintelligible)
(end handwritten)
(page 5)
August 1, 1989 - 8:30 a.m. S-230
Breakfast Meeting
Senator Dole
Senator Simpson
Senator Boschwitz
Senator Mack
Senator Domenici
(handwritten) Senator Grassley
Charls Walker
(handwritten) drawing of table seating)
(head of table on left) Dole
(top side) Walker Domenici Mack
(bottom side) Simspon Boschwitz Grassley
? Senator Pressler
(end handwritten)
(page 6)
American Council for Capital Formation Center for Policy Research
June 1989
SPECIAL REPORT
The U.S. Cost of Capital and Recent Tax Policy
The cost of capital in the United States today is considerably higher than in Japan, West Germany, and most of our other competitors-a situation that is of growing concern to economists and policymakers. Lower capital costs promote higher investment, which increases a nation's capital stock, provides more capital per worker, and results in greater productivity and growth in the standard of living. This special report focuses on how the U.S. compares internationally and how recent revisions to the federal tax code have affected U.S. capital costs.
The Concept of Capital Costs
The cost of capital is the pretax return on a new investment that is required to cover the purchase price of the asset, the market rate of interest, inflation, economic depreciation, and taxes. This capital cost concept is often called the user cost of capital or the "hurdle rate" because it measures the return an investment must yield before a firm would be willing to undertake the capital expenditure.
For example, for a typical manufacturing firm to be willing to purchase a new piece of equipment, given current tax law and economic conditions, the asset today would have to yield an annual return of approximately 22 percent. This yield would cover all costs, including the purchase price of the equipment, real (economic) depreciation, financing costs, and taxes.
Often a slightly different measure of the cost of capital, the pretax return required by an investor, is used. The only difference between the user cost (or "hurdle rate")
Chart 1: International Comparisons of the Cost of Capital
(bar chart comparing "Cost of Capital," y-axis, and countries " Japan, United Kingdom, West Germany, United States," x-axis)
(y-axis top to bottom)
6%
5%
4%
3%
2%
1%
0%
(Japan is 2.76%, United Kingdom is 3.56%, West Germany is 4.39%, United States is 5.66%)
Sources: B. Douglas Bernheim and John B. Shoven, "Taxation and the Cost of Capital: An International Comparison," in Charls E. Walker and Mark A. Bloomfield, eds., The Consumption Tax: A Better Alternative? (Cambridge, Mass.: Ballinger Publishing Co., 1987). Chart prepared by the American Council for Capital Formation.
Note: Cost of capital for an average of debt and equity funds. The cost of capital measure used here is the pretax return required by an investor, which is net of economic depreciation.
Chart 2: Impact of U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (User Cost Basis)
(bar chart comparing "Cost of Capital," y-axis, and U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (User Cost Basis), x-axis)
(y-axis top to bottom)
25%
20%
15%
10%
5%
0%
-5%
-10%
(x-axis left to right) ERTA 1981 TEFRA 1982 TRA 1986 Total Change 1981-86
(ERTA 1981 is -9.6%, TEFRA 1982 is 8.9%, TRA 1986 is 12.8%, Total Change 1981-86 is 22.9%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
Note: The cost of capital measure used here is the user cost, which includes economic depreciation.
The Economic Recovery Tax Act of 1981 (ERTA) reduced rates compared to prior law.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) reduced ERTA's investment incentives.
The Tax Reform Act of 1986 (TRA) further reduced the investment incentives available under TEFRA and raised effective tax rates to a level higher than that prevailing in 1980.
(page 7)
and the pretax return measure is that the former excludes economic depreciation (about 15 percent per year for equipment, for example). Economic depreciation, which measures the actual useful life of the asset, does not vary with the tax code.
International Comparisons
International comparisons based on the pretax return cost of capital measure show that the cost of capital for equipment in the United States is 5.66, compared with 2.76 in Japan-a difference of more than 100 percent. The U.S. cost of capital also exceeds the United Kingdom's 3.56 percent and West Germany's 4.39 percent. The most significant factors contributing to variations in capital costs among countries are differences in real interest rates and tax codes (see chart 1).
The most serious consequence of high U.S. capital costs is that productivity growth is impeded. Fiscal policy experts agree that U.S. productivity growth has lagged, in part because our investment per worker has been much lower than that of many of our competitors.
Recent U.S. Tax Policy
Federal tax policy was responsible for increasing the user cost of capital for equipment in the United States by about 23 percent from 1981 to 1986 (see chart 2). Capital costs (measured as the pretax return required by an investor) rose almost 90 percent during this period (see chart 3). Effective tax rates on new investment reflect capital costs. After the passage of the Economic Recovery Tax Act of 1981 (ERTA), the tax rate on equipment approximated expensing; by 1986 when the Tax Reform Act was enacted, the rate increased to 46.3 percent-which exceeds the statutory rate of 34 percent (see chart 4).
A major factor contributing to an effective tax rate of 46.3 percent is the lack of indexing for depreciation and for interest income and expenses. Such tax policies can and must be reversed in order to bring U.S. capital costs more in line with those of our major competitors.
Chart 3: Impact of U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (Pretax Return Basis)
(bar chart comparing "Cost of Capital," y-axis, and U.S. Tax Code Revisions for Equipment Used in Manufacturing (Pretax Return Basis), x-axis)
(y-axis top to bottom)
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
(x-axis left to right) ERTA 1981 TEFRA 1982 TRA 1986 Total Change 1981-86
(ERTA 1981 is -29.7%, TEFRA 1982 is 34.5%, TRA 1986 is 41.2%, Total Change 1981-86 is 89.8%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
Note: The capital cost used here is the pretax retum required by an investor, which is net of economic depreciation.
The Economic Recovery Tax Act of 1981 (ERTA) reduced rates compared to prior law.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) reduced ERTA's investment incentives.
The Tax Reform Act of 1986 (TRA) further reduced the investment incentives available under TEFRA and raised effective tax rates to a level higher than that prevailing in 1980.
Chart 4: Effective Tax Rates on Equipment Used in Manufacturing
(bar chart comparing "Effective Tax Rate," y-axis, and years, x-axis)
(y-axis top to bottom)
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
(x-axis left to right) Pre-1981 1981 1982 1986
(Pre-1981 is 28.3%, 1981 is -1.9%, 1982 is 24.2%, 1986 is 46.3%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
The ACCF Center for Policy Research is the education and research affiliate of the American Council for Capital Formation. Its mandate is to promote an understanding by the public of the importance of capital formation to the economy. For additional information please contact: ACCF Center for Policy Research, 1850 K Street, N.W., Suite 400, Washington D.C., 20006, (202)293-5811.
2
(page 8)
From the desk of
ANNE BASHAM
July 28, 1989
FOR: JOYCE
DR. WALKER SENT THE ATTACHED TODAY TO
Senators Simpson, Boschwitz, Mack and Domenici.
If you get any more attendees, you might slip them a copy.
Thanks.
(handwritten) Anne
(text) Charls E. Walker Associates, Inc.
1730 Pennsylvania Ave., N.W., Suite 200
Washington, D.C. 20006
(202) 393-4760
(page 9)
American Council for Capital Formation Center for Policy Research
June 1989
SPECIAL REPORT
The U.S. Cost of Capital and Recent Tax Policy
The cost of capital in the United States today is considerably higher than in Japan, West Germany, and most of our other competitors-a situation that is of growing concern to economists and policymakers. Lower capital costs promote higher investment, which increases a nation's capital stock, provides more capital per worker, and results in greater productivity and growth in the standard of living. This special report focuses on how the U.S. compares internationally and how recent revisions to the federal tax code have affected U.S. capital costs.
The Concept of Capital Costs
The cost of capital is the pretax return on a new investment that is required to cover the purchase price of the asset, the market rate of interest, inflation, economic depreciation, and taxes. This capital cost concept is often called the user cost of capital or the "hurdle rate" because it measures the return an investment must yield before a firm would be willing to undertake the capital expenditure.
For example, for a typical manufacturing firm to be willing to purchase a new piece of equipment, given current tax law and economic conditions, the asset today would have to yield an annual return of approximately 22 percent. This yield would cover all costs, including the purchase price of the equipment, real (economic) depreciation, financing costs, and taxes.
Often a slightly different measure of the cost of capital, the pretax return required by an investor, is used. The only difference between the user cost (or "hurdle rate")
Chart 1: International Comparisons of the Cost of Capital
(bar chart comparing "Cost of Capital," y-axis, and countries " Japan, United Kingdom, West Germany, United States," x-axis)
(y-axis top to bottom)
6%
5%
4%
3%
2%
1%
0%
(Japan is 2.76%, United Kingdom is 3.56%, West Germany is 4.39%, United States is 5.66%)
Sources: B. Douglas Bernheim and John B. Shoven, "Taxation and the Cost of Capital: An International Comparison," in Charls E. Walker and Mark A. Bloomfield, eds., The Consumption Tax: A Better Alternative? (Cambridge, Mass.: Ballinger Publishing Co., 1987). Chart prepared by the American Council for Capital Formation.
Note: Cost of capital for an average of debt and equity funds. The cost of capital measure used here is the pretax return required by an investor, which is net of economic depreciation.
Chart 2: Impact of U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (User Cost Basis)
(bar chart comparing "Cost of Capital," y-axis, and U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (User Cost Basis), x-axis)
(y-axis top to bottom)
25%
20%
15%
10%
5%
0%
-5%
-10%
(x-axis left to right) ERTA 1981 TEFRA 1982 TRA 1986 Total Change 1981-86
(ERTA 1981 is -9.6%, TEFRA 1982 is 8.9%, TRA 1986 is 12.8%, Total Change 1981-86 is 22.9%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
Note: The cost of capital measure used here is the user cost, which includes economic depreciation.
The Economic Recovery Tax Act of 1981 (ERTA) reduced rates compared to prior law.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) reduced ERTA's investment incentives.
The Tax Reform Act of 1986 (TRA) further reduced the investment incentives available under TEFRA and raised effective tax rates to a level higher than that prevailing in 1980.
(page 10)
and the pretax return measure is that the former excludes economic depreciation (about 15 percent per year for equipment, for example). Economic depreciation, which measures the actual useful life of the asset, does not vary with the tax code.
International Comparisons
International comparisons based on the pretax return cost of capital measure show that the cost of capital for equipment in the United States is 5.66, compared with 2.76 in Japan-a difference of more than 100 percent. The U.S. cost of capital also exceeds the United Kingdom's 3.56 percent and West Germany's 4.39 percent. The most significant factors contributing to variations in capital costs among countries are differences in real interest rates and tax codes (see chart 1).
The most serious consequence of high U.S. capital costs is that productivity growth is impeded. Fiscal policy experts agree that U.S. productivity growth has lagged, in part because our investment per worker has been much lower than that of many of our competitors.
Recent U.S. Tax Policy
Federal tax policy was responsible for increasing the user cost of capital for equipment in the United States by about 23 percent from 1981 to 1986 (see chart 2). Capital costs (measured as the pretax return required by an investor) rose almost 90 percent during this period (see chart 3). Effective tax rates on new investment reflect capital costs. After the passage of the Economic Recovery Tax Act of 1981 (ERTA), the tax rate on equipment approximated expensing; by 1986 when the Tax Reform Act was enacted, the rate increased to 46.3 percent-which exceeds the statutory rate of 34 percent (see chart 4).
A major factor contributing to an effective tax rate of 46.3 percent is the lack of indexing for depreciation and for interest income and expenses. Such tax policies can and must be reversed in order to bring U.S. capital costs more in line with those of our major competitors.
Chart 3: Impact of U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (Pretax Return Basis)
(bar chart comparing "Cost of Capital," y-axis, and U.S. Tax Code Revisions for Equipment Used in Manufacturing (Pretax Return Basis), x-axis)
(y-axis top to bottom)
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
(x-axis left to right) ERTA 1981 TEFRA 1982 TRA 1986 Total Change 1981-86
(ERTA 1981 is -29.7%, TEFRA 1982 is 34.5%, TRA 1986 is 41.2%, Total Change 1981-86 is 89.8%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
Note: The capital cost used here is the pretax retum required by an investor, which is net of economic depreciation.
The Economic Recovery Tax Act of 1981 (ERTA) reduced rates compared to prior law.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) reduced ERTA's investment incentives.
The Tax Reform Act of 1986 (TRA) further reduced the investment incentives available under TEFRA and raised effective tax rates to a level higher than that prevailing in 1980.
Chart 4: Effective Tax Rates on Equipment Used in Manufacturing
(bar chart comparing "Effective Tax Rate," y-axis, and years, x-axis)
(y-axis top to bottom)
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
(x-axis left to right) Pre-1981 1981 1982 1986
(Pre-1981 is 28.3%, 1981 is -1.9%, 1982 is 24.2%, 1986 is 46.3%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
The ACCF Center for Policy Research is the education and research affiliate of the American Council for Capital Formation. Its mandate is to promote an understanding by the public of the importance of capital formation to the economy. For additional information please contact: ACCF Center for Policy Research, 1850 K Street, N.W., Suite 400, Washington D.C., 20006, (202)293-5811.
2
(page 11)
American Council for Capital Formation Center for Policy Research
June 1989
SPECIAL REPORT
The U.S. Cost of Capital and Recent Tax Policy
The cost of capital in the United States today is considerably higher than in Japan, West Germany, and most of our other competitors-a situation that is of growing concern to economists and policymakers. Lower capital costs promote higher investment, which increases a nation's capital stock, provides more capital per worker, and results in greater productivity and growth in the standard of living. This special report focuses on how the U.S. compares internationally and how recent revisions to the federal tax code have affected U.S. capital costs.
The Concept of Capital Costs
The cost of capital is the pretax return on a new investment that is required to cover the purchase price of the asset, the market rate of interest, inflation, economic depreciation, and taxes. This capital cost concept is often called the user cost of capital or the "hurdle rate" because it measures the return an investment must yield before a firm would be willing to undertake the capital expenditure.
For example, for a typical manufacturing firm to be willing to purchase a new piece of equipment, given current tax law and economic conditions, the asset today would have to yield an annual return of approximately 22 percent. This yield would cover all costs, including the purchase price of the equipment, real (economic) depreciation, financing costs, and taxes.
Often a slightly different measure of the cost of capital, the pretax return required by an investor, is used. The only difference between the user cost (or "hurdle rate")
Chart 1: International Comparisons of the Cost of Capital
(bar chart comparing "Cost of Capital," y-axis, and countries " Japan, United Kingdom, West Germany, United States," x-axis)
(y-axis top to bottom)
6%
5%
4%
3%
2%
1%
0%
(Japan is 2.76%, United Kingdom is 3.56%, West Germany is 4.39%, United States is 5.66%)
Sources: B. Douglas Bernheim and John B. Shoven, "Taxation and the Cost of Capital: An International Comparison," in Charls E. Walker and Mark A. Bloomfield, eds., The Consumption Tax: A Better Alternative? (Cambridge, Mass.: Ballinger Publishing Co., 1987). Chart prepared by the American Council for Capital Formation.
Note: Cost of capital for an average of debt and equity funds. The cost of capital measure used here is the pretax return required by an investor, which is net of economic depreciation.
Chart 2: Impact of U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (User Cost Basis)
(bar chart comparing "Cost of Capital," y-axis, and U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (User Cost Basis), x-axis)
(y-axis top to bottom)
25%
20%
15%
10%
5%
0%
-5%
-10%
(x-axis left to right) ERTA 1981 TEFRA 1982 TRA 1986 Total Change 1981-86
(ERTA 1981 is -9.6%, TEFRA 1982 is 8.9%, TRA 1986 is 12.8%, Total Change 1981-86 is 22.9%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
Note: The cost of capital measure used here is the user cost, which includes economic depreciation.
The Economic Recovery Tax Act of 1981 (ERTA) reduced rates compared to prior law.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) reduced ERTA's investment incentives.
The Tax Reform Act of 1986 (TRA) further reduced the investment incentives available under TEFRA and raised effective tax rates to a level higher than that prevailing in 1980.
(page 12)
and the pretax return measure is that the former excludes economic depreciation (about 15 percent per year for equipment, for example). Economic depreciation, which measures the actual useful life of the asset, does not vary with the tax code.
International Comparisons
International comparisons based on the pretax return cost of capital measure show that the cost of capital for equipment in the United States is 5.66, compared with 2.76 in Japan-a difference of more than 100 percent. The U.S. cost of capital also exceeds the United Kingdom's 3.56 percent and West Germany's 4.39 percent. The most significant factors contributing to variations in capital costs among countries are differences in real interest rates and tax codes (see chart 1).
The most serious consequence of high U.S. capital costs is that productivity growth is impeded. Fiscal policy experts agree that U.S. productivity growth has lagged, in part because our investment per worker has been much lower than that of many of our competitors.
Recent U.S. Tax Policy
Federal tax policy was responsible for increasing the user cost of capital for equipment in the United States by about 23 percent from 1981 to 1986 (see chart 2). Capital costs (measured as the pretax return required by an investor) rose almost 90 percent during this period (see chart 3). Effective tax rates on new investment reflect capital costs. After the passage of the Economic Recovery Tax Act of 1981 (ERTA), the tax rate on equipment approximated expensing; by 1986 when the Tax Reform Act was enacted, the rate increased to 46.3 percent-which exceeds the statutory rate of 34 percent (see chart 4).
A major factor contributing to an effective tax rate of 46.3 percent is the lack of indexing for depreciation and for interest income and expenses. Such tax policies can and must be reversed in order to bring U.S. capital costs more in line with those of our major competitors.
Chart 3: Impact of U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing (Pretax Return Basis)
(bar chart comparing "Cost of Capital," y-axis, and U.S. Tax Code Revisions for Equipment Used in Manufacturing (Pretax Return Basis), x-axis)
(y-axis top to bottom)
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
(x-axis left to right) ERTA 1981 TEFRA 1982 TRA 1986 Total Change 1981-86
(ERTA 1981 is -29.7%, TEFRA 1982 is 34.5%, TRA 1986 is 41.2%, Total Change 1981-86 is 89.8%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
Note: The capital cost used here is the pretax retum required by an investor, which is net of economic depreciation.
The Economic Recovery Tax Act of 1981 (ERTA) reduced rates compared to prior law.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) reduced ERTA's investment incentives.
The Tax Reform Act of 1986 (TRA) further reduced the investment incentives available under TEFRA and raised effective tax rates to a level higher than that prevailing in 1980.
Chart 4: Effective Tax Rates on Equipment Used in Manufacturing
(bar chart comparing "Effective Tax Rate," y-axis, and years, x-axis)
(y-axis top to bottom)
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
(x-axis left to right) Pre-1981 1981 1982 1986
(Pre-1981 is 28.3%, 1981 is -1.9%, 1982 is 24.2%, 1986 is 46.3%)
Sources: Congressional Research Service, Library of Congress, "Effects of Altemative Tax Regimes on the Cost of Capital for Selected Types of Equipment," February 1989 (unpublished). Chart prepared by the American Council for Capital Formation.
The ACCF Center for Policy Research is the education and research affiliate of the American Council for Capital Formation. Its mandate is to promote an understanding by the public of the importance of capital formation to the economy. For additional information please contact: ACCF Center for Policy Research, 1850 K Street, N.W., Suite 400, Washington D.C., 20006, (202)293-5811.
2
(page 13)
MEMORANDUM OF CALL
(handwritten) Aug 1, 1989 (end handwritten)
TO:
YOU WERE CALLED BY- YOU WERE VISITED BY-
OF (Organization)
PLEASE CALL PHONE NO CODE/EXT.
WILL CALL AGAIN
IS WAITING TO SEE YOU
RETURNED YOUR CALL
WISHES AN APPOINTMENT
MESSAGE
(handwritten) Ann 393-4760 (end handwritten)
RECEIVED BY
DATE
TIME
(page 14)
(handwritten)
Tues. Aug.1
8:30
Joyce
get --
Domenici wcb
Boschwitz wcb
Simpson OK
Bond wcb - NO
Mack wcb
Phil NO
Gramm wcb
NO - Packwood speech w.c.b
(unintelligible)
(end handwritten)
CHARLS E. WALKER
1730 PENNSYLVANIA AVENUE. N.W.
WASHINGTON. D.C. 20006
June 16, 1989
Personal
Dear Mr. Leader:
Harmolyn and I thoroughly enjoyed the Connally outing and especially the opportunity to talk with Liddy and you. I'm writing not only to tell you that, but to follow up quickly on your invitation as we parted "to come up for a visit" and kick around some ideas.
I would like to do that just as soon as your schedule permits -- breakfast, lunch or whatever. One of the subjects at the top of my mind right now (and about which I am stimulating a legislative project in the House) is our very high capital costs, which are bound to retard productivity growth and competitiveness.
The enclosed one-pager and the four charts pretty much tell the story of where we are and where we came from.
Can we get together soon?
With best personal regards,
Sincerely,
(Charls Walker signature)
The Honorable Bob Dole
United States Senate
Washington, DC 20510
(handwritten)
Y Simpson - OK
N Gramm - NO
Y Boschwitz w.c.b.
Domenici - w.c.b.
Y Mark- Jackie will call back to Confirm on Friday
N Bond
(page 15)
The Cost of Capital
The cost of capital is the pretax return on a new investment required to cover the purchase price of the asset, the market rate of interest, inflation, economic depreciation and taxes. The capital cost concept described above is often called the user cost of capital or the "hurdle rate" because it measures the return an investment must yield before the firm would be willing to undertake the capital expenditure.
For example, for a manufacturing firm to be willing to purchase a new piece of equipment, given current tax law and today's economic conditions, the asset will have to yield about a 22 percent return per year. A yield of 22 percent per year will cover all costs, including the purchase price of the equipment, real (economic) depreciation, financing costs and taxes.
Often a slightly different measure of the cost of capital, the pretax return required by an investor, is used. The only difference between the "user cost" (or hurdle rate) and the pretax return measure is that the user cost concept includes economic depreciation (about 15 percent per year for equipment, for example). Economic depreciation does not vary with the tax code; it measures the actual useful life of the asset.
International comparisons based on the pretax return cost of capital measure show that the cost of capital for equipment in the U.S. is 5.66 compared with 2.76 in Japan, a difference of over 100 percent. The U.S. cost of capital also exceeds the United Kingdom's 3.56 percent and West Germany's 4.39 percent. The most significant factors contributing to variations in capital costs among countries are differences in real interest rates and tax codes (see chart 1) .
The most serious consequence of high U.S. capital costs, according to fiscal policy experts, is that it tends to impede productivity growth. U.S. productivity growth has lagged, in part, because investment per worker has been much slower than that of many of our competitors.
Federal tax policy increased the user cost of capital for investment in equipment in the U.S. by about 23 percent from 1981 to 1986 (see chart 2). Capital costs measured as the pretax return required by an investor rose almost 90 percent over the 1981-1986 period (see chart 2A). Effective tax rates on new investment reflect capital costs. After the passage of the Economic Recovery Tax Act (ERTA) of 1981 the tax rate on equipment approximated expensing; by 1986 when the Tax Reform Act was enacted, the rate increased to 46.3 percent (see chart 3). A major factor contributing to an effective tax rate of 46.3 percent, which exceeds the statutory rate of 34 percent, is the lack of indexing for depreciation and for interest income and expenses. Such tax policies can and must be revised.
(page 16)
Chart 1: International Comparisons of the Cost of Capital
(Bar chart comparing Cost of Capital and countries)
(y-axis) COST OF CAPITAL
7%
6%
5%
4%
3%
2%
1%
0%
(x-axis) Japan U.K. W. Germany U.S.
(Japan is 2.76%, U.K. is 3.56%, W. Germany is 4.39%, U.S. is 5.66%)
1/ Cost of capital for an average of debt and equity funds. The cost of capital measure used here is net of economic depreciation.
Source: John B. Shoven, "Taxation and the Cost of Capital: An International Comparison,' In The Consumption Tax: A Better Alternative?, edited by Charis E. Walker and Mark A. Bloomfield, Ballinger Publishing Company, Cambridge Mass. 1987
Prepared by the American Council for Capital Formation
(page 17)
Chart 2: Impact of U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing
(bar chart comparing Cost of Capital and tax code revisions)
(y-axis) COST OF CAPITAL
25%
20%
15%
10%
5%
0%
- 5%
- 10%
(x-axis) ERTA 1981 TEFRA 1982 TRA 1986 Total Change, 1981-86
(ERTA 1981 is -9.6%, TEFRA 1982 is 8.9%, TRA 1986 is 12.8%, Total Change, 1981-86 is 22.9%)
1/ The capital measure used here is the user cost which Includes economic depreciation.
Source: Congressional Research Service, Library of Congress "Effects of Alternative Tax Regimes on the Cost of Capital for Selected Types of Equipment." Feb 1989 (unpublished)
Prepared by the American Council for Capital Formation
(page 18)
Chart 2A: Impact of U.S. Tax Code Revisions on the Cost of Capital for Equipment Used in Manufacturing
(bar chart comparing cost of capital and U.S. tax code revisions)
(y-axis) COST OF CAPITAL
95%
90%
85%
80%
75%
70%
65%
60%
55%
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0
-5%
·10%
-15%
-20%
-25%
-30%
-35%
(x-axis) ERTA 1981 TEFRA 1982 TRA 1986 Total Change, 1981-86
(ERTA 1981 is -29.7%, TEFRA 1982 is 34.5%, TRA 1986 is 41.2%, Total Change, 1981-86 is 89.8%)
1/ The capital cost used here is the pre-tax return required by an investor; it excludes economic depreciation.
Source: Congressional Research Service, Library of Congress, "Effects of Alternative Tax Regimes on the Cost of Capital for Selected Types of Equipment," Feb 1989 (unpublished).
Prepared by the American Council for Capital Formation
(page 19)
Chart 3: Effective Tax Rates on Equipment Used in Manufacturing
(bar chart comparing effective tax rate and years)
(y-axis) EFFECTIVE TAX RATE
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
- 5%
(x-axis) Pre-1981 1981 1982 1986
(Pre-1981 is 28.3%, 1981 is -1.9%, 1982 is 24.2%, 1986 is 46.3%)
Source: Congressional Research Service, Library of Congress "Effects of Alternative Tax Regimes on the Cost of Capital for Selected Types of Equipment," Feb 1989 (unpublished)
Prepared by the American Council for Capital Formation
(page 20)
From the desk of
ANNE BASHAM
July 12, 1989
(handwritten)
Joyce
Pat will get (unintelligible) by (unintelligible)
(end handwritten)
THanks, Betty, for checking this out for Dr. Walker.
He'd be most appreciative if Sen. Dole has a half-minute to call him.
(handwritten) Anne
Charls E. Walker Associates, Inc.
1730 Pennsylvania Ave., N.W., Suite 200
Washington, D.C. 20006
(202) 393-4760
(page 21)
COPY
CHARLS E. WALKER
1730 PENNSYLVANIA AVENUE. N.W.
WASHINGTON. D.C. 20006
393 4760
June 16, 1989
Personal
Dear Mr. Leader:
Harmolyn and I thoroughly enjoyed the Connally outing and especially the opportunity to talk with Liddy and you. I'm writing not only to tell you that, but to follow up quickly on your invitation as we parted "to come up for a visit" and kick around some ideas.
I would like to do that just as soon as your schedule permits -- breakfast, lunch or whatever. One of the subjects at the top of my mind right now (and about which I am stimulating a legislative project in the House) is our very high capital costs, which are bound to retard productivity, growth and competitiveness.
The enclosed one-pager and four charts pretty much tell the story of where we are and where we come from.
Can we get together soon?
With best personal regards,
Sincerely,
s/Charly
The Honorable Bob Dole
United States Senate
Washington, DC 20510
(handwritten)
Senator
We are working on a breakfast meeting for August 1. you wanted to invite Domenici, Boschwitz, Simpson, Bond and Mack
Joyce
(end handwritten)
COPY
(page 22)
The Cost of Capital
The cost of capital is the pretax return on a new investment required to cover the purchase price of the asset, the market rate of interest, inflation, economic depreciation and taxes. The capital cost concept described above is often called the user cost of capital or the "hurdle rate" because it measures the return an investment must yield before the firm would be willing to undertake the capital expenditure.
For example, for a manufacturing firm to be willing to purchase a new piece of equipment, given current tax law and today's economic conditions, the asset will have to yield about a 22 percent return per year. A yield of 22 percent per year will cover all costs, including the purchase price of the equipment, real (economic) depreciation, financing costs and taxes.
Often a slightly different measure of the cost of capital, the pretax return required by an investor, is used. The only difference between the "user cost" (or hurdle rate) and the pretax return measure is that the user cost concept includes economic depreciation (about 15 percent per year for equipment, for example). Economic depreciation does not vary with the tax code; it measures the actual useful life of the asset.
International comparisons based on the pretax return cost of capital measure show that the cost of capital for equipment in the U.S. is 5.66 compared with 2.76 in Japan, a difference of over 100 percent. The U.S. cost of capital also exceeds the United Kingdom's 3.56 percent and West Germany's 4.39 percent. The most significant factors contributing to variations in capital costs among countries are differences in real interest rates and tax codes (see chart 1).
The most serious consequence of high U.S. capital costs, according to fiscal policy experts, is that it tends to impede productivity growth. U.S. productivity growth has lagged, in part, because investment per worker has been much slower than that of many of our competitors.
Federal tax policy increased the user cost of capital for investment in equipment in the U.S. by about 23 percent from 1981 to 1986 (see chart 2). Capital costs measured as the pretax return required by an investor rose almost 90 percent over the 1981-1986 period - (see chart 3). Effective tax rates on new investment reflect capital costs. After the passage of the Economic Recovery Tax Act (ERTA) of 1981 the tax rate on equipment approximated expensing; by 1986 when the Tax Reform Act was enacted, the rate increased to 46.3 percent (see chart 4). A major factor contributing to an effective tax rate of 46.3 percent, which exceeds the statutory rate of 34 percent, is the lack of indexing for depreciation and for interest income and expenses. Such tax policies can and must be revised.
(page 23)
Chart 1: International Comparisons of the Cost of Capital1/
(bar chart comparing Cost of Capital and countries)
(y-axis top to bottom) COST OF CAPITAL
7%
6%
5%
4%
3%
2%
1%
0%
(x-axis) Japan U.K. W. Germany U.S.
(Japan is 2.76%, U.K. is 3.56%, W. Germany is 4.39%, U.S. is 5.66%)
1/ Cost of capital for an average of debt and equity funds. The cost of capital measure used here is net of economic depreciation.
Source: John B. Shoven, 'Taxation and the Cost of Capital: An International Comparison,' in The Consumption Tax: A Better Alternative?, edited by Charla E. Walker and Mark Bloomfield, Ballenger Publishing Company, Cambridge, 1987.
Prepared by the American Council for Capital Formation
(page 24)
Chart 2: Impact of US Tax Code Revision on the Cost of Capital for Equipment Used in Manufacturing1/
(bar chart comparing Cost of Capital and US Tax Code Revision on the Cost of Capital for Equipment Used in Manufacturing)
(y-axis top to bottom) COST OF CAPITAL
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
(x-axis) ERTA 1981 TEFRA 1982 TRA 1986 Total Change, 1981-1986
(ERTA 1981 is -9.6%, TEFRA 1982 is 8.9%, TRA is 1986, Total Change 1981-1986 is 22.9%)
1/ The capital measure used here is the user cost which Includes economic depreciation.
Source: Congressional Research Service, Library of Congress, 'Effects of Alternative Tax Regimes on the Cost of Capital for Selected Types of Equipment,' Feb. 1989 (unpublished).
Prepared by the American Council for Capital Formation
(page 25)
Chart 3: Impact of U.S. Code Revisions on the Cost of Capital for Equipment Used in Manufacturing1/
(bar chart comparing Cost of Capital and U.S. Code Revisions on the Cost of Capital for Equipment Used in Manufacturing)
(y-axis top to bottom) COST OF CAPITAL
100%
80%
60%
40%
20%
0%
-20%
-40%
(x-axis) ERTA 1981 TEFRA 1982 TRA 1986 Total Change 1981-1986
(ERTA 1981 is -29.7%, TEFRA 1982 is 34.5%, TRA 1986 is 41.2%, Total Change 1981-1986 is 89.8%)
1/ The capital cost used here is the pre-tax return required by an Investor; It excludes economic depreciation.
Source: Congressional Research Service, Library of Congress, 'Effects of Alternative Tax Regimes on the Cost of Capital for Selected Types of Equipment,' Feb. 1989 (unpublished).
Prepared by the American Council for Capital Formation
(page 26)
Chart 4: Effective Tax Rates on Equipment Used in Manufacturing
(bar chart comparing Effective Tax Rate and years)
(y-axis top to bottom) Effective Tax Rate
60%
50%
40%
30%
20%
10%
0%
-10%
(x-axis) Pre-1981 1981 1982 1986
(Pre-1981 is 28.3%, 1981 is -1.9%, 1982 is 24.2%, 1986 is 46.3%)
Source: Congressional Research Service, Library of Congress, 'Effects of Alternative Tax Regimes on the Cost of Capital for Selected Types of Equipment,' Feb. 1989 (unpublished). Prepared by the American Council for Capital Formation
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