How Taxes Affect Economic Behavior

By Henry J. Aaron; Joseph A. Pechman | Go to book overview

PATRIC H. HENDERSHOTT and SHENG-CHENG HU


Investment in Producers' Equipment

THE RATES of growth in real output and labor productivity during the most recent economic upswing have been much below those of earlier expansions. Real gross national product grew at an annual rate of 2.5 percent from 1973 to 1978, in contrast to the annual 3.5 percent between 1955 and 1973. Annual growth in productivity in the nonfarm private economy fell from 1.6 percent between 1965 and 1973 to under 1 percent in 1973-78. A contributing factor was a sharp slowdown in the annual growth in the capital-labor ratio from nearly 3 percent in the 1948-73 period to 1.75 percent after 1973.1. While a consensus has emerged that government actions should be taken to raise the share of capital spending in GNP, there appears to be no agreement on the type of actions to be taken. Some contend that the user cost of capital for nonresidential structures should be reduced through liberalization of depreciation policies, expansions in investment tax credits, or a cut in the corporation income tax rate. Others maintain that the only sure way to increase investment is to keep the rate of capacity utilization high.

In an equilibrium economy, the sensitivity of investment to the user cost of capital depends on the ease with which capital and labor can be substituted for one another in production. If there can be no substitution between capital and labor, then capital acts as "pure clay" in the production function; ex ante as well as ex post net investment is motivated solely

____________________
1.
Economic Report of the President, 1980, pp. 85 and 204; and Economic Report of the President, 1979, p. 68.

-85-

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