U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001

30–550—PDF 2005

S. HRG. 109–664

UPDATING DEPRECIABLE LIVES: IS THERE

SALVAGE VALUE IN THE CURRENT SYSTEM?

HEARING

BEFORE THE

SUBCOMMITTEE ON LONG-TERM GROWTH

AND DEBT REDUCTION

OF THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

JULY 21, 2005

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

RICK SANTORUM, Pennsylvania

BILL FRIST, Tennessee

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

KOLAN DAVIS, Staff Director and Chief Counsel

RUSSELL SULLIVAN, Democratic Staff Director

SUBCOMMITTEE ON LONG-TERM GROWTH AND DEBT REDUCTION

GORDON SMITH, Oregon, Chairman

CHARLES E. GRASSLEY, Iowa JOHN F. KERRY, Massachusetts

(II)

(III)

C O N T E N T S

OPENING STATEMENTS

Page

Smith, Hon. Gordon, a U.S. Senator from Oregon, chairman, Subcommittee

on Long-Term Growth and Debt Reduction ....................................................... 1

Kerry, Hon. John, a U.S. Senator from Massachusetts ........................................ 5

WITNESSES

Mikrut, Joseph M., partner, Capital Tax Partners, Washington, DC ................. 2

Neubig, Dr. Thomas S., national director, Quantitative Economics and Statistics, Ernst & Young, LLP, Washington, DC ...................................................... 5

Gravelle, Dr. Jane, Senior Specialist in Economic Policy, Congressional Research Service, Library of Congress, Washington, DC ..................................... 7

Simonson, Kenneth D., chief economist, Associated General Contractors of

America, Alexandria, VA ..................................................................................... 10

Anderson, Christopher R., president, Massachusetts High Technology Council,

Inc., Waltham, MA ............................................................................................... 12

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Anderson, Christopher R.:

Testimony .......................................................................................................... 12

Prepared statement .......................................................................................... 23

Responses to questions from subcommittee members ................................... 26

Baucus, Hon. Max:

Prepared statement .......................................................................................... 27

Grassley, Hon. Charles E.:

Prepared statement .......................................................................................... 28

Gravelle, Dr. Jane:

Testimony .......................................................................................................... 7

Prepared statement .......................................................................................... 29

Responses to questions from subcommittee members ................................... 39

Kerry, Hon. John:

Opening statement ........................................................................................... 5

Prepared statement .......................................................................................... 46

Kyl, Hon. Jon:

Prepared statement .......................................................................................... 47

Mikrut, Joseph M.:

Testimony .......................................................................................................... 2

Prepared statement .......................................................................................... 48

Responses to questions from subcommittee members ................................... 58

Neubig, Dr. Thomas S.:

Testimony .......................................................................................................... 5

Prepared statement .......................................................................................... 60

Responses to questions from subcommittee members ................................... 66

Simonson, Kenneth D.:

Testimony .......................................................................................................... 10

Prepared statement .......................................................................................... 69

Smith, Hon. Gordon:

Opening statement ........................................................................................... 1

Page

IV

COMMUNICATIONS

National Association of Real Estate Investment Trusts (NAREIT) .................... 83

The Real Estate Roundtable ................................................................................... 88

U.S. Chamber of Commerce .................................................................................... 97

(1)

UPDATING DEPRECIABLE LIVES: IS THERE

SALVAGE VALUE IN THE CURRENT SYSTEM?

THURSDAY, JULY 21, 2005

U.S. SENATE,

SUBCOMMITTEE ON LONG-TERM

GROWTH AND DEBT REDUCTION,

COMMITTEE ON FINANCE,

Washington, DC.

The hearing was convened, pursuant to notice, at 2:39 p.m., in

room SD–215, Dirksen Senate Office Building, Hon. Gordon Smith

(chairman of the subcommittee) presiding.

Present: Senator Kerry.

Also present: Republican staff: Dean Zerbe, tax counsel and senior counsel to the Chairman; Nick Wyatt, tax assistant. Democrat

staff: Bill Dauster, deputy staff director; Pat Heck, chief tax counsel; Jonathan Selib, tax counsel; and Mary Baker, detailee.

OPENING STATEMENT OF HON. GORDON SMITH, A U.S. SENATOR FROM OREGON, CHAIRMAN, SUBCOMMITTEE ON

LONG-TERM GROWTH AND DEBT REDUCTION

Senator SMITH. Ladies and gentlemen, thank you for your attendance at this very important hearing of the Senate Finance

Subcommittee on Long-Term Growth and Debt Reduction. Our

topic today is ‘‘Updating Depreciable Lives: Is There Salvage Value

in the Current System?’’

We will soon be joined by my colleague, Senator Kerry. He and

I were both led to believe that there was a vote on at 2:30, but it

was called off as we arrived, so I expect he will be here soon.

But in the interest of time, we will go ahead with my opening

statement, and his when he arrives.

We are going to hear from a distinguished panel of witnesses,

who will provide us with their insights on the current tax depreciation system and its effects on long-term economic growth.

Over the last 2 decades, the U.S. economy has changed dramatically, and many new technologies and industries have emerged.

Twenty years ago, no one had ever heard of the Internet or e-mail,

such things as e-commerce, Blackberries, and iPods, just to name

a few.

We all know the use of computers has also revolutionized and

streamlined manufacturing processes in many traditional industries.

Unfortunately, however, we have not modernized our tax depreciation system. It has not kept pace with these industry changes.

2

Our depreciation system is simply out of date. An un-updated tax

depreciation system is not good for the American economy.

We need a system that promotes and encourages capital investment, especially investments in technology, and also a system that

responds to the emergence of new technologies and industries. The

more companies invest in equipment and buildings, the more our

economy grows.

An example of how the current depreciation system is out of

date, is the fact that the recovery periods used to calculate depreciation allowances for many types of equipment, especially hightech assets, do not reflect the actual economic lives of such equipment.

As one of our witnesses, Dr. Neubig, pointed out in an article on

depreciation, when the asset classes for computerized equipment

under the current system were developed, mainframe computers

were the norm. The fact that such asset classes have not been updated since that early time demonstrates the need for modernization of our tax system.

For example, a personal computer has a depreciable life of 5

years. However, its economic life is really only 2 or 3. Although a

personal computer may work perfectly for 5 or more years, we all

know from our own experiences that after a couple of years, more

technologically advanced computers enter the marketplace, and

such new computers are faster and have superior applications,

making the older computer economically obsolete.

Another example that all of us on Capitol Hill can relate to is

Blackberries. They may run for several years, however, many of us

replace our Blackberries every couple of years to take advantage of

new and helpful features. Like personal computers, a Blackberry

has a depreciable life of 5 years.

As these examples demonstrate, years ago, useful lives were determined by the wear and tear on the asset. However, these days

there is a greater frequency of change in our society, so today we

must focus on an asset becoming economically obsolete, not just actual wear and tear.

To address these concerns with the depreciation system, I am

working with my colleague, Senator Kerry, and also Senator Baucus, on legislation aimed at modernizing and simplifying the depreciation rules. This bill will encourage capital investment, strengthen the economy, and make it easier for companies to comply with

depreciation rules.

I would like to thank all of our witnesses for coming today, and

I look forward to hearing your testimony. As soon as Senator Kerry

arrives, we will hear from him as well.

Why do we not then proceed to our first witness, Joseph M.

Mikrut? The mic is yours.

STATEMENT OF JOSEPH M. MIKRUT, PARTNER,

CAPITAL TAX PARTNERS, WASHINGTON, DC

Mr. MIKRUT. Thank you, Mr. Chairman.

Mr. Chairman, I would like to start by, first, commending you

and the subcommittee for holding this hearing. Depreciation is not

the most glamorous of tax topics, yet it is probably one of the most

important. Capital investment is the backbone of the U.S. economy.

3

As pointed out by the staff of the Joint Committee in their pamphlet for this hearing, over $1.5 trillion of depreciable property is

placed in service every year in the United States. Tax depreciation

rules, or how those costs are recovered, significantly influence the

level and direction of investment.

Thus, it is important for the tax depreciation rules to ‘‘get it

right.’’ This hearing represents an important step in ensuring that

our system of tax depreciation is made and kept efficient and current.

The cost of a capital asset is generally thought of as the present

value of the future stream of income that could be generated from

that expenditure. Expensing of the cost of an asset is the economic

equivalent of exempting from tax the expected income stream from

the asset. Thus, consumption taxes, which seek to exempt from tax

the return from capital, allow the immediate expensing of capital

investment.

Income taxes, however, attempt to match the income from an

asset with its cost. Thus, income taxes generally require the capitalization of the cost of productive assets and provide depreciation

deductions to spread this capitalized cost over the life of the asset

to provide such matching, however roughly, and to account for the

expected decline in the value of the asset over time.

Income tax depreciation deductions are generally determined by

the use of several conventions regarding a property’s placed-inservice date, its useful life, its rate of depreciation, and its salvage

value.

Since its inception in 1913, the Federal income tax has allowed

depreciation deductions for the exhaustion, wear, tear, and

obsolence of property. Since the Tax Reform Act of 1986, depreciation deductions generally have been determined by the Modified

Accelerated Cost Recovery System, or MACRS.

MACRS assigns property to one of 10 recovery periods, and each

recovery period is assigned a recovery method. Most personal property—for example, machinery and equipment—is assigned to the 5-

or 7-year recovery periods and is depreciated using the 200-percent

declining balance method.

Real property is generally recovered using 27.5 years for residential property, or 39 years for non-residential property, and the

straight-line method. Less beneficial allowances are provided on

the Alternative Minimum Tax.

MACRS assigns property to its various recovery periods in one

of two ways. Certain properties are assigned by statute. For instance, automobiles and light-purpose trucks are assigned the 5-

year recovery period. However, most property is assigned to a recovery period based on industry-specific class lives developed by the

Treasury Department over 40 years ago.

Reliance on this class life system results in some controversy as,

as you have pointed out, new industries have emerged, new assets

have been developed, and the rate of obsolescence has changed

since these prior Treasury studies.

Thus, some new industries often do not properly fit into the

present class life, while others find their assigned recovery periods

to be too long relative to their industry’s rate of reinvestment.

4

As the name suggests, MACRS is the successor to ACRS, the depreciation system that was put in place in 1981 and was intended

to provide an incentive to invest in productive property. ACRS resembles MACRS in format, except that the depreciation allowances

provided under ACRS were much more liberal.

Prior to ACRS in 1981, taxpayers had considerable leeway in determining the depreciation allowances based on their present facts

and circumstances. From the 1930s to the enactment of ACRS in

1981, the Treasury Department had conducted numerous studies

and promulgated guidance to provide depreciation guidelines for

various industries and assets. These guidelines generally corresponded to some degree with the observed useful lives of property

within various industries.

An examination of prior and present law leads to certain conclusions. As you pointed out, Mr. Chairman, first, the class life system

upon which present law is based is outdated. This results in economic discontinuities for some taxpayers and industries and leads

to controversies between the IRS and other taxpayers.

Consideration should be given to changes in the process to improve the depreciation system. Treasury has demonstrated the ability to study and provide guidance with respect to appropriate depreciation allowances in the past, but under present law has no authority to change the class life system.

With sufficient resources, industry input, and Congressional direction and oversight, processes could be put in place to allow

Treasury to again take up this work toward modernizing our tax

system. I believe Dr. Neubig is going to speak in greater detail on

some of these processes.

The second observation is that, whatever changes are made, care

should be given to promote equity between industries and among

industry participants, something that Dr. Gravelle has written of

significantly.

But, for one example, there should be an examination regarding

the extent to which depreciation under the Alternative Minimum

Tax creates a tax wedge between certain taxpayers on the AMT

and those not on the AMT.

Finally, any changes in the system should promote simplification. Of all the broad-based deductions, depreciation imposes the

greatest number of calculations and the greatest record-keeping

burdens.

This stems, in part, from the requirement to classify assets into

class lives, to calculate and maintain depreciation for a variety of

purposes—separate depreciation is required for the regular tax, for

the Alternative Minimum Tax, for earnings and profits purposes,

for State and local purposes, and financial accounting purposes.

This all has to be done on an asset-by-asset basis. More liberal

use of mass asset accounts, where groups of assets are placed together and depreciated as one asset, should be explored to provide

simplification.

This concludes my prepared statement. I would be happy to answer any questions at the appropriate time.

[The prepared statement of Mr. Mikrut appears in the appendix.]

5

Senator SMITH. We have been joined by my colleague. If there is

no objection, we will conclude with statements by other members

that may want to be part of the record.

But with that, John, we invite your opening testimony.

OPENING STATEMENT OF HON. JOHN KERRY,

A U.S. SENATOR FROM MASSACHUSETTS

Senator KERRY. Well, Mr. Chairman, thank you. I apologize for

being late. I was down on the floor, both in anticipation of a vote

that did not happen, as well as working on some scheduling issues.

I apologize.

I really want to just hear the testimony. I do not need to say a

lot, except that I am glad that we are having this hearing. You can

tell, from the turnout of the press, what a scintillating subject it

is.

Most people here would say, ‘‘Class life? What is that?’’ But for

those of us who represent States, as both Gordon and I do, that

have a huge base in technology and other kinds of product development, health care and so forth, which is technology in many cases,

this is an enormous issue, of enormous consequence, and it has

great implications, obviously, for the economy as a whole.

Right now, we are going through what people call the ‘‘roulette

audit system,’’ this great uncertainty. It is not, frankly, smart in

terms of the incentives that we are putting in place and the expectations that people are operating with.

So, for all those reasons, and more that you will all describe, I

think we have to revamp it. I want to work with the Chairman.

We have not introduced it, but I know we are developing legislation

to change the class life designation and to work on how we adjust

the depreciation process. We clearly need a bipartisan approach to

this, and hopefully we can get that done.

So, I welcome your testimony. Thank you all for being here, particularly, Mr. Anderson. Thanks a lot for being here. I have admired and worked with the Massachusetts High Technology Council for a long time, and it has done a lot of good. So, we welcome

your testimony and presence. Thank you all.

Senator SMITH. Thank you, Senator Kerry. I think it is fair to

say that there is a very bipartisan interest in this issue, because,

if we do nothing, we damage our economy, and no one has an interest in that.

So, let me see. Next, is Thomas S. Neubig, the national director

of Quantitative Economics and Statistics with Ernst & Young. Welcome.

STATEMENT OF DR. THOMAS S. NEUBIG, NATIONAL DIRECTOR, QUANTITATIVE ECONOMICS AND STATISTICS, ERNST &

YOUNG, LLP, WASHINGTON, DC

Dr. NEUBIG. Thank you, Mr. Chairman and Senator Kerry. I also

would like to compliment you on holding this hearing on depreciation, and especially trying to keep the class lives current.

As the former Director and Chief Economist of the Treasury’s Office of Tax Analysis, I was responsible for setting up the Depreciation Analysis Division after the 1986 Tax Reform Act, and that was

intended to keep the class lives current.

6

Unfortunately, 15 years later, I wrote an article called ‘‘Twentyfirst Century Distortions from 1950s Depreciation Class Lives.’’

The current system of depreciation class lives is heavily based on

a survey of corporate income tax returns done in 1959, and only

modest changes have been made since that time.

This hearing’s title asks if there is salvage value in the current

system, and my answer is yes. The system does work, but the depreciation class life system can be improved, and some administrative flexibility is badly needed.

If the U.S. is going to retain its income tax, then we need a tax

depreciation system that reflects our dynamic economy, which relies on innovative technologies, new assets, and new industries,

such as DNA sequencing equipment, wireless cell site equipment,

and digital photography and printing that were not contemplated

in 1986, let alone in 1959 or 1962.

This outdated classification system results in a number of distortions. First, new assets do not have a class life, so they have to get

shoe-horned into some existing class life, like wire-line telecommunication, or they are assigned an arbitrary 7-year default

life.

Other assets that might have been originally appropriately classified back in the early 1960s may have experienced technological

or economic changes resulting in shorter economic lives.

Finally, as a result of controversy about asset classifications,

there can be a number of assets where taxpayers in the same industry take different recovery periods, and there can be costly and

lengthy disputes with the IRS.

Assets embodying new technologies in rapidly innovating industries are most likely to see rapid economic obsolescence from significant price reductions and increases in capacity, as have occurred with computers and communications. Assigning a nascent

asset the same class life as a mature asset could be very far from

reality.

The 1986 Tax Reform Act anticipated the need to stay current

by giving the Treasury Secretary authority to study and change

class lives. That is why we set up the Depreciation Analysis Division. However, that authority was removed by Congress just 2

years later, in 1988. Treasury then stopped studying asset depreciation.

Technical changes based on factual experience can be more

quickly, thoroughly, and consistently handled by administrative,

rather than legislative, action. In addition, legislative changes involve revenue scoring, which is a further impediment to appropriate technical changes.

The Treasury Department’s 2000 Depreciation Report suggested

several alternative mechanisms for adjusting class lives, but all of

those would rely upon having additional government resources to

do those studies.

As an alternative, one could expand on several successful IRS

programs which involve taxpayers in resolving technical and factual issues. The IRS currently does this on many other tax issues

with pre-filing agreements, advanced pricing agreements, and the

IRS’s new industry issue resolution program.

7

What I call an advanced depreciation agreement could be part of

the industry issue resolution program. In this ADA, if Treasury is

given the authority to change depreciation class lives, both taxpayers and the Treasury would have an incentive to work together

to resolve factual issues involving the appropriate class life.

In an ADA, the taxpayer or an industry association would be responsible for providing the resources to conduct the analysis, but

it would be subject to Treasury’s review and agreement. This is

very similar to the APA.

It would also alleviate some of the problems that we have seen

occur with the APA as a result of insufficient government funding

so that the government is not able to make as quick a resolution

of the issues as would be desirable.

This approach would focus government and taxpayer resources

on assets whose economic lives are expected to be significantly

shorter than their current tax lives. Concern about private sector

analysis would be addressed through Treasury review and oversight.

The ADA process could also be used to address new assets by assigning a temporary class life for new assets, with an expiration

date, pending a more complete analysis.

It is important that the definition of class life used in the ADA

process be feasible empirically, and also set a reasonable, consistent standard against which new class lives are determined.

Most class lives were based on a typical holding period of only the

initial holder of the asset.

If we stay with the current income tax, then the tax depreciation

rules need more administrative flexibility to remain current. This

can be done with two changes. First, Treasury’s successful administrative programs should be expanded to include an advanced depreciation agreement that covers depreciation class lives, and, second,

Treasury should have the authority to set class lives for assets

which have undergone an advanced depreciation agreement.

Those two changes would keep my great-grandchildren from

writing about 22nd century tax distortions from 20th century class

lives.

I would be happy to answer any questions later.

Senator SMITH. Thank you very much, Doctor.

[The prepared statement of Dr. Neubig appears in the appendix.]

Senator SMITH. Dr. Gravelle?

STATEMENT OF DR. JANE GRAVELLE, SENIOR SPECIALIST IN

ECONOMIC POLICY, CONGRESSIONAL RESEARCH SERVICE,

LIBRARY OF CONGRESS, WASHINGTON, DC

Dr. GRAVELLE. Thank you. I would like to thank you for the invitation to appear before you today to discuss depreciation policy.

Senator SMITH. Jane, maybe I should tell them you are a part

of the Congressional Research Service.

Dr. GRAVELLE. Yes, I am a Senior Specialist with the Congressional Research Service. Also, this is a very narrow topic, but my

dissertation was entitled, ‘‘Non-Neutral Taxation of Depreciating

Assets,’’ so I have had a longstanding interest in this issue.

Senator SMITH. That is wonderful.

8

Dr. GRAVELLE. That was a long time ago, and things have

changed.

Senator SMITH. I am sure the people in the press are going to

have some questions for you afterwards. [Laughter.]

Dr. GRAVELLE. Tax depreciation rules are important to an efficient economy. Absent specific market imperfections, business investment is efficiently allocated, but different types of assets and

returns are subject to the same effective tax rate.

In an income tax system, this goal is achieved from the value of

tax depreciation equals the value of economic depreciation. If subsidies are provided, they should be provided in a way that is neutral across assets.

In 1986, an explicit attempt was made to achieve this goal, and

estimated tax rates on different types of assets were fairly even,

with very slightly lower tax rates on equipment, on average, than

on buildings.

This treatment was a significant departure from the past, when

wide differences across assets existed. Since that time, legislative

and economic changes have led to a fall in the tax rate on equipment.

In 1986, the average tax rate on equity investments and equipment in the corporate sector was estimated at around 32 percent,

2 percentage points below the 34 percent statutory tax rate at that

time. Taxes on buildings were slightly above that rate, ranging

from 35 percent to 38 percent.

In 1993, the statutory tax rate was increased to 35 percent, and

the useful life for non-residential buildings expanded from 31.5

years to 39 years. The inflation rate also fell from an expected rate

of about 5 percent to an expected rate of about 2 percent.

These effects were offsetting because inflation raises the tax burden on capital income, lowering tax rates on equipment to 27 percent, while keeping tax rates on buildings essentially unchanged.

Incorporating new depreciation estimates lowers the projected 27

percent by a couple of percentage points. This current law is characterized by a favorable treatment of equipment in the aggregate

compared to real estate. There are also differentials across types of

equipment assets which arise, in part, from the limited number of

class lives.

In 1986, rates and equipment were estimated to range from 22

percent to 41 percent. The current range is from 17 percent to

about 33 percent—these are all estimates, of course, you understand—reflecting changes in inflation rates and some undated depreciation numbers.

Although there are problems with the present depreciation system, by historical standards it is more even-handed than was the

case with most past combinations of depreciation and investment

subsidies.

There are certain rigidities in the current system that arise because of the limited number of asset classes and legislation adopted

in 1988 that restricted the authority of the Treasury Department

to assign assets to classes.

The limited number of classes means that within a class the

shorter-lived assets are subject to higher tax rates than the longerlived assets. Limitations on Treasury authority mean that assets

9

may not be assigned to the appropriate classes because, for example, they are new and because changes in technology have affected

their durability, or because they were not properly assigned in the

first place.

Proposals have been made to provide more generous treatment

to equipment or to ‘‘high-tech’’ equipment. The argument that these

assets should be favored simply because they embody technology is

not consistent with economic theory, which suggests that assets

should be treated in a neutral fashion.

A different argument is that many of these assets really have

shorter lives than assumed when the asset lives were assigned. A

review of evidence on economic depreciation does not suggest that

there are major changes in the estimated economic depreciation

rates assumed in 1986. Indeed, overall, equipment assets’ effective

tax rates have declined slightly with the new estimates—not in

every case, but overall.

In addition, these concerns are often directed at very short-lived

assets and these assets have a built-in protection against lives that

are too long, since the remaining costs can be deducted when they

are disposed of.

Moreover, investment in short-lived assets is less sensitive to

changes in effective tax rates than is investment in long-lived assets.

Among the options for change is to provide Treasury some additional authority to assign assets to classes. Other options include

taking measures to narrow the gap between equipment and structures, and expanding the number of asset classes to provide more

even tax treatment within equipment.

Expensing or partial expensing of equipment or of a narrow

group of assets would exacerbate current differences across assets.

Full expensing across all assets would be neutral, but would result

in significant negative tax rates unless other measures, such as

disallowing interest deductibility, were taken and would be extremely costly in the short run, unless deductions for existing assets were disallowed. Thank you.

[The prepared statement of Dr. Gravelle appears in the appendix.]

Senator SMITH. So are you arguing then for us to give specific authority to redefine lives and that we not necessarily dictate it here?

Dr. GRAVELLE. Well, you might want to oversee it. The Treasury

Department is where they have more skills to determine technical

things.

Senator SMITH. That is true, actually.

Dr. GRAVELLE. I mean, I really cannot make recommendations,

but I think there is a general recognition, which you will hear from

lots of people, that we do need a more flexible system. We have not

changed anything since 1986, and that was almost 20 years ago.

Senator SMITH. Is it fair to say I have not really heard any disagreement from our first three witnesses? I think everyone is pretty much in agreement. All right.

Mr. Simonson?

10

STATEMENT OF KENNETH D. SIMONSON, CHIEF ECONOMIST,

ASSOCIATED GENERAL CONTRACTORS OF AMERICA, ALEXANDRIA, VA

Mr. SIMONSON. Good afternoon. Thank you for this opportunity.

I am Ken Simonson, chief economist for Associated General Contractors of America, the leading national trade association of the

construction industry, representing over 32,000 firms, most of them

small businesses.

I will wear my AGC hard hat today, but also draw on my past

lives in the Small Business Administration’s Office of Advocacy as

chair of the Tax Committee of the Small Business Legislative

Council, staffer for the Capital Resources Committee for the President’s Commission on Industrial Competitiveness, and other positions in which the tax system, and specifically capital cost recovery,

were very important issues.

Construction is a major creator and buyer of depreciable assets. The value of construction put in place last year totaled $1 trillion,

of which $270 billion was for depreciable private, non-residential,

and multi-family structures.

As for equipment, shipments of new construction machinery ac- counted for $29 billion, or 11 percent of total domestic machinery

shipments. Contractors spent billions more on imported and used

equipment, and on vehicles, computers, and other equipment that

are not classified as construction machinery, but are integral to

their operations.

Because equipment, tools, and vehicles are so essential in construction, capital cost recovery rules, depreciation, expensing, tax

credits, recapture, et cetera are an important aspect of the taxes

contractors must contend with.

Getting depreciation right for assets used and created by construction firms is vital for all construction-related businesses, contractors themselves, supplier industries, and building owners.

Most construction firms are very small. In 2002, more than 91

percent of construction firms had fewer than 20 employees, and

only 1 percent had 100 or more. Approximately 79,000 of the nearly

600,000 firms were new. There were also 2 million construction

firms without employees.

These facts suggest that most construction firms do not have the

size or experience to be able to cope with complex or frequently

changing tax rules.

A simple, rational, and relatively stable set of tax rules, particularly with reference to capital cost recovery, will enable small contractors to adapt and concentrate on building a strong economy

rather than having to become tax experts.

In response to the invitation to testify at this hearing, AGC conducted a quick survey by e-mail—thank goodness for new technologies. The questions and responses received to date are on page

8 of my written testimony.

I would summarize the points as follows. For the most part, contractors said that the accelerated 5-year write-off allowed for most

of their property fairly reflects the life and decline in economic

value of major machinery.

However, some contractors said that hand tools and smaller

equipment, such as pumps, generators, and tamps, tend to wear

11

out or be damaged beyond the cost of repair after less than 5 years

and should be written off over 3 years, or expensed and immediately deducted.

In addition, contractors, like taxpayers in many other industries,

said their computers and associated software are obsolete in less

than 5 years.

Respondents split on whether the amount and timing of investments are affected by either the general rules or temporary incentives, such as the recently expired bonus depreciation or the current higher limits for small investor expensing under code section

179.

I would urge that any changes be large and long-lasting enough

to be worth the considerable cost small businesses incur in managers’ and owners’ time to learn about, analyze, and, if appropriate,

adapt their business practices. Short-term provisions, even if later

extended, exact a high overhead cost.

As for other recommendations, one respondent listed ‘‘tax simplification!’’ I think he understated the case. I believe enormous efficiency gains throughout the economy could be achieved by making

the tax system—and notably the capital cost recovery rules—simple and generally unchanging for long periods.

A good way to start, and one mentioned by several survey respondents, would be to eliminate the Alternative Minimum Tax, or

at least the separate depreciation required for it.

If this is too expensive or elaborate a change to enact this year,

I hope Congress will at least substantially raise the income floor

below which it does not apply for all types of business, whether

taxed as C corporations or through the individual income taxes, S

corporations, partnerships, or sole proprietorships.

Congress should permanently spare most individuals and small

businesses from devoting time and expense to duplicate accounting

and tax computations.

Alas, simplification is not simple to enact, or even agree on the

approach. In the interim, there may be cases where small adjustments to the present system are appropriate.

One of these is in the area of pollution control equipment. Contractors generally receive no financial benefit from the expense of

overhauling their existing equipment to add pollution controls.

Therefore, AGC believes it is appropriate to allow contractors to

expense the cost of purchasing and installing pollution-reducing devices. Such tax treatment would be consistent with the deductions

for clean fuel vehicles and refueling property, and for small refiners

who install equipment to comply with EPA low-sulfur regulations

now allowed under the tax code. In fact, Oregon has a tax credit

to compensate contractors, in part, for installing this kind of equipment.

Thank you.

Senator SMITH. Well, you are the first one to hit on my big question, when Mr. Anderson is finished, and that is obviously the AMT

and how we ought to deal with that.

[The prepared statement of Mr. Simonson appears in the appendix.]

Senator SMITH. Mr. Anderson, you are with the Massachusetts

High Technology Council from Waltham.

12

Mr. ANDERSON. That is right.

Senator SMITH. Go ahead.

STATEMENT OF CHRISTOPHER R. ANDERSON, PRESIDENT,

MASSACHUSETTS HIGH TECHNOLOGY COUNCIL, INC.,

WALTHAM, MA

Mr. ANDERSON. Thank you, Mr. Chairman, for the opportunity to

discuss this issue with the committee. My name is Chris Anderson,

president of the Massachusetts High Technology Council. I have

been with the council since 1984, as president since the end of

2000.

I would also like to thank Chairman Smith and Senator Kerry

for the opportunity as well to testify on this issue, which is one of

significant importance to the technology employers, certainly in

Massachusetts, and, I am sure, around the country.

A quick little thumbnail on who we are. The Massachusetts High

Technology Council was founded in 1977 by technology CEOs

whose goal is to help make Massachusetts the world’s most attractive place in which to live, work, and operate high-tech companies.

That remains our mission today. Today, our members employ

hundreds of thousands of skilled workers in all of Massachusetts

key technology sectors, including computer hardware, life sciences,

software, medical products, semiconductors, defense technology,

and communications.

Our members include the executive leadership of such employers

including EMC, Boston Scientific, Analog Devices, Genzyme, and

MITRE.

I might say that when I joined the council we had companies

called Digital Equipment Corporation, Data General, Wang, and

Colonet Software, none of whom exist in their current or previous

form today.

As many of you know, Massachusetts, historically, has had a reputation for being a high-tech State, but over the past 15 years the

political leadership has realized that a high-tech State like ours

needs tax policies that help maintain a stable, predictable, and

competitive business cost climate. Because of that attitude, we

have done a number of things to help shed that Taxachusetts moniker.

A few of those examples—and I will be brief—include a competitive Research and Development Tax Credit, and making permanent

the 3-percent Investment Tax Credit that rewards companies for

making capital expenditures.

This, and a number of other initiatives, resulted in, as Senator

Kerry cited in testimony on July 6 before the Base Realignment

and Closure Commission hearing in Boston, that Massachusetts is

the top technology State in the U.S., according to the annual

rankings by the Milken Institute.

The lesson is that we have, and need, a thoughtful and strategic

tax policy that can have a positive impact on economic competitiveness.

Despite the ever-evolving nature of technology and growing global reach of innovation firms, investment in capital assets and the

cost recovery for those assets are critical to the competitiveness of

U.S. employers.

13

According to the April 2005 study led by PricewaterhouseCoopers

for the President’s Advisory Panel on Federal Tax Reform, in 2002,

gross corporate depreciable and amortizable assets were valued at

$10 trillion. The depreciation and amortization deductions for the

same year totaled $825 billion.

By comparison, corporate incomes, with all deductions, came in

at $1.4 trillion. This shows that, even in an innovation-based economy, capital investment is still king.

As the committee contemplates the future structure of depreciation, it should consider that—while technology, factories, and jobs

are becoming more and more portable—technology- and science-oriented research companies strongly want to invest in operations

close to their home base. We applaud your interest in seeking out

how best to achieve this objective.

Let me put a face on a specific example where the current structure is a problem. A precision equipment manufacturer outside of

Boston had a very negative experience due to the current depreciation structure.

This company had the type of opportunity that every ambitious

tech firm yearns for, the chance to be a sole-source global supplier

for Intel. This high-tech firm of about 200 employees had the expertise and workforce to do the job, but needed to make significant

capital investments in a short period of time to meet the needs of

Intel.

The company invested $10 million in real estate and capital

equipment to accommodate the new project, a significant capital

outlay for a firm of its size. They were able to successfully meet

Intel’s goals and, from a business and technological standpoint, the

venture was a success.

But from a tax standpoint, it became a nightmare that lasted for

years. The contract with Intel had been for a finite period, which

the company knew but, in the end, had millions of dollars of equipment that they could not put back to use right away.

They also could not expense the assets because of the depreciation schedule, unless they were to sell them off, which would prevent reuse.

The depreciation schedule did not recognize that some capital investments were destined to be short-term, or would likely have unpredictable lives, so what at first glance was an ideal opportunity

became a burden on an otherwise successful company.

They had cash flow problems for a few years and, as a result,

bumped up against issues concerning the AMT. They were forced

to leverage the company’s assets, which made for some nervous moments for executives and employees alike.

They have since bounced back, but, as the President of this firm

told me this week, ‘‘We were forced to take our focus away from

operational activities and move it to financial activities.’’

There are many more stories, many with more damaging outcomes, from across Massachusetts and the Nation. It seems that a

system which may have made sense decades ago is ripe for an overhaul to reflect the speed and flexible nature of the new economy.

Besides the economic effects on the economy, the depreciable

lives schedule has an unintended effect of suppressing investment

14

in technological areas that would have a direct impact on improving society.

One specific example is in the area of renewable energy, another

technology cluster emerging in Massachusetts. Investment in this

area is in the best interests of the United States.

New, innovative energy technology will ease our dependence on

foreign oil and help the environment. However, many clean energy

solutions are very costly and require significant private sector capital investment. They also depreciate at rates faster than traditional energy capital investments.

In this case, the depreciation structure is chilling investments in

renewables, which delays important discoveries and enhancements

that would benefit our environment, economy, and national security.

We would urge you to consider at least five recommendations,

some of which you have heard: update the seven depreciable categories to better reflect the useful life of an array of technology

equipment, like computers, which experts have suggested depreciate twice as fast as traditional assets.

Second, consider partial expensing or reducing the statutory rate

to promote more efficient allocation of capital.

Third, allow a 50-percent tax depreciation deduction in the first

year of service and the balance over the standard life.

Fourth, grant the Treasury Department flexibility in categorizing

assets based on technological capabilities.

Finally, reinstate the bonus depreciation that ended last year.

We look forward to working with the committee to craft a plan

that encourages investment in economic growth in a way that reflects the competitive realities of the 21st century economy.

Thank you for your time. I would be happy to answer questions.

[The prepared statement of Mr. Anderson appears in the appendix.]

Senator SMITH. Thank you very much, Mr. Anderson. We appreciate all of you so very much for—both from practical experience

and long study, writing, and thinking on these issues—adding

much to the Senate record today in our efforts to craft a fair and

accurate depreciation system.

But as we contemplate doing this, again, there is no partisan difference in this. We are anxious to do it, to do it right, and in a way

that advances the interests of the American economy.

But even if we do it right, I come back to the AMT question. If

we do it right, does it not just simply re-raise the specter of AMT,

of wiping out any good that we may do here? Does anybody have

any comments on that?

Mr. SIMONSON. Absolutely. I think there is a real danger that we

take too many partial steps and fail to see the unintended consequences, and the AMT is a great example of that, where it was

enacted, of course, to get at a few high-income taxpayers who had

made legal use of the tax system, but it just seemed inequitable to

lawmakers to allow them to pay no tax. So, a set of complicated

rules were drafted and added to, and now we are facing the prospect of tens of millions of ordinary, middle-income taxpayers paying

that.

15

At the same time, corporate AMT has been developed and much

less publicized, but it is also a hidden drain on the talent and

money of millions of businesses.

Senator SMITH. The truth is, a lot of people would regard depreciation as a loophole, the kind of loophole that AMT was designed

to stop. I was not here, fortunately, to vote on such a horrible proposal, but I am sure what AMT was designed to say is, whether

you are profitable or not, you ought to pay something.

People were using many kinds of loopholes that deserved to be

closed. But, clearly, depreciation reflects—should reflect—reality.

But, as we are seeing now, it no longer does, because it is a very

antiquated system for a much different world than we live in.

Dr. GRAVELLE. Senator, as you know, in 1997, they did move the

depreciation provisions closer together. That was the biggest preference in the corporate Alternative Minimum Tax.

So, certainly, if you want to move in the direction of eliminating

or reducing the presence of the Alternative Minimum Tax, further

steps in that direction could be taken and they could be taken to

different degrees to deal with any revenue costs.

I think you would be very hard-pressed to find economists who

thought the AMT was a good idea. But it is also true that, at the

time it was enacted, we also enacted Safe Harbor Leasing and

some very accelerated depreciation, which caused a public perception that, for example, big corporations were paying less than ordinary individuals.

That was sort of a short-term thing that was fixed in 1982. So,

in a sense, one of the things that caused us to embark on this Alternative Minimum Tax has actually disappeared, in any case.

So I think the biggest problem is the revenue. If you were to just

repeal it outright, you have all these accumulated credits that

firms have that would be very costly in a single year. But if you

move depreciation closer together, then it would work its way out

slowly over a period of time. So, there are different options for dealing with that.

The other thing is, if you decide to repeal the individual AMT at

some point—and certainly there is a lot of concern about the number of taxpayers who are going to be paying the AMT—then that

certainly would be a time you would want to look at the corporate

AMT, because unincorporated businesses are going to be basing

their calculations on the individual AMT.

Senator SMITH. Paying individual rates. Absolutely.

Mr. Mikrut, when you talked about the significant problems with

the current tax depreciation system, would you identify the complexity you spoke of as the biggest difficulty, or just its antiquation?

Mr. MIKRUT. Well, I think sometimes these issues go hand in

hand. The antiquation of the system creates some of the complexities. If you have a new or emerging industry or a new or emerging

technology, they have to classify into whatever class lives they fit,

and that is an outgrowth of the outdated system.

I think Dr. Neubig mentioned telecommunications as an example. When the class lives were first set up, there was no such thing

as wireless telecommunications, so the wireless systems and all the

16

underlying assets for wireless have had to fit into the various class

lives. Those class lives generally are 10 to 16 years.

Class lives were developed when telecommunications was a regulated business. There was no turnover, there was no competition,

so the old class lives do not reflect economic depreciation.

Outside of that, probably the greatest record-keeping or complexity burden is with respect to the AMT. Under the AMT, one

must calculate depreciation a second or third time. In addition, one

must calculate depreciation on an asset-by-asset basis, as opposed

to trying to create a mass asset account where all your assets are

treated as one, and to which one depreciation rate applies.

Senator SMITH. Do any of the others have comments on AMT as

it overlies this issue of depreciation?

Mr. ANDERSON. Mr. Chairman, I just might add that the technology community typically views its employees as its best assets.

And Senator Kerry, I think, is familiar with some of the unintended consequences, when there are stock options, at best, as to

what happens to an employees’ tax liability that may get caught up

under the AMT, so, clearly, there is some interest in reforming or

eliminating the personal AMT.

But the corporate AMT is also an inhibitor of growth. If we could

try to give some boost to investing in capital assets in an extremely

competitive international economy that continues to be more so

each and every day, then I think you are on the right track.

This may, as mundane as it might be to most people back home,

certainly have an impact on where dollars are invested, how rapidly they are invested, and what kind of jobs resulted from that.

So, I think there would be a tremendous amount of interest in pursuing some implementable reform in that regard.

Senator SMITH. I just have one other question, and then I will

turn it over to Senator Kerry. That is, are any of you familiar with

our foreign competitors and their tax laws on depreciation that represent good models or give them competitive advantages relative to

us?

Dr. GRAVELLE. The last I knew, at least the German and Japanese depreciation systems were actually less generous than ours.

Britain, for a time, had expensing, but I think they abandoned that

at some point.

Senator SMITH. And went back to depreciation?

Dr. GRAVELLE. Went back to depreciation, because they had such

technical problems with it.

Senator SMITH. I see.

Dr. GRAVELLE. So everybody is struggling with the same problem

of trying to deal with lots of different differentiated assets and still

give taxpayers simple enough rules, as Ken puts it, so they do not

change constantly. So, they are all struggling.

The Germans and the Japanese originally inherited their depreciation system from ours, which was from the 1950s. I think, for

a long time, they did not change it. They might have since then.

But I can look into that issue.

Senator SMITH. I would be interested to know. I am obviously

anxious to see our businesses be competitive in this global economy.

Senator SMITH. Any other comments?

17

[No response.]

Senator SMITH. If not, then Senator Kerry?

Senator KERRY. Thank you, Mr. Chairman.

Let me try to see if I can clarify a few things, at least in my own

mind. There is a complete consensus here, on this side of the table

and that side, that the system is broken.

There is a complete consensus that we need to change the current class designation, life, and the recovery period. What there is

not a consensus on—yet, anyway, I think—is who ought to do it,

and how it gets done, and what specifically is done.

Mr. Anderson, you mentioned, we have to update the categories.

We have to do partial expensing and the 50-percent depreciation in

the first year, and so forth. More flexibility to Treasury, which is

different from what Dr. Neubig said, which was to basically give

all the flexibility to Treasury. Am I correct?

Dr. NEUBIG. Not completely. But a lot of flexibility to Treasury.

Senator KERRY. Where do you draw the line?

Dr. NEUBIG. The way that the advanced depreciation agreement

would be set up, it is voluntary. So you would probably see taxpayers and industries only coming in if it was going to shorten the

depreciation lives.

Senator KERRY. Well, let me sort of get to the threshold question.

Should we be setting about to establish new, specific categories or

do we establish general categories? In other words, do we give a

class life to a specific area? For instance, I did.

In the last two Congresses, I introduced small business legislation that specifically shortened from 5 years to 3 years the life on

computers. So, we specifically took a category, we gave it a life, and

said, here it is. Now, that is Congressional designation. Are you for

that or against that?

Dr. NEUBIG. I think the legislature should always be able to

change policy. I also think that it makes sense to have some administrative flexibility that the Service and Treasury have for all

other types of tax issues.

They have flexibility in terms of dealing with valuation issues,

with transfer pricing issues, with capitalization issues, and to just

wall off class life depreciation does not make sense to me.

Senator KERRY. Well, the truth is, there is a public policy component to class life designation. I would be very wary about giving

up to the Treasury Department, no matter whose it is, that ability

to fully out-flex the Congress, so to speak. Because the way the system gets gamed, you wind up with a whole bunch of people who

start setting up specialized ways of sheltering income or playing

games.

How do you prevent that and still have an adequate certitude

and rapidity of reaction to the marketplace? I mean, you cannot

come back to Congress and change this every 6 months when a

raging, new technology comes out that is going to hugely change

capitalization and expectations.

So, is there a balance? I am trying to figure out, sort of, what

is the best balance? My instinct is, we have to set basic classes. We

have to sort of establish what categories, anyway, may fit in and

perhaps even establish some guidelines and structure so that

Treasury has the flexibility, but without the ability to game the

18

system. Does that make sense? I see your head nodding, Mr. Anderson.

Mr. ANDERSON. Yes. Actually, you are recognizing the conundrum. I find it difficult to suggest that you should have the responsibility of identifying the classes, unless you want to spend full

time overseeing the constantly evolving changes and introduce legislation every few months.

On the other hand, anybody could have reasonable concern about

whose Treasury Department it is that has all the flexibility to

make changes at will without your involvement.

Senator KERRY. Incidentally, that can wind up being as much of

a roulette audit system as anything else. Correct?

Mr. ANDERSON. Correct.

Dr. GRAVELLE. Historically, the Treasury had this administrative

authority. I mean, a lot of the depreciation innovations that came

about in history were the Treasury. The 1962 guidelines. Some of

them were legislative, some of them were regulatory.

Your point is, if you want fine tuning, for Treasury to do fine

tuning, then you might want to say, first we have to figure out

what our objective is that they are going to match, and perhaps

have some kind of oversight authority.

Of course, none of that would preclude explicit legislative

changes to enact policy. But as you can see from the effective tax

rates that I presented in my study, if you had a policy of making

the effective tax rate the statutory rate, you would be lengthening

a lot of equipment lives.

But you may not want to do that, so you may just want to have

a rule that says, all right, group like assets together. So, do not let

a short-lived asset be in a long-lived category when there are other,

similar assets. I guess that is one kind of guideline.

But I think it is true, there is a policy issue here. If Treasury

is going to be given authority, it has to be within whatever policy

you are trying to pursue, whether it is neutrality or some kind of

subsidy for certain assets.

Senator KERRY. What are the products and/or categories that

most rapidly come to your mind, in some order of priority, that you

think are most out of sync right now?

Mr. MIKRUT. I think most of the high-tech assets that have developed since Treasury has done their last studies, so computers,

telecommunications, and other applications of computers in various

industries.

Mr. ANDERSON. I would agree with that.

Senator KERRY. Do you have a recommendation for what the life

ought to be?

Mr. MIKRUT. Not being an economist, no. But I think, to go back

to your prior question, a process ought to be set up. I think Treasury has demonstrated the ability to do it.

As Dr. Gravelle has said, they have been the traditional arbiters

of determining depreciation allowances. I also believe the Congress

should have a significant role in this. Congress, should they give

Treasury the authority to change lives, should direct which assets

they should review first and give priority to those studies.

I think there should be some sort of Congressional oversight of

the Treasury recommendations before they go into effect. That way

19

you would have the give and take that you traditionally have in

these sorts of broad policy matters.

Dr. GRAVELLE. Actually, if you would, let me talk about an asset

that is the other way, that has probably been given too short a

life—that is from the NIPA depreciation that is in my testimony—

which is commercial aircraft. Commercial aircraft are in the shortlife class, but they are very long-lived assets.

Senator KERRY. That is what I mean about pushing the system.

Dr. GRAVELLE. Right. Well, at the time that these were assigned,

they were mapped into the old ADR guideline lives. So, wherever

they were, that is where they fell in the new system.

Senator KERRY. That was a specific economic decision, too,

though, to try to increase aircraft sales and make it particularly attractive to people to be able to purchase. The accelerated depreciation on certain aircraft has, indeed, accelerated the sales of those

aircraft very significantly.

Dr. GRAVELLE. But if there is a place where the evidence suggests that they are favored, all you have to do is look in the column

in Table 3 of my testimony, and if the tax rate is low there, then

that suggests they are being——

Senator KERRY. Is there an economic purpose test that we ought

to apply also, just as I described? You have an industry, you are

trying to help it be competitive. You are prepared to give it an accelerated depreciation because it makes it particularly competitive,

even though it does not adequately reflect the life?

Dr. GRAVELLE. No. The economic analysis says, unless you can

find some market failure or market imperfection—we call them

failures; it is not really a failure, they just do not work well—you

should be neutral. But, of course, being neutral, the tax system is

kind of hard to come by because we do have some assets, like unoccupied housing, that are very favored, no matter what else we do.

So, you are always in a second-best world about what you want to

do.

Senator KERRY. My last question, because the light is on: if we

were to, say, embrace the broad range of technology assets that we

currently know we have—wireless, computers and so forth, hardware, et cetera—is there any guesstimate or estimate as to what

the lost revenue would be as a consequence of that? What are we

dealing with? What are we looking at budget-wise, fiscally?

Dr. GRAVELLE. Going from 5 years to 3 years, or something like

that?

Senator KERRY. Yes, or even less.

Dr. GRAVELLE. That is a lot of money in the short run. I do not

know.

Dr. NEUBIG. I have not seen estimates of it. I guess that raises

the issue that, where you have assets that have too long of a life,

what everybody agrees is too long of a life, and you have Congress

enact legislation, it will be scored as losing revenue. That is a big

hurdle to overcome.

The conventions of budget scoring would be, if IRS changes the

regulation, yes, it would reduce cash flow to the Treasury, but it

would not be scored for legislation.

Senator KERRY. Not be scored.

20

Dr. NEUBIG. So, one of the impediments to trying to correct these

technical and factual issues through legislation is, you have this

extra hurdle.

Senator KERRY. The scoring beast to get over.

Senator SMITH. If I may.

Senator KERRY. Go ahead. Yes.

Senator SMITH. If it is a short-term hit that CBO has to score,

it all washes out in the end. I mean, it is not ultimately really costing anything.

Dr. GRAVELLE. Going from 5 years to 3 years in a 10-year budget

horizon will be negligible, I would think.

Dr. NEUBIG. I think it would have a significant revenue effect,

because, even though it does switch, as long as the assets are growing, there will be a positive revenue loss associated with it. Clearly,

there is a benefit to having 3 years compared to 5 years. It is time

value of money, and that shows up in significant differences in effective tax rates.

Senator SMITH. It also shows up in significant additional economic activity.

Dr. GRAVELLE. A bunch of numbers are not discounted, though,

so you are not going to pick up budget numbers that discount that.

Senator KERRY. Right. We never get the plus side, we only get

the down side.

Dr. GRAVELLE. Right. I mean, I could look into that for you as

well, if you are interested, about what, say, switching that particular class from 5 to 3 years might look like. The Joint Tax Committee, of course, is the official revenue estimator.

Senator SMITH. Well, the conundrum that Senator Kerry and Mr.

Anderson spoke of, really, is that we have to find some kind of balance between the legislative and executive branch that gives some

authority to us, but also the ability, budgetary ability, to make

these adjustments in a way that expands the economy without

hampering our ability to proceed.

Mr. SIMONSON. Unfortunately, there have been cases where Congress has turned to depreciable lives as a way to raise revenue.

Twice, the depreciation period for rental housing and for non-residence structures was lengthened significantly, and that caused a

lot of collateral damage, shall we say, for the construction industry,

which was geared up to expect a certain level of investment, and

then the props were knocked out from under them.

Senator KERRY. Didn’t that happen in the 1986 bill?

Mr. SIMONSON. And subsequent bills, yes.

Dr. GRAVELLE. 1993 was when they increased the depreciation

period from 31.5 to 39 years for non-residential structures, and I

think it was to pay for loosening of passive loss.

Mr. SIMONSON. Correct.

Dr. GRAVELLE. It was during that period when you had very

tight budget problems. Not to say that we do not have them now.

Mr. SIMONSON. So, I think to the extent that Congress is willing

to let Treasury make adjustments—and I think Tom Neubig’s suggestion to have this negotiation or advanced-depreciation agreement process in place, and also something like the IRS’s current industry resolution program that allows addressing relatively small,

manageable, well-bounded problems administratively—I think that

21

you can cure some injustices without opening the floodgates to

huge revenue losses or wholesale disruptions of the tax system.

Dr. GRAVELLE. It is an asymmetric approach, though.

Mr. SIMONSON. Yes.

Dr. GRAVELLE. You are only going to do it if you want a shorter

life. So if your objective is to implement a certain kind of policy,

in terms of what kind of effective tax rates you want, what kinds

of assets, or who you want to encourage, you have to make something explicit.

Senator KERRY. Picking up on Senator Smith’s question earlier,

I was not sure if it was the same question or not, but in Europe,

in the emerging economies, how are they treating it? Do they have

depreciation?

Dr. GRAVELLE. If they have a corporate tax, I am sure they do.

Senator KERRY. On the same balance, though?

Senator SMITH. And how about Estonia, Ireland, and some of

these countries that are going to flat rates and things like that?

Dr. NEUBIG. My understanding is that they all have depreciation.

Again, the devil is in the details. A number of them have different

recovery periods. I have seen some studies that contrast the U.S.

versus other countries’ treatment of equipment, and there is disparity.

Senator KERRY. Could I suggest to the staff that I think it is

going to be impossible for us to do this in an intelligent way, that

is sensitive to our economic and competitive structure, without

doing a thorough analysis and seeing what the competition is doing

abroad.

Mr. ANDERSON. I agree.

Senator SMITH. It would be easy enough to find out, certainly

from technology firms, many of which are in Massachusetts, that

are thriving in places like Ireland and elsewhere around the world

that can capture that information for you, Senator.

Senator KERRY. We need to just make a call.

Senator SMITH. Do you have any other questions, John?

Senator KERRY. No.

Dr. GRAVELLE. There are past studies that I could find. The problem is getting up-to-date information on other countries. But we

can certainly look into that for you.

Senator SMITH. That would be very helpful. To do this right, we

have to do it in the context of the world in which we live, and that

is the globalized world. So, notwithstanding our budget strictures,

we have to also keep our eye on what our competitors are doing.

Dr. GRAVELLE. Maybe we could get Ernst & Young’s best resources to help us on that.

Senator SMITH. Yes. Get into Ernst & Young’s vast treasury, I

am sure. [Laughter.]

Ladies and gentlemen, this, to me, has been an interesting hearing, and very helpful. You have added measurably to our Senate

record and our understanding, and we recognize the need to do

something. It is certainly, I think, a very bipartisan recognition,

and we will proceed to that end. You have been helpful, and we are

thankful.

We are adjourned.

[Whereupon, at 3:43 p.m., the hearing was concluded.]

(23)

A P P E N D I X

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

41

42

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

80

81

(83)

COMMUNICATIONS

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

100

101

Æ