Tax Incentives and Economic Growth

THE heightened concern with capital formation in recent years is a reflection of several developments. First, the sharp slowing of productivity growth, with its implications for smaller gains in real incomes, has emerged as a major economic problem. Although there is considerable disagreement on the extent to which lower rates of capital formation contributed to the shortfall of productivity, increased investment is often proposed as the cure. In addition, there is a concern that the United States lacks the industrial capacity to employ a work force that has expanded rapidly in the last decade. As a result, future efforts to provide enough jobs may be frustrated by the inflationary consequences of shortages and capacity constraints, particularly in the basic materials industries.

Second, there is a fairly widespread perception that investment has slowed over the last decade. Even that seemingly straightforward factual issue is the subject of substantial debate, however. Those who deny that such a slowdown has occurred point to the rise in the gross investment share of nonfarm business output, shown in the first two lines of table 2-1. Even the share of output devoted to net investment (the addition to the capital stock after deduction of depreciation of existing capital) is low only in comparison to the last half of the 1960s. The evidence of a capital shortfall, on the other hand, is most striking if the growth of the stock of plant and equipment is contrasted with the increase in the work force. Because the rapid expansion of the labor force during the 1970s was not matched by a similar acceleration of investment, the capital- labor ratio grew at an average annual rate of 0.6 percent between 1975 and 1980, compared with a 1950-70 average growth rate of about 3.5 percent (see last line of table 2-1).¹ The capital-labor ratio is highly

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