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Posts Tagged ‘Investment’

Our tax system includes many provisions to boost business investment, particularly by startups and innovative firms. In a new Tax Policy Center study, Joe Rosenberg and I find that those incentives are often blunted by other features of the tax code:

We examine how tax policies alter investment incentives, with a particular focus on startup and innovative businesses. Consistent with prior work, we find that existing policies impose widely varying effective tax rates on investments in different industries and activities, favor debt over equity, and favor pass-through entities over corporations. Targeted tax incentives lower the cost of capital for small businesses, startups, and those that invest in intellectual property. Those advantages are weakened, and in some cases reversed, however, by two factors. First, businesses that invest heavily in new ideas rely more on higher-taxed equity than do firms that focus on tangible investment. Second, startups that initially make losses face limits on their ability to realize the full value of tax deductions and credits. These limits can more than offset the advantage provided by tax incentives. We also examine the effects of potential tax reforms that would reduce the corporate income tax rate and achieve more equal tax treatment across the various forms of business investment.

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The economy contracted at a 1.0% pace in the second quarter, according to the advance estimate from the Bureau of Economic Analysis. That’s bad, of course, but much better than the 5.4% and 6.4% pace of declines in the two previous quarters.

Whenever the GDP data come out, the first thing I look at is Table 2, which shows how much different sectors of the economy contributed to the growth (or, in this case, the decline). The most striking thing about Q2 is how broad the weakness was:

Broad Weakness in Q2 2009

As the chart shows, Q2 witnessed declines in every major category of private demand: consumer spending, residential investment, business investment in equipment and software (E&S), business investment in structures, and exports. Wow.  To find the last time that happened, you have to go all the way back to … the fourth quarter of last year, when it was even more severe. But before that, you have to go back five decades to the sharp downturn of the late 1950s.

Not surprisingly, government spending helped offset the declines in private spending. Most of the boost came from defense spending, but state and local investment also helped (perhaps some glimmers of stimulus?).

A sharp decline in imports, finally, was the biggest contributor to growth in Q2, at least in an accounting sense. It’s important to choose your words carefully here, since declining imports are clearly not the path to prosperity. In a GDP accounting sense, however, import declines do boost measured growth. Why? Well consider the fall in consumer spending. That decline affected both domestic production and imports. GDP measures domestic production, so we need a way to net out the decline in consumer spending that was attributable to imports. That’s one of the factors being captured in the imports figure.

Note: If the idea of contributions to GDP growth is new to you, here’s a quick primer on how to understand these figures. Consumer spending makes up about 70% of the economy. Consumer spending fell at a 1.2% pace in the second quarter. Putting those figures together, we say that consumer spending contributed about -0.9 percentage points (70% x -1.2%, allowing for some rounding) to second quarter growth.

As I mentioned a few weeks ago, today’s GDP release is particularly important because the fine people at the BEA have gone back and made revisions to the entire history of GDP statistics. I will post again once I have a chance to review how history has changed.

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