Does Tres. Secy Snow Get the Difference Between CapEx and Cap Gains?

John Snow seems like a nice enough guy. Problem is, in his ongoing sales pitch for the administration’s economic policy, he tends to gloss over some facts too readily while ignoring other completely.

A perfect example was his piece this week in the WSJ: The Heart of the Economy. In that Op-Ed, Snow argues that the dividend tax cuts have made the nation’s allocation of capital more efficient:

"While officially the recession had ended in late 2001, the pace of the recovery was too slow. Growth was anemic, business confidence low and — of critical importance — capital investment was way down. As a result job growth was nonexistent.

President Bush recognized that something needed to be done to overcome those headwinds and, in particular, to create a more favorable climate for capital investment that would result in job creation. To do so he sent Congress far-reaching proposals to encourage capital formation by lowering taxes on investment returns. Congress responded with the Jobs and Growth Act, which was signed into law in May 2003.

While many factors contributed to the improved performance of the economy, the tax reductions on capital have been at the heart of the progress we have seen."

Snow is out shilling for the extension of the Capital Gains Tax Cut (lowering it to 15% from 20%) and an even bigger cut on dividends (to 15% from ordinary income — top bracket was 38-39%). As proof of the impact of these cuts, a chart of Business Investment was included (see below). 

For some reason, in his discussion on Business Investment, Treasury Secretary Snow quite notably omitted any discussion of what was arguably the most effective tax cut of the 2003 legislation: The Accelerated Depreciation of Capital Spending (ADCS).

This legislation allowed companies to write down an enormous amount of capital costs on purchases of capital goods. This accounting shift sunsetted on December 31, 2004.  As the table below shows, the incentives to make large purchases were tremendous:

50% Accelerated Depreciation vs. Ordinary Depreciation
Capital Purchase Depreciation Schedule 2004 (write down) 2005 (write down)
Laptop 3 years 67% (50% + 1/2 of 33%) 33%
Router 5 years 60% (50% + 1/2 of 20%) 20%
Earth Mover 7 years 57% (50% + 1/2 of 14%) 14%


The key is that in order to qualify for the 2004 depreciation
schedule, the capital equipment must be Placed in Service by that
12/31/04 — not merely ordered, or sitting in a warehouse, but in
actual use. That suggests that capital goods orders would have to be made way in advance of the 12/31/04 deadline, in order to have any hardware, machinary or software installed by that year end date.

Funny thing is, that’s precisely what the chart that Snow included in his Op-Ed reveals: Business Investment peaked mid-year 2004, and continued sliding as the ADCS sunsetted year’s end. If the Capital Gains and Dividend tax cuts were truly responsible for the CapEx increase, then we should NOT see this slide.

Oh, and somehow, the Treasury Secretary seems to have omitted Q4 2005, which saw an even worsening of this trend. (Q3 was quite robust, however).      


graphic courtesy of the WSJ


Ironically, it appears that Snow is arguing for the wrong tax cut. If we want to see Business Investment continue at the prior hot pace of 2004, then perhaps the legislation actually responsible for it is what should be discussed. 

Of course, there is no free lunch, and the trade off was that companies which chose to spend their capital making Business Investments ended up hiring fewer workers. Indeed, since the ADCS expired, hiring, while still below historic trend, has improved notably.

Snow sidesteps this in his pitch for re-upping on the 15% CapGains and Dividend Rates:   

"If Congress fails to extend the 15% rate on capital gains and dividends, what harm will it bring to our economy? To me, the answer is very straightforward: Raising tax rates on capital gains and dividends would strike at the heart of the economy with damaging long-term effects on economic growth. A slowdown in investment would be inevitable, and a slowdown in job growth almost certain to follow."

This may be a case of pre-emptively anticipating a slow down, and trying to assess blame in advance.  Despite the cheerleading, economists and policy analysts know the dope. They can read beneath the headlines and figure out what’s going on. Perhaps part of the problem is that Snow has become (unfortunately) caught in a
never ending battle to retain his postion as Treasury Secretary/Econ

The ideological push for these tax cuts ignores the reason for Business Investment’s rise and more recent slowdown. It has nothing to do with Dividends or Capital Gains . . .

UPDATE:  February 17, 2006 3:33pm

Economics Prof Mark Thoma adds:

"The other thing I find disingenuous about this – beyond whats covered here – is that jobs acts are always passed in the trough of a recession.

Whether it does any good or not because the economy will naturally recover, so it’s really hard to say the policy itself was responsible and not simply the natural course of the recovery. In other words, its difficult to identify the incremental effects beyond the part that would have happened anyway — that’s hard to parse.

The Heart of the Economy                  
February 15, 2006; Page A16

Accelerated Depreciation of Capital Spending          

When Accounting Rules Matter     Contributor
9/1/2004 1:00 PM EDT

The Unintended Effects of Accelerated Depreciation         
9/3/2004 11:32 AM EDT

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