Investing in people or machines?

Last night, the House of Representatives House Ways and Means Committee voted to make permanent a tax break for buying machines (see The HillHouse GOP clears $287B tax break for business“). The so-called bonus depreciate that allows companies to immediately write off equipment investments as expenses (thereby lowering their pre-tax income and their overall tax bill). Many praise the move as an important step in helping business (see for example, the Heritage Foundation’s write up.) Others, such as Forbes, are more critical. Part of the debate is over how to pay for the $287 billion it would cost over ten years.
As I’ve noted before, my concern is that the this tax break is ineffective in the knowledge economy. It goes after the wrong target. The problem facing manufacturing today isn’t the ability to buy equipment. It is the ability to find trained employees. Over and over we hear that the manufacturing skill shortage is the biggest hurtle to companies’ expansion.
Back in 2011, the on-line journal The Economists’ Voice published an article on “Should the Government Invest, or Try to Spur Private Investment?”:

The U.S. economy clearly needs stimulation, but the Obama administration’s plan for accelerated depreciation is an ‘old economy’ approach to stimulating aggregate investment and unlikely to ease the Great Recession, according to Michael Cragg of Brattle Group and Joseph Stiglitz of Columbia University. The authors suggest alternative policies consisting of carefully designed carrots and sticks.

As I noted in my comment in the article (also published in The Economists’ Voice), Drs. Cragg and Stigliz are exactly correct when they point out that accelerated depreciation is a limited tool — as they put it “an ‘old economy’ approach to stimulating investment.” However, they only touch upon the reason. Accelerated depreciation applies to tangible plant and equipment. Yet, as numerous studies have shown, the composition of investment and capital formation has shifted from tangible plant and equipment to intangibles. Since investments intangibles are generally expensed rather than depreciated, any accelerated depreciation schedule completely misses the mark.
Investment tax credits are the more appropriate tool. But our policy toward tax credits for intangibles is weak at best. The Research and Experimentation Tax Credit (commonly referred to as the R&D tax credit) fights off near-death experiences on a route basis. It is also more limited in scope and scale than what is available in other developed nations. Investment incentives for other intangibles, most notably worker training, are completely absent. If we are to move beyond “old economy,” we need to focus on policy ways to provide incentives for investment in intangibles.
As I have argued too many times to recount, one policy change would be to turn the R&D tax credit into a broader knowledge tax credit. A knowledge tax credit would apply to company expenditures on worker training and education — just like the R&D tax credit applies to expenditures on research activities. In only make sense that boosting worker skill levels is a necessary compliment to any activities to raise innovation and productivity. After all, innovation doesn’t come solely from the lab any more.
Likewise, the knowledge tax credit could be paired with any job sharing programs that compensate workers for lost wages due to working fewer hours. Rather than reduce their hours, a tax credit could be given for workers spending those hours for training, either on-the-job training or in the classroom. This would have a dual effect. It would increase our human capital — a major input to productivity and economic growth. And it would immediately increase consumer demand as companies would use the funds to pay workers to take classes (thereby creating more employments slots for others to fill the working hours of those in the classes).
It seems however, that we are stuck in the past focusing on “old economy” policies. We need to think more creatively about what tax policy would work in this new situation. Key to that effort is focusing on incentives for increased investment in intangible assets.
So, for start, what if we used that $287 billion to provide a tax credit to train workers instead?

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