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1 Stephen J. Entin, The Neutral Cost Recovery System: A Pro-Growth Solution for Capital Cost Recovery 1 (2013)

handle is hein.taxfoundation/taxfaana0001 and id is 1 raw text is: TAXO Fiscal Fac FOUNDATION October 29, 2013 No. 398 The Neutral Cost Recovery System: A Pro-Growth Solution for Capital Cost Recovery By Stephen J Entin Chairman Dave Camp (R-MI) of the House Ways and Means Committee has pledged to offer a tax reform package that would significantly reduce corporate and individual tax rates (to 10 percent and 25 percent for individuals, and to a top rate of 25 percent for corporations) while remaining revenue neutral over the ten- year budget window. The revenue neutrality would be achieved by eliminating many of the tax preferences found on the tax expenditures list published by the Joint Committee on Taxation (JCT). This list measures deviations from a hypothetical normal tax system, based on the broad-based income tax, as defined by JCT.' Chairman Camp has also suggested that some consideration would be given to the revenues expected from faster economic growth, assuming the tax package would lead to a stronger economy. The greatest difficulty in crafting such a package lies in the fact that many so-called tax expenditures are necessary to avoid various types of double taxation of saving and investment that are built into the broad- based income tax. The normal income tax routinely taxes income used for saving and investment more heavily than income used for consumption. These income tax biases damage growth. Some of the major tax expenditures (including reduced tax rates on capital gains and dividends, all pension arrangements, and so-called accelerated depreciation) offset these biases to some degree. They either reduce rates directly or provide the equivalent of a tax rate reduction through their impact on taxable income. Repealing these tax expenditures would amount to a rate hike. To the extent that they offset the statutory rate reductions in the tax package, they will also offset any growth that the rate cuts are expected to produce. One such adverse trade-off consists of switching from the current Modified Accelerated Cost Recovery System (MACRS) to the Alternative Depreciation System (ADS). Cost recovery is slower under ADS than under MACRS. In many cases, asset lives are longer under ADS, and for any given asset life, the depreciation write-offs are more back-loaded than under MACRS. Because the deductions for investment costs would be delayed, the present value of the write-offs (adjusted for inflation and the time value of money) would fall. Taxes would be shifted forward in time, and the after-tax returns on the investments 1 It bears noting that there is some disagreement about what constitutes a normal income tax system and that any definition necessarily involves some arbitrary assumptions.