Tax Reform, U.S. Investment and Job Growth: Does Cash Flow Matter?

Published in Congressional Testimony

Executive Summary

Cash Flow, U.S. Investment and Jobs: New academic research provides evidence of the strong link between investment and cash flow; a dollar of current and prior-year cash flow is associated with $0.32 of additional investment for firms that are least likely to face difficulty in raising money in capital markets and with $0.63 of new investment for firms likely to face constraints. These results have implications for U.S. investment and job growth since ACCF research shows that each $1 billion in new investment is associated with an additional 23,300 jobs.

Accelerated Depreciation, the Cost of Capital, U.S. Investment and Jobs: If accelerated and bonus depreciation for equipment is repealed and replaced with economic depreciation which is generally longer than the current Modified Accelerated Cost Recovery System (MACRS), the cost of capital for new equipment will rise and investment is likely to decline. The benefit of MACRS and bonus depreciation is its positive impact on cash flow, which occurs immediately as the investment is put in place. If, as seems likely, higher hurdle rates were to cause U. S. investment in equipment (which averaged $1.1 trillion in 2011) to decline, there would be a significant negative impact on employment.

Role of Oil and gas Industry in U.S. Economic Growth: In the last 4 years, the U.S. oil and gas sector has been one of the few bright spots in terms of investment and job growth. Maintaining a viable, growing domestic energy industry can help strengthen U.S. economic recovery. In addition, other U.S. industries such as steel, chemical and plastics production have benefited from the energy boom, especially from reduced prices for natural gas.

Tax Reform and U.S. Energy Investment: Several tax reform proposals put forward in the last several years eliminate accelerated and bonus depreciation, LIFO and other deductions applicable to capital intensive industries, including oil and gas, while lowering the corporate income tax rate. As a new report by the Progressive Policy Institute notes, strong domestic investment by U.S. oil and gas companies in 2011 was due in part to outlays that would be classified as intangible drilling costs and geological and geophysical expenses. If IDCs had to be depreciated rather than deducted or, in the case of G&G, amortized over longer periods, it is likely that less investment would have occurred in the oil and gas industry and fewer new jobs would have been created in the U.S.

Conclusions: As policymakers contemplate fundamental tax reform, they need to weigh carefully the possible consequences of eliminating accelerated depreciation and other provisions which affect the cash flow from new investments and slow the payback period in order reduce the corporate income tax rate. It may be well to consider “paying for” corporate and business income tax rate reductions with cuts to entitlements for upper income individuals (as suggested in the Bowles/Simpson tax reform plan) rather than eliminating proven investment provisions such as accelerated depreciation that enhance growth and further, consider even more powerful approaches to tax reform such as a consumed income tax where all investment is expensed.

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