International and Country Perspectives
Edited by Iris Claus, Norman Gemmell, Michelle Harding and David White
Chapter 3: Economic Effects of Investment Subsidies
3. Economic effects of investment subsidies Jane Gravelle* INTRODUCTION 3.1 Explicit investment subsides in the United States can be dated back to the early 1960s when the investment tax credit was introduced, although the accelerated depreciation methods adopted in 1954 and 1962 were also justified on the basis of economic stimulus; see Gravelle (1994) for a history. While the investment credit was initially considered as a permanent part of the tax system, the credit was subsequently used as a short-term stimulus, and then returned to being a permanent tax feature. In 1986, however, the United States repealed the investment credit and created a system with the present value of tax depreciation close to economic depreciation. Depreciation was accelerated but designed to offset inflation, although a subsequent decline in inflation reduced effective tax rates, especially for shorter-lived assets that are more sensitive to inflation, as discussed in Gravelle (2001). The revenue gains from the repeal of the investment credit were used to reduce the corporate tax rate. According to Pechman’s (1987) study of comparative tax systems, every country studied (Sweden, the Netherlands, France, Italy, Germany, the United Kingdom, Canada, and Japan) had experimented with tax incentives for investment. Pechman noted a growing disenchantment almost everywhere with investment incentives because of their distortions and inequities. Investment subsidies have tended to favor certain types of assets – plant and equipment – and have been provided in a form that is distorting even among the class of assets covered. Indeed, despite the move towards lower statutory...
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