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Three Tax Reforms to Encourage Modernization of the Manufacturing Sector

December 19, 2012 - 6:18pm
By Steven Nadel, Executive Director

Much of the equipment and production processes in America’s factories are decades old and not as efficient as modern equipment and processes in use by many of our international competitors. While some factories have been modernized, many have not. Modernizing these factories will allow them to better compete in world markets by improving product quality and reducing product costs, including savings through reduced energy use. Modernization of our factories will build on several competitive advantages the U.S. now has—low electric and natural gas prices (relative to the rest of the world) and lower labor costs due to higher productivity.

As we emerge from the Great Recession, many industrial firms have capital to invest, but a nudge from the tax code could spur substantial additional investments here in the U.S.  We suggest three possible tax policies that could spur investment in a new ACEEE working paper. The paper recognizes that any incentives need to be low cost because of concerns about the federal budget deficit and a desire by many tax reform proponents to reduce tax rates by reducing tax expenditures.

The first policy we examine would allow repatriation of company profits at a low tax rate, provided these repatriated profits are used to increase a company’s capital investments relative to their average capital investments in recent years. This provision would apply to multinational firms with substantial profits now parked abroad. Since this taps funds now overseas and not yet subject to taxes, the cost to the U.S. Treasury would be low.

The second policy approach would allow accelerated depreciation on increased capital investments in production capacity, allowing companies to reduce their near-term taxes. The federal government would recoup these expenses in the long term since this proposal would only affect the timing of depreciation and not the amount of depreciation. If depreciation periods were cut in half, the amount of the incentive would be similar to the incentive on repatriated profits discussed above.

A third approach would provide repayable tax incentives for increased capital investments. The credit would be taken on taxes in the year the expenses were made, but the credit would then be paid back to the Treasury in subsequent years.  A credit of 35% of the amount of the capital investment increase that is repaid over ten years would provide about the same incentive as the other two approaches.

We recommend that at least two of these approaches be enacted. The first approach would benefit only large multinational firms, while the second and/or third approach should be included in order to benefit firms that primarily serve the domestic market. A firm would only be able to use one of the approaches.

For the commercial sector, a different approach is needed since much of capital investment is for land and buildings and not for energy-consuming systems. Our paper discusses an option to provide accelerated depreciation for purchases of high-efficiency equipment in the commercial sector. We suggest applying the accelerated depreciation to equipment that meets energy efficiency specifications set by the Federal Energy Management Program (FEMP).

For all of these incentives, the costs to the Treasury are low, but the advantages in terms of energy savings and more competitive U.S. manufacturers would be substantial for years to come.

R. Neal Elliott contributed to this blog post.