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TAX REFORM OPTIONS: INCENTIVES FOR CAPITAL 

INVESTMENT AND MANUFACTURING 

HEARING 

BEFORE THE

COMMITTEE ON FINANCE 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

MARCH 6, 2012 

( 

Printed for the use of the Committee on Finance 

COMMITTEE ON FINANCE 

MAX BAUCUS, Montana, Chairman 

JOHN D. ROCKEFELLER IV, West Virginia 

KENT CONRAD, North Dakota 

JEFF BINGAMAN, New Mexico 

JOHN F. KERRY, Massachusetts 

RON WYDEN, Oregon 

CHARLES E. SCHUMER, New York 

DEBBIE STABENOW, Michigan 

MARIA CANTWELL, Washington 

BILL NELSON, Florida 

ROBERT MENENDEZ, New Jersey 

THOMAS R. CARPER, Delaware 

BENJAMIN L. CARDIN, Maryland 

ORRIN G. HATCH, Utah 

CHUCK GRASSLEY, Iowa 

OLYMPIA J. SNOWE, Maine 

JON KYL, Arizona 

MIKE CRAPO, Idaho 

PAT ROBERTS, Kansas 

MICHAEL B. ENZI, Wyoming 

JOHN CORNYN, Texas 

TOM COBURN, Oklahoma 

JOHN THUNE, South Dakota 

RICHARD BURR, North Carolina 

RUSSELL SULLIVAN, Staff Director 

CHRIS CAMPBELL, Republican Staff Director 

(II) 

(III) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee 

on Finance ............................................................................................................ 1 

Hatch, Hon. Orrin G., a U.S. Senator from Utah ................................................. 3 

Grassley, Hon. Chuck, a U.S. Senator from Iowa ................................................. 18 

WITNESSES 

Gravelle, Dr. Jane G., Senior Specialist in Economic Policy, Congressional 

Research Service, Washington, DC ..................................................................... 5 

Brannon, Dr. Ike, director of economic policy and congressional relations, 

American Action Forum, Washington, DC ......................................................... 6 

Atkinson, Dr. Robert D., president, Information Technology and Innovation 

Foundation, Washington, DC .............................................................................. 8 

Foster, Dr. J.D., Norman B. Ture senior fellow in the economics of fiscal 

policy, The Heritage Foundation, Washington, DC ........................................... 10 

Hanlon, Dr. Michelle, associate professor of accounting, Sloan School of Management, Massachusetts Institute of Technology, Cambridge, MA ................. 12 

ALPHABETICAL LISTING AND APPENDIX MATERIAL 

Atkinson, Dr. Robert D.: 

Testimony .......................................................................................................... 8 

Prepared statement .......................................................................................... 37 

Responses to questions from committee members ......................................... 54 

Baucus, Hon. Max: 

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

Prepared statement .......................................................................................... 59 

Brannon, Dr. Ike: 

Testimony .......................................................................................................... 6 

Prepared statement .......................................................................................... 61 

Foster, Dr. J.D.: 

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

Prepared statement .......................................................................................... 67 

Responses to questions from committee members ......................................... 77 

Grassley, Hon. Chuck: 

Opening statement ........................................................................................... 18 

Letter from Senator Grassley to President Obama, dated August 11, 

2011 ................................................................................................................ 81 

Letter from Emily S. McMahon, Department of the Treasury, to Senator 

Grassley, dated October 3, 2011 .................................................................. 84 

Gravelle, Dr. Jane G.: 

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

Prepared statement .......................................................................................... 86 

Responses to questions from committee members ......................................... 101 

Hanlon, Dr. Michelle: 

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

Prepared statement .......................................................................................... 106 

Responses to questions from committee members ......................................... 114 

Hatch, Hon. Orrin G.: 

Opening statement ........................................................................................... 3 

Prepared statement .......................................................................................... 121 

Rockefeller, Hon. John D., IV 

Prepared statement .......................................................................................... 123 

Page

IV 

COMMUNICATIONS

The Association of Equipment Manufacturers ...................................................... 125 

Center for Fiscal Equity .......................................................................................... 127 

Reforming America’s Taxes Equitably (RATE) Coalition ..................................... 133 

Third Way Progressives .......................................................................................... 136 

(1) 

TAX REFORM OPTIONS: INCENTIVES FOR 

CAPITAL INVESTMENT AND MANUFACTURING 

TUESDAY, MARCH 6, 2012 

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC. 

The hearing was convened, pursuant to notice, at 10:03 a.m., in 

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus 

(chairman of the committee) presiding. 

Present: Senators Rockefeller, Wyden, Cantwell, Carper, Hatch, 

Grassley, Coburn, Thune, and Burr. 

Also present: Democratic Staff: Russ Sullivan, Staff Director; Lily 

Batchelder, Chief Tax Counsel; Holly Porter, Tax Counsel; and 

David Hughes, Senior Business and Accounting Advisor. Republican Staff: Chris Campbell, Staff Director; Tony Coughlan, Tax 

Counsel; and Maureen McLaughlin, Detailee. 

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR 

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE 

The CHAIRMAN. The committee will come to order. 

Warren Buffett once said, ‘‘It has never paid to bet against America.’’ From Montana’s lumber, to Michigan’s automobiles, to California’s semiconductors, American products have always been worldclass, and U.S. manufacturing remains critical to the long-term 

strength of the American economy. Make no mistake, ‘‘Made in the 

USA’’ still matters. 

The reasons are simple: manufacturing creates jobs, and manufacturing pays good wages. The average wage at a manufacturing 

company is 20 percent higher than those in the wider economy. 

These wages give Americans the purchasing power to help their 

family and the entire economy. 

Manufacturing also spurs innovation, and it generates related 

jobs for engineers, scientists, designers, shippers, and many others. 

In fact, though manufacturers accounted for only 11 percent of the 

GDP in 2008, they contributed 68 percent of U.S. corporate spending on research and development. In 2010, manufacturing employed 35 percent of all engineers in this country. If we want these 

jobs to stay in the United States, we need manufacturing to stay 

here. 

U.S. manufacturing is essential to America’s economic stability. 

It is critical to U.S. innovation, to our national security and intellectual property, and it is central to our balance of trade. So manufacturing is key to our competitiveness in the world and our economic growth. 

2 

* For more information, see also, ‘‘Background and Present Law Relating to Cost Recovery and 

Domestic Production Activities,’’ Joint Committee on Taxation staff report, February 27, 2012 

(JCX–19–12), https://www.jct.gov/publications.html?func=startdown&id=4401. 

Despite its importance, manufacturing is a declining percentage 

of our economy. After World War II, manufacturing made up more 

than one-quarter of our economy’s total output, and today makes 

up just a tenth. We need to stem this downward trend, and we 

should consider the best ways to do so through tax reform. 

There are numerous incentives in the tax code to encourage manufacturing, and there are many provisions to boost capital investment in the United States generally. Manufacturers claim more 

than one-quarter of the capital investment incentives. We need to 

ensure that these tax incentives are effective to make sure we are 

getting the most bang for our buck. 

These incentives include accelerated depreciation and expensing 

provisions. Accelerated depreciation is currently the largest business tax expenditure. In some cases, bonus depreciation and section 179 allow companies to fully write off the cost of equipment 

in the year placed in service. 

The tax code also provides special depreciation schedules for everything from racehorses and NASCAR racetracks to corporate jets. 

America’s depreciation rules are some of the most generous among 

developed countries. Only Greece, Italy, and Portugal are more favorable. 

Faster depreciation, however, helps to offset the United States’ 

higher statutory corporate tax rate. As we work to make our corporate tax rate more competitive, we must carefully examine 

changes to our current depreciation system and strike the right 

balance. 

Today we will ask whether these policies are working to encourage broad-based economic growth and job creation. Do they spur investment in the United States’ economy? Are they more effective 

than a rate reduction with the same cost? 

We will also discuss the deduction for domestic production activities, which was enacted in 2004. This provision reduces the effective tax rate on manufacturing activity by 3 percentage points, but 

unfortunately, even with this provision, manufacturing has still declined. 

There is no single cause for the struggles of U.S. manufacturing 

in recent years. Some argue that low labor costs and the availability of technically skilled employees have pushed manufacturing 

overseas. Others say that technological improvements and increases in productivity may have reduced the need for workers in 

the U.S. 

But we cannot give up on American manufacturers. We need to 

determine whether the current incentives adequately address the 

existing challenges, or whether there are simpler, more effective 

ways to encourage manufacturing and investment in the United 

States. 

So let us find the best and the most efficient ways to boost American manufacturing. Let us ensure that our tax code is helping 

businesses create jobs here at home. Let us keep the ‘‘Made in 

USA’’ label strong.* 

3 

[The prepared statement of Chairman Baucus appears in the appendix.] 

The CHAIRMAN. Senator Hatch? 

OPENING STATEMENT OF HON. ORRIN G. HATCH, 

A U.S. SENATOR FROM UTAH 

Senator HATCH. Thank you, Mr. Chairman. Thank you very 

much for calling this hearing on tax reform and its relationship to 

manufacturing and capital investment. The manufacturing sector 

remains a critical segment of our economy. For the year 2010, the 

manufacturing sector generated about $1.8 trillion in Gross Domestic Product. The United States still has the world’s largest manufacturing sector. If it were a separate economy with its own GDP, 

the U.S. manufacturing sector would be the world’s 9th-largest 

economy. 

At the same time, America’s manufacturing sector is not static, 

and it has experienced significant changes in recent decades. Manufacturing jobs have been in decline for a number of years. In 1979, 

manufacturing employment peaked at about 19.6 million workers. 

In 2010, manufacturing employment was about 11.5 million workers. 

Coupled with this decline in U.S. manufacturing jobs is a decline 

in U.S. manufacturing as a percentage of GDP, from about 27 percent of GDP in the 1950s to about 11 percent in 2010. Much of the 

decline in manufacturing jobs is due to increased productivity and 

automation. Because U.S. workers are among the most productive 

in the world, the number of manufacturing jobs necessary to 

achieve similar outputs has declined. 

However, part of the decline in the U.S. manufacturing is also 

due to offshoring. In a recent survey of 287 manufacturing companies, labor costs were listed as the most important factor in selecting locations for manufacturing operations or supplier operations. 

U.S. labor costs are significantly higher than labor costs in many 

countries around the world. 

After labor costs, the next three most important factors identified 

in the survey were proximity to the market, skills in the workforce, 

and taxes. As a result, taxes can play an important part in a company’s decision about where to locate its manufacturing operations. 

In the United States, we have a top corporate tax rate of 35 percent. When coupled with State corporate taxes, a U.S. corporation 

may face a marginal tax rate of 39 percent, which is the secondhighest corporate tax rate in the world, behind Japan. 

I want America to be the leader in many areas, including manufacturing, but having one of the highest corporate tax rates in the 

world is something that just does not work. 

In 2004, Congress enacted a deduction for manufacturers that reduces their effective tax rate by about 3 percentage points. But we 

need to do more, much more. We need to bring the corporate tax 

rate down to a level in line with other OECD countries. We need 

to reform our tax system to make our U.S. companies, including 

manufacturers, more competitive with the rest of the world. 

Closely related to manufacturing, of course, is capital investment. We have a number of tax incentives with respect to capital 

investment. Some of these incentives are relatively new, such as 

4 

bonus depreciation, but other incentives are quite old, such as the 

current accelerated depreciation rules that date back to 1986 and 

even earlier. Still other tax incentives seem to go in and out of the 

tax code, such as the Investment Tax Credit, which was first enacted in 1962 and was last in effect in 1985. 

When dealing with tax incentives, the focus seems to be on 

whether the incentives are achieving their intended purposes. Do 

these tax incentives enhance economic growth? How much bang for 

the buck are we getting from the various tax incentives for capital 

investment? For example, one recent economic paper suggests that 

the investment tax credit may be a better incentive for capital investment than accelerated depreciation. 

Sometimes tax incentives for capital investment are viewed as 

interchangeable with a corporate tax rate cut, yet they are really 

two separate issues. First, a corporate tax rate cut would not affect 

many small businesses that are conducted as partnerships, S corporations, or limited liability companies, et cetera. Second, a corporate tax rate cut affects both old and new corporate capital, while 

expensing and accelerated depreciation affect only new capital. 

Finally, as we go about our business today, I think it is important for us to recall the damage that is done to the manufacturing 

sector not only by tax policy, but by over-regulation. We should not 

lose sight of underlying issues, such as environmental and labor 

policies that artificially drive up the cost of labor, distort resource 

allocations, and make America an unnecessarily costly place to do 

business. 

Mr. Chairman, we have a great panel here. We have some very 

learned economists and a prominent accounting professor with us 

today, and I for one am looking forward to their testimony. 

Thank you. 

The CHAIRMAN. Thank you, Senator. 

[The prepared statement of Senator Hatch appears in the appendix.] 

The CHAIRMAN. I would now like to introduce our witnesses. 

First is Dr. Jane Gravelle. Dr. Gravelle is a Senior Specialist in 

Economic Policy in the Government and Finance Division of the 

Congressional Research Service. Thank you very much, Dr. 

Gravelle, for being here. You have testified many times. You are 

well-known and very highly regarded. Thank you very much. 

Next is Dr. Ike Brannon. Dr. Brannon is the director of economic 

policy and congressional relations at the American Action Forum 

Policy Institute. Dr. Brannon, thank you very much for taking the 

time to appear. 

The third witness is Dr. Robert Atkinson, founder and president 

of the Information Technology and Innovation Foundation. We look 

forward to hearing what you have to say. 

Fourth is Dr. J.D. Foster, senior fellow in the economics of fiscal 

policy at The Heritage Foundation. Dr. Foster, thank you. 

Finally, we have Dr. Michelle Hanlon. Dr. Hanlon is associate 

professor of accounting at MIT’s Sloan School of Business. 

We will begin with you, Dr. Gravelle. You know the drill here. 

Your statements will automatically be included in the record, and 

we would like you to summarize them. We have five witnesses this 

morning, so I encourage you in two respects. One, keep within your 

5 

5 minutes if you could, please, and second, just say what you think. 

Let ’er rip. Do not pull any punches, all right? 

Dr. Gravelle? 

STATEMENT OF DR. JANE G. GRAVELLE, SENIOR SPECIALIST 

IN ECONOMIC POLICY, CONGRESSIONAL RESEARCH SERVICE, WASHINGTON, DC 

Dr. GRAVELLE. Thank you very much. 

Although much attention has been focused on statutory tax rates 

compared to tax rates in other countries, tax burdens on investment are influenced by provisions that affect the tax base. In fact, 

effective tax rates in the United States are similar to those in the 

rest of the OECD. 

Rules for measuring the tax base, as well as the rate, affect tax 

burdens. This is a central issue of any tax reform, including one 

that is revenue-neutral: the need to balance rate reductions and 

base broadening. 

I review the most significant provisions associated with capital 

investment and with manufacturing: accelerated depreciation and 

the production activities deduction. Accelerated depreciation will 

normally cost about $35 billion a year after eliminating the bonus 

depreciation effects. The production activities deduction costs about 

$15 billion a year. 

Accelerated depreciation could be liberalized by continuing some 

form of bonus depreciation, or it could be limited to finance a rate 

reduction or raise revenue. Bonus depreciation was intended as a 

temporary stimulus. Based on estimates of overall effective tax 

rates for equipment, currently at 26 percent, effective tax rates 

would fall to 15 percent for permanent 50-percent expensing, and 

all the tax rates I discuss are compared at the 35-percent statutory 

rate. They do not include the production activities deduction. 

The cost of 50-percent bonus depreciation is estimated at around 

$30 billion annually in the steady state, although this cost could 

be reduced if it were targeted more narrowly. 

Most evidence suggests that investment incentives are actually 

not very effective in stimulating investment. Also, given that the 

evidence suggests domestic savings is relatively unresponsive to increases in returns, investment diverted into equipment would be 

withdrawn from other uses. 

A reduction might attract investment from abroad, but the estimated effects of that inflow on capital income are actually small. 

My study estimated that a large change, lowering the rate to 25 

percent, would increase output by only two tenths of 1 percent of 

GDP, and national income or national welfare by 2 one-hundredths 

of a percent. Now, these are small, but the corporate tax as a percent of GDP is also quite small, only about 2 percent. 

Much of the discussion about corporate tax reform, however, proposes to use tax expenditures to finance rate reduction. Eliminating the tax expenditure for equipment would raise the tax rate 

on equipment from 26 percent to 36 percent, and the tax rate for 

manufacturing equipment from 24 percent to 36 percent. There is 

also a more limited CBO option that would raise the rate by about 

the same amount. 

6 

Some of the increased burden would be offset if the statutory tax 

rate were lowered; however, revenue raised in the budget horizon 

is almost twice the size of revenue in the steady state from depreciation. It is a timing provision. 

Some of this revenue is for unincorporated business, so only 

about a 2 percentage-point reduction would be possible in a steady 

state, revenue-neutral corporate tax change. I have more details 

about options in my testimony. It would be about 1 percentage 

point with the CBO option. 

The effective tax rate would rise, because corporate rate cuts provide a larger windfall. They affect existing capital as well as new 

investment. These calculations illustrate the trade-offs in using depreciation changes to offset rate reductions. A more neutral set of 

tax rates is obtained, and the headline statutory rate is reduced, 

but the burden on new investment is increased. 

The production activities deduction, costing about $15 billion 

with about 35 percent projected to go to unincorporated businesses, 

would allow about an 8 tenths of a percentage-point reduction in 

a revenue-neutral corporate tax change. 

It has been criticized as distorting the treatment of different industries by granting differential tax rates, and by creating administrative problems. Corporate manufacturing receives only 44 percent 

of this benefit. This deduction is more likely to apply to multinationals because of the industry restrictions, and it may be more 

targeted to international concerns. We can never be certain about 

any policy. 

It is doubtful, however, that this issue outweighs the drawbacks 

of the provision, making this change a good candidate for revenue 

raising. One option is to limit the benefit to corporate manufacturing, which will recoup more than half the revenue loss, and 

limit the number of firms affected by the complexity. 

Thank you. 

The CHAIRMAN. That was very interesting. Thank you very 

much. 

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

The CHAIRMAN. Dr. Brannon? 

STATEMENT OF DR. IKE BRANNON, DIRECTOR OF ECONOMIC 

POLICY AND CONGRESSIONAL RELATIONS, AMERICAN ACTION FORUM, WASHINGTON, DC 

Dr. BRANNON. Mr. Chairman, Senator Hatch, thank you very 

much for having me here. Let me try not to summarize just my testimony, but briefly try to opine on everybody else’s thoughts here. 

The American Action Forum, along with the ITIF Foundation, actually did a very similar panel on this back in August, so I think 

almost all of us on the panel have shared our thoughts in one form 

or another. 

I think Dr. Gravelle’s attitude in terms of how corporations make 

their investment decisions is that they really do not respond all 

that much to incentives. And certainly there is some strand of literature that suggests that that is correct. 

I think Dr. Hanlon would say that they do respond to incentives, 

but they respond to entirely different incentives than economists 

7 

are comfortable talking about. They respond very much to trying 

to maximize, not the economic profit that economists are concerned 

about—and that is the profits that they share with their shareholders—but the profits that they report to the SEC, to their shareholders, and that affect their profits. 

I think Dr. Atkinson would say that manufacturers and businesses respond wildly to tax incentives, or they are very responsive 

to tax incentives, and that, if we do tax incentives right, in terms 

of our research and experimentation credit and some kind of bonus 

depreciation, we will see significant bang for the buck in terms of 

increased investment and increased economic growth. 

Three very different schools of thought, and each of them contains a little bit of certain truths to them. To me it seems that I 

am very uncomfortable in a situation where we say that people— 

firms, individuals, companies, whatever—do not respond to incentives. I think it is clear that if you lower the hurdle rate for investment, more investment will be done. It might be very little more, 

it might be a lot more, but more investment will be done. 

I also think that there are significant spill-over effects to investment, depending on where the investment occurs. So I think, since 

the relevant question going forward is, if we are reforming the tax 

code, do we reform the tax code by getting rid of all investment incentives and going for the lowest rate possible, or do we go for the 

lowest rate possible given that we need to craft certain investment 

incentives? I would go for the latter. I think not having any specific 

investment incentives would be a shame. 

And then the other question that Dr. Gravelle came to is that it 

is a very difficult political task that you have before you, if you are 

going to do something like add bonus depreciation, because if you 

do bonus depreciation or, say, full expensing, what you are doing 

is you are giving a reward solely to new capital, which is where we 

get the most bang for the buck, but then you are going to have a 

whole lot of businesses that made investments the previous year 

quite angry with you, as they should be. 

There is going to be a natural inclination for politicians to respond to that and to try to create some kind of transition rules. If 

you create transition rules that cost money, you are going to have 

to have a higher rate. All of a sudden, benefits from doing some 

kind of corporate tax reform are going to be smaller and smaller 

and smaller. 

So, to my mind, it is a very difficult political situation you have 

yourself in. I do not have the political answer, but I think the economic answer is that you want to provide, as best you can, incentives for manufacturing. To me the simple way to do that, the least 

arbitrary way to do that, is not to single out manufacturing, but 

to simply allow full and immediate expensing, allow companies to 

write off their investments right away. 

I think the advantage to that is that it does not put Congress or 

the IRS in the position of deciding what is and is not a manufacturing company. The other thing to keep in mind is, when the IRS 

sets up depreciation schedules anyway, that is somewhat arbitrary, 

if you think about it. How long do computers really last? How long 

do certain machines last? There is a little bit of empirical analysis 

going on, but a lot of it is guess work. So there is one way to conVerDate Nov 24 2008 21:04 Feb 13, 2013 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 R:\DOCS\78228.000 TIMD
8 

strue that full expensing as simply being the most logical way to 

do things. 

Then I just want to briefly respond to Senator Baucus’s statement, which I largely agreed with. One of the things that is going 

on in manufacturing, I think, in the last 30 years, is that the definition of ‘‘who is a manufacturing worker’’ has radically changed. 

I will give you one example. I am from a town called Mossville, 

IL, which is the home of a lot of Caterpillar factories. In fact, 90 

percent of the people who live in Mossville work for Caterpillar. I 

have a friend whose goal, his whole life, was to take his father’s 

job in Caterpillar as a sheet metal worker. Eventually he did that 

at the age of 38. He became a sheet metal worker for Caterpillar. 

But the way he did that is, he ended up having to get two associates degrees, a degree in engineering, and he had to become Six 

Sigma certified. When he took over his father’s job, he had to wear 

a tie, and he was in the office in front of a computer. That blue 

collar job had become a white collar job. So, transitions like that 

are actually wonderful success stories, and we need to recognize 

those. There have been a lot of changes to manufacturing in the 

last few years, and some of them have been good. 

The CHAIRMAN. Thank you very much, Dr. Brannon. 

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

The CHAIRMAN. Dr. Atkinson? 

STATEMENT OF DR. ROBERT D. ATKINSON, PRESIDENT, INFORMATION TECHNOLOGY AND INNOVATION FOUNDATION, 

WASHINGTON, DC 

Dr. ATKINSON. Thank you, Mr. Chairman and Senator Hatch. It 

is a pleasure to be here today. 

I want to put this a little bit in context, as you both did in your 

opening remarks. In the last decade, the United States has lost 32 

percent of its manufacturing employment. That is a rate of loss 

that was greater than the Great Depression. There is a popular, 

and commonly held view, that this was principally—in fact, only— 

due to superior productivity performance. 

We have new research we will be releasing in 2 weeks which argues, as a number of other economists have, that the U.S. measurement system for manufacturing output is significantly flawed, and 

that, when measured properly, manufacturing output actually declined by 11 percent in the last decade. Again, never ever a decline 

like that in American history, expect for the Great Depression. 

This is in contrast to other countries, our major competitors like 

Germany, Japan, Sweden, who have all seen stable manufacturing 

output over the last decade. So our loss is not something normal, 

it is not something that is about superior performance. It is about 

loss of international competitiveness. And we see that in particular 

with manufacturing capital stock. This is the amount of capital 

that manufacturers have. You add it all up together, and, in every 

decade from the 1950s through to 2000, that stock increased at 

minimum by 25 percent per decade. 

In this last decade, the 2000s, that capital stock increased by just 

1.2 percent. So this is, again, an unprecedented slow growth in the 

amount of capital that our manufacturers have to be competitive. 

9 

One reason for that is that companies are increasingly investing 

overseas. In 2000, U.S. multinationals invested 33 cents overseas 

for every dollar they invested in America. In 2009, that had increased to 71 cents. So there is increased competition. The reason 

they are doing that is not because they are disloyal, it is because 

other countries have put in place very aggressive incentives for 

them to move facilities and investment overseas. 

We see this in countries like Austria, Canada, France, Japan, 

Malaysia, Singapore, Taiwan, the U.K., which all have robust investment incentives to attract that kind of investment. We see it 

with a number of nations in the last 3 or 4 years, including China, 

France, Ireland, and the Netherlands, that have put in place what 

are called patent boxes. 

The U.K., for example, is set to do this next year. They will be 

taxing corporate income that is related to patents, so anything related to a patent, you get income from it. That will be taxed in the 

U.K. at a rate of 10 percent instead of the normal rate, the statutory rate of 28 percent. 

So these countries are putting in place all of these specific incentives. I would argue we have to catch up. Unfortunately, many 

economists are distrustful of these incentives, and they think they 

distort the marketplace, and therefore we should get rid of them. 

I think much of that is not based on real analysis, it is based more 

on the way they view the role of markets. 

Now, a good example of that was a study by Larry Summers and 

Alan Auerbach, two well-known economists, in 1979 for the National Bureau of Economic Research. They analyzed the effect of 

the investment tax credit. In their model, they found that the investment tax credit led to more capital investment in the United 

States in machinery and equipment, and it led to a larger GDP 

than if the credit did not exist. 

Therefore, you would expect that they would then suggest that 

Congress retain the investment tax credit. In fact, they said just 

the opposite; we should get rid of the investment tax credit because 

it is distorting capital allocation away from—get this—housing. 

So, in their model, they wanted more houses and fewer machines. I actually think our problem over the last 15 years is we 

had too much housing and too few machines, because our tax code 

favored housing and did not favor investment. 

When we get down to it, what we have to focus on is that we 

have to get more capital investment—real machines, software, computers, and other kinds of things—in our companies. One of the 

reasons we want to do that, and this is why I think the domestic 

production deduction is so important, is that we are facing increased competition from other countries. 

Other countries are competing for the highest value-added production in the world. They want to get that in their country. Many 

of the models that economists use still are based on the idea that 

we are a closed economy where we do not really compete with other 

countries. 

So, what do we need to do? I would suggest several things. One 

is retaining the domestic production deduction, section 199, if not 

expanding it, as the President has proposed. There is a widely held 

10 

view that this is a distorted deduction because it goes to companies 

that make coffee or something. 

In fact, according to the IRS, 83 percent of the value of the deductions claimed under section 199 go essentially to traded sectors, 

sectors that are in international markets: mining, manufacturing, 

and information. So, yes, it could be tighter, but still, 83 percent 

is not bad as a way to focus on those kinds of sectors. 

Second, I would encourage, as Dr. Brannon has, maintaining the 

accelerated depreciation and actually moving to either first-year expensing or an investment tax credit. Either one will help spur new 

capital investment. 

A couple of out-of-the-box ideas, then I will stop. In the last decade, U.S. companies have cut the amount that they invest every 

year in training their workers by half. So companies just simply 

are investing less money training their workers every year than 

they used to, and that is a key source of competitive advantage for 

our economy. 

The reason they are doing that is because workers are staying 

much shorter periods of time with any one employer. The amount 

of time an average worker stays in a company has fallen by about 

45 percent. I would suggest that Congress should consider expanding the research and development tax credit into what could be 

called a knowledge tax credit, and companies could get an R&D 

credit for both conducting R&D as well as expenditures on workforce training. I would also encourage you to think about a patent 

box, as many of our other competitor nations have done. 

Thank you very much. 

The CHAIRMAN. Thank you, Dr. Atkinson. 

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

The CHAIRMAN. Dr. Foster? 

STATEMENT OF DR. J.D. FOSTER, NORMAN B. TURE SENIOR 

FELLOW IN THE ECONOMICS OF FISCAL POLICY, THE HERITAGE FOUNDATION, WASHINGTON, DC 

Dr. FOSTER. Thank you, Chairman Baucus, Ranking Member 

Hatch, members of the Finance Committee. Thank you for the 

honor and opportunity to testify today. 

There is much the Federal Government could do to help the manufacturing sector today and the economy overall, a list that need 

not fall back on policy gimmicks. We would do well, for example, 

to take a long holiday from all the tax holidays. The Federal Government should adopt, in my view, a very simple guiding principle 

for deciding what to do for manufacturing and the economy overall. 

That principle is: do less harm. 

There is very little new policy government can do at this stage 

to help the manufacturing sector recover, and a great deal of intended help that would harm, either by raising the budget deficit 

to no good effect, or by creating more uncertainty and less clarity, 

and thereby slowing the natural recovery process. Do less harm 

means getting spending under control and thereby cutting the 

budget deficit. 

Americans are worried about spending and the deficit, and that 

worry by itself is holding us back. Do less harm means policyVerDate Nov 24 2008 21:04 Feb 13, 2013 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 R:\DOCS\78228.000 TIMD
11 

makers should stop threatening higher taxes on anyone. We can 

have debates about who should pay what, once we have returned 

to full employment. 

In the meantime, the threat alone is debilitating to jobs. Do less 

harm means policymakers should stop meddling with the economy. 

There is almost no limit to the harm Washington can do to the 

economy in its efforts to do something for the economy. 

The patient is in recovery, slowed by the incessant proddings and 

procedures of Washington’s policy doctors. The patient—that is, the 

economy and the manufacturing sector in particular—does not need 

another procedure or new nostrum. Let it heal. Do less harm. 

In this vein, businesses do not need new tax incentive trinkets 

to encourage them to invest today. To contribute to a more rapid 

recovery, a strong economy, including the manufacturing sector, 

businesses basically need two fundamental changes in tax policy: 

more tax certainty and fewer fundamental tax distortions. 

The foremost threat to certainty today is the President’s repeated 

insistence that certain individual income tax rates must go up. 

These rates are the rates paid by all successful profitable jobcreating businesses, including smaller manufacturers that are not 

C corporations. A jobs policy of taxing job creators more is a paradox, to say the least. 

The Federal income tax itself is rife with distortions, so the growing interest in revenue-neutral tax reform is most welcome. But 

businesses do not need more tax distortions, they need a tax code 

that imposes fewer distortions to the economic decision as to how 

much to invest, where to invest, what to produce, and how to finance their operations. In short, businesses need a neutral tax system, not a newly biased one. 

President Obama is to be applauded for his past support for 

broad expensing of capital purchases. But, Mr. Chairman, expensing is not a tax incentive. Language matters. In this case, the language itself is distorting how we think about tax policy. Expensing 

and accelerated depreciation are not tax incentives, they are a policy that eliminates a clear tax bias against business investment 

and would help the manufacturing sector toward faster productivity growth in the long run. 

Unfortunately, expensing’s effectiveness has been substantially 

diminished under current circumstances, specifically extraordinarily low interest rates and the depth and duration of the recession. It is far less a stimulus policy than it is a long-term growth 

policy. 

In contrast, if Congress offers special tax goodies to preferred industries, like the new wards of the State known as renewable energy, then to be sure those industries will provide the expected assurances as to what they will do with the tax goodies and all the 

good that will follow from them. Few turn down an apparently free 

lunch. 

But there is no confidence in these assurances. On balance, the 

economy will not be strengthened, thereby the Nation’s resources 

will be put to less productive uses, and yet another industry will 

become more attentive to Washington’s goody bag than to their customers and workers. 

12 

In addition to moving toward a neutral tax base, business investment would accelerate over time if tax rates for both the C corporations and all other businesses were reduced substantially. Again, 

President Obama is to be applauded loudly for his framework for 

corporate tax reform featuring a 28-percent top corporate income 

tax rate. This framework may well prove a landmark event in 

American tax policy. 

While there is much else in his framework that would do enormous harm to the economy, the critical centerpiece of the proposal, 

which should not be lost in these details, is a drive to lower the 

corporate income tax rate. The President’s framework to reduce the 

corporate tax rate, while welcome, is nevertheless curious when 

considered alongside his proposal to increase significantly the tax 

rates paid by other businesses. 

One might easily surmise, all protests to the contrary notwithstanding, that the President has an appropriately high regard for 

the economic importance of large corporations and curiously little 

or no real appreciation of the importance of smaller businesses to 

job creation and dynamism. 

In light of the ongoing high unemployment, policymakers should 

be keenly focused on what they can do to help the economy recover, 

and the manufacturing sector in particular. But they must also recognize the limitations of new policy. Tax gimmicks are of value 

only in slaking politicians’ natural desire to be seen as doing something, anything. Though it may require a difficult discipline to implement, government’s guiding principle today should be simplicity 

itself: do less harm. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Dr. Foster, very much. 

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

The CHAIRMAN. Dr. Hanlon? 

STATEMENT OF DR. MICHELLE HANLON, ASSOCIATE PROFESSOR OF ACCOUNTING, SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY, CAMBRIDGE, MA 

Dr. HANLON. Chairman Baucus, Ranking Member Hatch, and 

distinguished members of the committee, thank you for the opportunity to testify before you today. 

The main point of my testimony is that the responsiveness to tax 

policies, including policies related to investment, can be affected by 

financial accounting implications of those policies. As you know, 

publicly traded companies are required to compute income under 

two separate sets of rules. They compute taxable income on their 

tax returns and report those to the tax authorities. They also compute financial accounting income under Generally Accepted Accounting Principles and report those to the SEC and external 

stakeholders. 

Whether, and how, a public firm’s response to a tax policy incentive will be reflected on their financial accounting statements is an 

important factor that they will consider. I would like to first offer 

some general examples of the importance of financial accounting to 

managers of publicly traded companies. 

13 

One example is found in a study of companies accused by the 

SEC of fraudulently overstating their accounting earnings. It turns 

out that these companies also overstated their income to the IRS 

and paid taxes on their inflated accounting earnings. This suggests 

that these companies were willing to pay substantial sums of cash 

taxes to report higher financial accounting income. 

A second example is found in a recent survey of tax executives 

of publicly traded companies. Eighty-five percent of the tax executives said that top management at their company views the accounting effective tax rate as being at least as, or more important 

than, the actual cash taxes paid. 

To illustrate the financial accounting effects of tax policy, my 

written testimony discusses three current tax policies related to investment. As you know, the U.S. has one of the highest statutory 

corporate tax rates in the world, with a top rate of 35 percent. 

Rather than reducing our corporate rates, our policies have instead 

included targeted tax provisions such as bonus depreciation in section 199 and attempts to reduce economic effective tax rates and 

promote investment. 

In addition to a high corporate statutory tax rate, the U.S. has 

a worldwide tax system with deferral which has, in part, led to 

U.S. multinational corporations holding a great deal of cash overseas. Financial accounting has affected corporations’ tax policy responses in each of these cases. 

Because the details can become technical, quickly I will discuss 

in depth only one of these examples today: accelerated depreciation, 

which includes bonus depreciation. Accounting earnings are computed using the accrual method of accounting. This means, for example, that expenses are recorded in financial statements when incurred, regardless of when the cash is actually paid. 

The same method of accounting applies to the accounting for income tax expense. In the case of depreciation, most companies use 

straight-line depreciation for book purposes and accelerated depreciation for tax purposes. Thus, the tax deduction for depreciation 

is larger than the expense for financial accounting in the early 

years of the assets’ life. 

However, this is only temporary in nature, because the same 

amount will be depreciated for financial accounting and for tax 

purposes over the life of the asset. The deduction is just faster for 

tax than it is for book. 

To compute the income tax expense for financial accounting purposes in this case, the accounting rules require expensing not only 

the cash taxes actually paid, but accruing and expensing the future 

taxes that will be paid because a company used that tax shield 

early. Thus, accelerated or bonus depreciation does not reduce a 

firm’s accounting income tax expense, it will not reduce their reported effective tax rate, and it does not increase reported accounting earnings relative to a world without accelerated depreciation 

for tax purposes. 

When asked, corporate management will often reveal a preference for a rate cut over bonus depreciation for several reasons, 

one of which is that there is no reduction in income tax expense 

on the income statement, but there would be with a rate cut. 

14 

In addition, empirical evidence on the responsiveness to accelerated depreciation relative to the investment tax credit, which did 

reduce financial accounting income tax expense, reveals that the 

responsiveness to the credit was greater, holding the present value 

of the cash tax savings constant. 

This evidence suggests that the accounting effect is important 

and serves to mitigate the responsiveness to accelerated depreciation, because there is no financial accounting benefit. 

In conclusion, the main point of my testimony is that, what many 

consider to be cosmetic accounting effects actually play a role in the 

responsiveness to tax policy. These financial accounting implications can often mitigate the effectiveness of policies such as bonus 

depreciation for public firms. 

In addition, as I discuss more fully in my written testimony, 

sometimes the accounting implications lead to other unintended 

consequences, such as exacerbating the tax incentives for U.S. multinationals to leave cash overseas. 

In addition, at times concern over the accounting implications 

has caused tax policy to be enacted in a particular way, as was the 

case with section 199. In sum, it is important to recognize that 

both tax and financial accounting effects are included in the set of 

factors that public corporations consider in their decision-making 

process. 

Thank you for inviting me to testify today. I look forward to your 

questions. 

The CHAIRMAN. Thank you. That is very interesting. 

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

The CHAIRMAN. I would just like to ask the other witnesses—in 

fact, all five of you; it is just hard to ask all five in a short period 

of time—the degree to which accounting decisions trump tax decisions made by corporate executives, multinationals. I mean, is this 

minor? Is this significant? I will start with you, Dr. Gravelle. 

Dr. GRAVELLE. I tend to be a little skeptical of evidence that is 

from a survey. I think also I would like to be clear what the tradeoffs are. But, I think there is some reason—I have heard Michelle 

speak, and many other people, that these accounting measures do 

matter. 

I mean, it is a simple enough matter to substitute a credit for 

bonus depreciation. You would need to do a different one for each 

class, because a flat investment credit is very distorting, and you 

are not going to be talking about anything in the magnitude of 10 

percent, not with our low tax rates, without getting into negative 

taxes. So, you know, it is possible to design something. 

The CHAIRMAN. Let me ask the others. Dr. Brannon? 

Dr. BRANNON. I think it does matter. I have been reading 

Michelle’s work for some time, and it is uncomfortable for an economist to admit that at times companies do something other than 

maximize their real or economic profits. I think there is definitely 

something to that. 

The CHAIRMAN. Dr. Atkinson? 

Dr. ATKINSON. I think that there is something to that. I do not 

think it is as big as some people say. Studies show that there is 

elasticity of response to tax incentives. One other key thing we 

should consider when we think about this is, there is considerable 

15 

evidence that there are externalities from investment, so companies rightly do not care about externalities. They do not care 

whether their investment helps other companies. 

But there are clear externalities on the order of 1:1, so, with the 

benefits that a company gets from investment incentives, it does 

not get another one unit of benefits. Therefore, companies inherently will be less supportive of investment incentives than they 

might be if we considered these. 

The CHAIRMAN. Dr. Foster? 

Dr. FOSTER. Yes, Mr. Chairman. I think when a decider says 

something matters in his decision process, you have to presume 

that it matters in his decision. Corporate executives say tax accounting issues are relevant to the investment decisions they make. 

I think we have to take their statements at face value, that there 

is some truth to them. Even though it flies in the face of standard 

economic theory, the statement regarding the importance of accounting rules for investment decisions is consistent with other economic approaches; that is, there is a reasonable formulation under 

which the importance of tax accounting rules makes perfect sense. 

There are, in fact, fairly good theoretical explanations for why 

tax accounting is also relevant to the decisions of large multinationals alongside the economic considerations, and these are basically that the CEO has a somewhat different time frame in mind, 

and a fundamentally different goal in mind—maximizing economic 

profit. 

The CHAIRMAN. Let me ask this question. You have already spoken, Dr. Hanlon, so I think I know your answer. I wish we had a 

lot more time here. 

To what degree do tax consequences affect a company’s decision 

to manufacture in the U.S. or someplace else? There are a lot of 

factors. Taxes clearly are a big one. But there is political stability, 

transportation costs, labor force quality, wages. I mean, there are 

lots of factors. To what degree do the changes we are talking about 

here encourage manufacturing, and to what degree are there really 

lots of other factors that really matter? 

Dr. GRAVELLE. There is actually a lot of evidence on the substitutability of capital across countries. It is large. It is large elasticity, as economists would say, but it certainly is limited in scope. 

Again, that is why I found a very small effect from changing the 

rate. 

Again, let me remind you of that number: two tenths of 1 percent 

of GDP. So the evidence—we have a lot of empirical evidence that 

there is a limited mobility of capital, and there is also a limited response of investment, because you have to combine capital with 

labor and inventories and other things in order to produce, and all 

of those make the effect smaller. 

The CHAIRMAN. Dr. Brannon, your thoughts? 

Dr. BRANNON. Obviously, there are lots of things that go into it. 

The CHAIRMAN. To what degree are taxes a factor? 

Dr. BRANNON. I think it is a factor. 

The CHAIRMAN. Compare the current regime, if we talk about 

some of the changes that were discussed, maybe broaden the base, 

lower the rate, et cetera. 

16 

Dr. BRANNON. If you lower the rates by 10 percent, I think you 

definitely see a boost in investment and manufacturing here. By 

what standard, I do not know. 

The CHAIRMAN. That raises all the questions about, what are the 

distortions that that would cause, if you take away accelerated depreciation and 199 to pay for it, right? 

Dr. BRANNON. I agree, yes. 

The CHAIRMAN. All right. 

Dr. Atkinson? 

Dr. ATKINSON. The evidence is pretty clear that higher corporate 

taxes in the U.S. reduce investment, and they reduce foreign direct 

investment coming into the U.S., and that effect has grown over 

time. I think one of the problems when most economists study this 

is, they do not think about the fact that we are in a traded, globalized economy, so taxes matter because they determine where 

companies make investments. 

The CHAIRMAN. Do we race to the bottom? 

Dr. ATKINSON. I do not see it as a race to the bottom. I see it 

as a race that, if we do not compete in it, we will go to the bottom 

automatically. The reality is, countries are increasingly having a 

hard time taxing internationally mobile activities. That is just the 

reality. That is why the Europeans have moved to much more 

consumption-based taxes, and many countries have done that. We 

call that a race to the bottom. I just think it is the reality. 

The CHAIRMAN. My time is expiring. It has expired. But what 

about consumption taxes? Is that part of the solution here? 

Dr. ATKINSON. I think it should be. I think we should consider 

a border-adjustable value-added tax, or a business activity tax of 

some kind. The advantage of a consumption tax is, you could use 

it to lower corporate rates, and you can make it also borderadjustable. 

The CHAIRMAN. Any other panelists agree? Raise your hand if 

you do. Anybody disagree? 

Dr. GRAVELLE. I think you have to be very careful for distributional reasons in embracing a value-added tax without looking 

carefully at that issue. 

The CHAIRMAN. Can that be accomplished? 

Dr. GRAVELLE. If you want to raise tax rates somewhere else and 

give a rebate. But a value-added tax can never be progressive like 

an income tax at the top. 

The CHAIRMAN. I understand. But my time has expired. 

Senator Hatch? 

Senator HATCH. Well, thank you, Mr. Chairman. 

This question is for Dr. Hanlon. In your testimony you note that, 

simply because of the way the tax code and the financial accounting rules interact, lowering the U.S. corporate tax rate can cause 

a 1-time reduction in a company’s reported earnings. 

Now, this is potentially important because a hit to earnings 

would also mean a hit to earnings per share, which can affect the 

stock price. Now, I am very supportive of a corporate tax cut. Moreover, I would think that the capital markets are sophisticated 

enough to understand this in context. Am I right on that, or is this 

something we should be thinking about as we consider how to imVerDate Nov 24 2008 21:04 Feb 13, 2013 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 R:\DOCS\78228.000 TIMD
17 

plement a corporate tax rate cut, and, if so, what should we do 

about it? 

Dr. HANLON. Yes, you are right that there is a subset of companies that has significant deferred tax assets on their balance sheet 

that would, if we implemented a corporate tax rate cut, have a hit 

to corporate earnings. That is basically because now those deferred 

tax assets are valued at that lower tax rate. That is essentially 

why that happens. That is only a 1-time hit to earnings. Hopefully 

you are right, the capital markets would figure out that this happens just due to a cut to the corporate tax rate. 

In my opinion this should not stop the U.S. from reducing the 

corporate tax rate. I do not think that should stop us. Other jurisdictions, such as the United Kingdom and the State of Ohio, have 

implemented methods to gradually reduce the corporate tax rate 

over time, or different strategies, so it is less of an impact on those 

companies with significant deferred tax assets. 

Senator HATCH. Right. 

Dr. Gravelle, you noted that the domestic production deduction 

has been criticized as distorting the tax treatment of different industries by granting differential tax rates. It creates administrative 

and compliance problems, both in distinguishing domestic content 

and identifying eligible activities. 

But is that not what President Obama’s framework proposal for 

corporate tax reform does? That is, is the President not proposing 

to have the corporate tax rate on manufacturing lower than the 

corporate tax rate on other sectors of the economy? 

Dr. GRAVELLE. Well, that is my understanding. In his outline he 

says 25 percent, I think, for manufacturing and something like 28 

for everybody else. I do not know whether he is planning to do that 

through the domestic activities production, the existing one, or 

how. But, yes. Anytime you want to have a different rate for different industries, it is going to create administrative problems. 

Senator HATCH. That does not make sense to me. 

Let me go to you, Dr. Atkinson. In your written testimony you 

advocate that Congress should not be focused on reducing distortions in the tax law, but rather that Congress should be focused on 

spurring the effective creation of new goods and services, and on 

spurring increased activity. I have been pleased, along with the 

chairman, to be a strong supporter of the R&D tax credit. We 

would like to make that permanent, and for the very reasons that 

you cite. 

The R&D credit increases R&D closer to optimal levels, in my 

opinion. That said, I wonder if you would put us on a slippery slope 

where all sorts of tax expenditures become justified. That is, there 

will always be some lobbying group that will justify some particular tax expenditure, and Congress does not have a great record 

in resisting such lobbying groups. So, give us your thoughts on 

that, will you? 

Dr. ATKINSON. Well, thank you, Senator. Absolutely, there are 

many distortions in the tax code that are not pro-growth. I think 

some of those were mentioned here. I did not imply that we should 

be embracing all distortions, but rather that some distortions are 

pro-growth. 

18 

The Research and Experimentation tax credit has actually been 

called, by some economists, a distortion. I know you and Senator 

Baucus are huge supporters of it, as ITIF is. I do not see the R&E 

tax credit as a distortion, I see it as a way to correct a market failure, in that companies under-invest in R&D. I think the same is 

true with the investment tax credit. Again, there is a lot of evidence that companies have big spill-overs when they invest in new 

machinery. 

With regard to the manufacturing or domestic production deduction, my only point there is that we have to recognize that there 

are sectors of our economy that face intense international competition, and they can and do easily move in response to that. There 

are other sectors of our economy that do not face any competition 

and will never move, and therefore we should be reflecting and 

thinking about that when we craft a tax code. 

Senator HATCH. Thank you. 

Dr. Brannon, in your written testimony you advocated for full expensing. That is, the immediate full deduction of capital goods. In 

justifying that, you noted that the current depreciation schedules 

are ‘‘complicated, arbitrary and often nonsensical.’’ My question is 

this: if Congress could make them less arbitrary and more reflective of economic reality, would you still advocate that the cost of 

capital goods be immediately and fully deducted? 

Or perhaps you find this question excessively hypothetical. Perhaps, somewhat inevitably, the depreciation schedules will always 

be arbitrary and complicated. Thus, we are better off going to complete and full expensing. Could you give us your thoughts on this? 

Dr. BRANNON. Sure. So, like Rob, I think that the research and 

experimentation tax credit was a boon for the U.S. manufacturing 

sector. The problem is, it is a little antiquated, and it could be 

tightened, and it could be made a lot more effective. 

Senator HATCH. We can make it a lot better. 

Dr. BRANNON. It is very difficult, I think, with all the political 

exigencies that exist, to maybe make that what we really want. So 

it seems to me that, kind of to untie the Gordian knot, the most 

simple thing to do to really encourage investment in manufacturing, and investment across the board, would be to simply go to 

full expensing. So, if we did have some magic wand, and we could 

make depreciation schedules that magically matched up to what 

the reality is, I would still want to have manufacturing incentives 

or investment incentives. 

Senator HATCH. Thank you. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you. Thank you very much, Dr. Brannon. 

Our next in line is Senator Grassley. 

OPENING STATEMENT OF HON. CHUCK GRASSLEY, 

A U.S. SENATOR FROM IOWA 

Senator GRASSLEY. I am going to ask for a response in writing 

because I have a statement prefacing my questions, and it is going 

to take too long to take away from my colleagues, so I would ask 

that, when I get to the end, I will tell you when the questions are 

coming. 

19 

As the tax reform debate continues, whether and how the tax 

code should incentivize capital investment in domestic manufacturing is obviously a hot topic, as it is here for this hearing. The 

tax code has tried to spur investment through accelerated cost recovery provisions, including the expensing provisions of section 

179. 

However, it is frustrating to see these provisions sometimes referred to as loopholes. Depreciation itself is not a loophole. For financial statement purposes, Generally Accepted Accounting Principles require that companies expense the cost of capital assets 

over their useful lives. Obviously, the goal of financial accounting 

is to properly match revenue and expenses so that third parties, including investors, have an accurate picture of a company’s finances. 

This goal conflicts with the goal of tax reporting, which is to minimize taxable income. Since depreciation deductions will always 

exist for financial accounting purposes, by default, a tax deduction 

should also always exist. The question to consider in the context of 

tax reform is whether that deduction should match financial accounting deductions, or whether that deduction should be accelerated, as it is currently. Given this, it is fair to say that the current 

tax code provisions for capital cost recovery, including accelerated 

depreciation, bonus depreciation, and even expensing, are not loopholes. 

Last year I wrote to the President and asked him to define ‘‘loophole.’’ I received a response from the Acting Assistant Treasury 

Secretary for Tax Purposes that stated the following: ‘‘We agree 

with you that tax expenditures are, in many cases, incentives that 

reflect intentional government policy. In this respect, they differ 

from pure tax loopholes, which are unintentional benefits derived 

by taxpayers who may have found a way to game the system.’’ 

Mr. Chairman, I would like to have consent to include my letter 

to the President and the Treasury Department response in the 

record. 

The CHAIRMAN. Without objection. 

[The letter and response appear in the appendix on p. 81.] 

Senator GRASSLEY. You would think from this response that the 

President agrees that capital cost recovery provisions in the tax 

code are not loopholes. Yet the President, both in his recent budget 

proposal and his tax reform framework document, singles out the 

depreciation life of general aviation aircraft as a loophole, as just 

one example. 

This type of approach to tax reform is not helpful. True tax reform requires us to consider the evidence that suggests that accelerated cost recovery provisions may not incentivize additional investment. This evidence should be balanced, however, with a consideration that small and medium-sized businesses may actually 

make investment decisions based upon cash flow. 

Continuing to allow expensing would mean that a company 

might choose to spend dollars on capital investment sooner and 

defer payment of taxes. In addition, as Dr. Gravelle notes in her 

testimony, expensing also simplifies compliance for small business. 

Separately, to the extent that accelerated depreciation is retained, we should consider what the most effective way to determine asset lives is. In the 1986 Tax Reform Act, Treasury was auVerDate Nov 24 2008 21:04 Feb 13, 2013 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 R:\DOCS\78228.000 TIMD
20 

thorized to determine tax asset lives. This authority was repealed 

2 years later. 

Over the last several years, we have seen an uptick in lobbying 

to change the tax code asset lives for assets in various industries. 

Aside from the President’s focus on aircraft depreciation, there are 

temporary provisions regarding racetracks, restaurant improvements, and even agricultural equipment. 

The listing of asset lives in the tax code stands in stark contrast 

to the financial accounting practices. There is no master list that 

dictates the useful life of an asset. Companies make judgment calls 

which are reviewed by independent auditors. 

So, the question that I want to refer to you is this. This raises 

the question of, what is the most effective way to determine asset 

lives for tax purposes? Should Congress continue to be responsible 

for this, or would it make sense to reauthorize the Treasury Department, or possibly look at an independent panel of experts to periodically review asset lives? 

Lastly, in addition, for financial accounting purposes, if the value 

of a tangible or intangible asset becomes impaired, the impairment 

loss is recognized when the asset is impaired. In contrast, for tax 

purposes the impairment loss generally is not recognized until the 

asset is disposed of or abandoned. So, lastly, does it make sense for 

the tax code to include the concept of impairment? As I said, I 

would appreciate answers in writing. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

Next, Senator Coburn. 

Senator COBURN. Thank you. I appreciate so much the work that 

the Congressional Research Service does. Thank you for what you 

do. 

I want to kind of go back to the underlying aspects of capital formation. If we did not have a tax code, what we would want is people making capital investments based on the greatest return of 

that capital. Does anybody disagree with that? I mean, that is what 

basically business does. If there is no tax implication, then they are 

going to make an investment based on the return of that capital 

investment, correct? 

Now, we do not have it that way. We have, number one, comparative tax rates because we are in a global economy. What influences capital investment is the return net of tax, or through accelerated depreciation net of tax. Has anybody looked at what rate the 

corporate tax rate would have to be to have the minimal amount 

of influence, given the global environment that we have, to where 

we did not pick winners or losers, or we did not say we want to 

incentivize R&D? 

Sure, we want to incentivize R&D, but we do not want to 

incentivize it any more than the individual who is in that area 

wants to make more money. So, has anybody looked at what the 

tax rate would need to be in this country to throw off that effect 

of taxes influencing capital investment? In other words, would it be 

zero? Would it need to be zero before we have the tax effect play 

no role? Dr. Gravelle? 

21 

Dr. GRAVELLE. Well, I think it would be very hard to make it be 

zero, because you have unincorporated businesses, and problems 

with separating capital. 

Senator COBURN. Well, let us talk about C corporations for a 

minute, not S corporations and not LLCs. 

Dr. GRAVELLE. So, if you set those rates at zero, then you would 

have big incentives to organize as incorporated businesses. So the 

only way you can be sure to get equal treatment for all investments 

is to have no taxes. So, short of that, what we need to do is try 

to make those taxes equal everywhere. 

So, if you think about manufacturers, they benefit from some 

things, like accelerated deprecation, the production activities deduction, but they also are not as beneficially treated as owneroccupied housing, not as beneficially treated as intangibles, including marketing cost. 

So I think you cannot say we have to get the tax rate really low. 

You have to think about trying to make it even everywhere. I think 

on the international side, you can either lower the tax rate here, 

or you can raise it on our firms. I mean, both of those will work 

to even out tax rates. 

Senator COBURN. Dr. Brannon? 

Dr. BRANNON. So, in 2007, I was a staffer at the Treasury Department at the time, and I was one of the authors of the 2007 

Treasury study on corporate tax reforms. One of my tasks was to 

interview a whole mess of manufacturing firms, and other firms, 

and ask them, what tax rate would you be okay with if it came 

with eliminating all special investment incentives? And almost everyone gave the same answer: if it got down to 20 or 19 percent, 

we would not complain about everything else. 

So I think Dr. Gravelle is right, you are always going to have 

some incentives. There are always going to be companies that will 

make decisions based on even a 10-percent tax rate. But I think 

a corporate tax rate below 20 percent, 20, 19 percent, I think you 

would see a lot of companies being okay with getting rid of a lot 

of these special incentives. 

Dr. ATKINSON. I would agree with Dr. Brannon that it would be 

good to get that rate down to that level, and have incentives, but 

I think the notion that we can get equality—I think we are never 

going to get equality because we now live in a global economy, and 

every other country is going to have a different rate. They are 

going to have different incentives on different things. 

Lastly, I would argue there is a lot of economic literature with 

regard to the optimal amount of corporate R&D that is being conducted in the United States, and much of it finds that corporations 

under-invest in R&D by at least a factor of one. 

So, in other words, there should be double the amount of corporate R&D. To maximize societal welfare, you want to invest up 

to the return—the societal return, not the firm return. With R&D 

in particular, the reason we have an R&E tax credit is because 

companies do not get all the benefits. They spill over. Other companies use that knowledge, that innovation. So I think, Senator, in 

some areas it is important to have a differential in the tax code, 

because companies will not maximize societal economic welfare 

without it. 

22 

Dr. FOSTER. Senator, as Dr. Gravelle noted, you have to have a 

zero rate to have zero effect, and, if that is not practical, then the 

question becomes how best to look at tax distortions. To get to the 

spirit of your question, the answer is that taxes affect decisions at 

the margin, and so that is where you have to look. 

So, if I am talking about a difference between a 10-percent rate 

and a 15-percent rate, I should expect a certain differential amount 

of economic damage, a certain amount of reduction in investment, 

which would be a very, very small amount relative to the difference 

in damage between a rate between 20 and 25. So, as the rate goes 

higher, the damage rises more than proportionally. 

Well, where does that leave us? It leaves us with at least an attempt to get towards neutrality across countries in the distribution 

of the harm done to our economies. 

The average statutory tax rate of the OECD, excluding the U.S., 

is about 25 percent. So that becomes a pretty good target, inclusive 

of Federal, State, and local taxes. Remember, State and local tax 

is another 4 percentage points on top of the Federal rate. So we 

need to get the Federal rate way down to get the combined rates 

below the OECD average, and that should be a minimum goal. 

Senator COBURN. Dr. Hanlon? 

Dr. HANLON. In general, I agree in principle with all these statements. Basically, the companies will maximize their after-tax return. In that sense, tax is not that special. They are going to maximize their returns, considering all their expenses. We just need a 

rate that makes them competitive in this global marketplace and 

a system with the fewest distortions. 

Senator COBURN. Mr. Chairman, I would like for them to address 

in writing, if they would, the effect of our non-territorial tax system 

on both the global effect, and the investment in capital in this 

country at this time. 

[The answers appear in the appendix.] 

Senator COBURN. I would also note for Dr. Hanlon, when I graduated from Oklahoma State University I got the Arthur Andersen 

Award for the top accounting student. [Laughter.] 

The CHAIRMAN. Why are you here? [Laughter.] 

Senator COBURN. My wife asked me that question Sunday before 

I left. [Laughter.] 

The CHAIRMAN. Senator Rockefeller? 

Senator ROCKEFELLER. Actually, Dr. Coburn, that is very impressive. Congratulations. 

I am interested generally in the behavior of corporations large 

and small. I want to start just with a statement. I think it was you, 

Dr. Brannon—it may have been you, Dr. Atkinson—who said that 

companies were simply not giving enough training to the people 

they already have. This is not tax policy. 

For example, I am thinking of Toyota. When they are here, they 

send scads of the American workers over to Japan for a number of 

weeks, maybe a month or two, to learn the Toyota way of doing 

things. I would think that, forget the R&D tax credit for a moment, 

that corporations would want to train their people. I mean, why is 

it—to whomever made that statement—true? Why is that happening? Yes? 

23 

Dr. ATKINSON. Well, I made that comment. I think it is happening for two main reasons. One is that, according to the Bureau 

of Labor Statistics, the average worker tenure—in other words, the 

time they spend with a particular company—has shrunk by about 

40 to 45 percent over the last—— 

Senator ROCKEFELLER. From what to what? How many years to 

how many? 

Dr. ATKINSON. It was something—I am going to get it wrong. 

Something around 6 to 4. So, 6 years to 4 years. So, if I invest in 

training a worker at ITIF, it is just like buying a machine. I get 

annual returns from that training, but I do not get it all in the first 

year. 

Let us just say the returns are over 8 years, but the worker 

leaves after 2. I have only gotten a quarter of those returns, and 

whoever that worker goes to work for gets the other portion of it. 

So, in that sense, it is similar to research and development. Training produces a positive externality. 

The other reason companies have cut back on that is U.S. companies have become much more short-term in their focus. They are 

pressured by the markets to get very, very short-term returns. 

Training is not a short-term return, it is a stream of returns over 

the long run. 

I would argue companies like Toyota, Japanese companies, German companies, are less pressured for short-term returns, which is 

why they invest more in training than American companies do. 

That is why I would suggest a tax provision might be a way to correct for that. 

Senator ROCKEFELLER. All right. 

Let us go to the tax credit itself, because it is interesting. What 

is it that actually makes a corporation do something which it otherwise was not going to do anyway? Obviously you arrive at that 

point through taxes and other things. 

But the last figures, at least that I have, for 2005 show that 

about half of the R&D tax credit went to businesses which earned 

$1 billion or more. It would seem to me that they would be less inclined to respond to that—I may be wrong—than, let us say, a 

smaller business, which makes up the larger part of the employment in this country. 

Now, I agree I am not putting in the international factor in this 

question, but what would happen, for example, if you did put the 

R&D tax credit all up front? I mean, it costs about $3 billion a year 

to do it, right, or $30 billion over 10 years to do it? Three billion 

a year is not an enormous amount, but it would seem to me that 

that would make a really strong incentive to, particularly, midsized and smaller companies that were not going to be buying that 

machinery anyway, or whatever that investment would be. It 

makes sense to me. It makes sense to me. 

Now, maybe Chairman Baucus is blanching at the $30 billion, 

but I am just trying to think of the effect on companies. I would 

think that would be very helpful. Any of you? 

Dr. ATKINSON. Senator, when you said—I am a little unclear 

what your change would be. You said—— 

Senator ROCKEFELLER. That you do not do it over 10 years, you 

do it right up front. 

24 

Dr. ATKINSON. In terms of, they can take it all at once? 

Senator ROCKEFELLER. Yes. 

Dr. ATKINSON. Well, I think—— 

Senator ROCKEFELLER. I mean, if they purchase something, machinery or whatever. 

Dr. ATKINSON. Oh, on machinery? I would agree with that, that 

if we let companies expense machinery all up front they will invest 

more in it, and that we will have a more productive and higherwage economy. Yes, I would agree with that. 

Senator ROCKEFELLER. Well then, quickly, the bottom line is totally crucial, but for GE, for example, or a small mining machinery 

company in West Virginia or something, what makes them do 

something? It is not just tax policy. 

People start up, and they have a ferocious desire to contribute to 

something, or they are very smart. Yes, sometimes they get these 

tax credits, and then they develop their product, and then they sell 

it off to somebody else so they can produce it often overseas. That 

is not such a good idea. 

But it is just—I do not understand corporate thinking to move 

from this level to this level. Do you have to do it through adjusting 

the tax code, or is it sometimes just not very visionary leadership, 

or are they just accustomed to getting it for the last 30 years, 

whatever it is, so that they just are in that mood, waiting to receive? My question is opaque, but meaningful to me. 

Dr. ATKINSON. I guess, just very quickly, the research shows fairly convincingly—from economists, at least—that the research and 

development tax credit or R&E tax credit actually does spur an additional amount of corporate R&D, including in big companies and 

small companies. So I agree with you, Senator, there are multiple 

factors as to why there are problems with U.S. competitiveness, 

and the tax code is only one of those, but I do think it plays some 

role. 

Dr. GRAVELLE. I understand you to be talking about investment 

in capital equipment as well, right? 

Senator ROCKEFELLER. Right. 

Dr. GRAVELLE. The problem is, if you wanted to turn accelerated 

depreciation into an investment credit, you could do it. Some of 

these young new firms that you are talking about are not going to 

benefit from any of it because they might not have tax liability. 

A credit, you could make refundable if you wanted to. It is flexible that way. You would have to figure out the discount right, so 

there is nothing easy about it. But it is certainly possible to convert 

any subsidy, bonus depreciation, anything, into a credit—a presentvalue credit, I mean. According to Michelle’s research, that might 

work better. I am not sure. I like to believe that corporations are 

profit-maximizing, otherwise I feel very uncertain about my profession. I hope that is what they are doing. 

Senator ROCKEFELLER. But I do not want you to feel uncertain 

about your profession. 

I have gone over my time. Thank you, Mr. Chairman. 

Senator HATCH. Senator Cantwell? 

Senator CANTWELL. Thank you, Mr. Chairman, and thank you to 

all the panelists. Dr. Atkinson, thank you for being here this morning. 

25 

I feel like one thing I learned being in the private sector is that 

you can design products and features and you can say, this is what 

we want to attack, and this is what we want to do. But, if you have 

not properly assessed the environment in which that product development is happening, then you may miss the fundamentals of what 

you are trying to achieve. 

It seems to me that your testimony today has hit on the fundamentals of what we are looking at here in the tax code debate, 

not about this tax versus that tax, or longevity, or what have you, 

but what environment are we in. 

You clearly outline that we are in an Information Age environment where innovation can flow to anywhere it wants, and that the 

tax codes and policies of these various nations are attracting more 

on the manufacturing side than we in the United States. In fact, 

we are losing on the manufacturing side. Thank you for your innovative ideas on the patent box and what you just said about the 

R&D tax credit as it applies to training. 

So my question is, how can we put a model to the outcome of 

those policies that you are suggesting in the context of getting people to better understand what is at stake? I know you had one ratio 

in there, on some nations a 1:3 ratio, or 1.5:3 ratio on changing the 

tax code. But could we say on this tax credit, as it relates to putting manufacturing under R&D, here would be the yield so that we 

could better move forward on these policies? 

Dr. ATKINSON. Is your question sort of, what kinds of real outcomes should we be striving for and be able to measure? 

Senator CANTWELL. It is very frustrating to live in a—in Washington State, we know that we need 20,000 aerospace jobs in the 

next 10 years, plain and simple. We could probably come up with 

a whole host of other jobs, so to me it is very clear. 

It is frustrating to know that, and to then come here and say, 

well, why can we not get more on job training, knowing that we 

have lost some of the edge in manufacturing? So what output could 

you put to this R&D tax credit expansion to job training that would 

give my colleagues some confidence to move forward on that kind 

of idea? 

Dr. ATKINSON. Well, I think what we could try to have, as a goal, 

is to restore corporate business training in workers, as a share of 

the economy, back to where it was a decade ago, and try to get that 

done within 5 years. To me, if we could do that, we would be a 

much more competitive Nation, so companies like Boeing, Intel, 

and a whole lot of other companies, who are already training their 

workers, would be able to do more, and would do more, and we 

would become more competitive. 

I think the same thing is true with regard to R&D. U.S. companies have expanded their corporate R&D over twice as fast overseas as they have here domestically, and in part it is because our 

R&D credit, frankly, is not very generous anymore. We are 23rd 

now in the world. So we have not kept up, and I think if we did 

we would see real measurable outcomes. 

Senator CANTWELL. So on the training, get it back up to the level 

of investment, is that what you are saying? 

Dr. ATKINSON. Yes, up to the level of investment. The investment 

has actually dropped over the last 10 years, and I think a goal for 

26 

our Nation could be to get it back to where it was 10 years ago, 

so that companies are just putting more money into getting their 

workers higher skills. 

Senator CANTWELL. When you look at this phenomenon, and you 

are saying an employee is spending less time at a company, what 

do you think that phenomenon reflects? 

Dr. ATKINSON. Oh, I think it reflects two things. I think it reflects, on the one hand, workers who just have, because of the way 

the economy has evolved, less of their own loyalty—they want to 

move along. And at the same time I think it reflects companies 

having less loyalty to their workers. That is just the way the economy has evolved. 

Companies, 2 decades ago, were very, very recalcitrant to lay off 

workers because they did not want to lose those skills. If you compare that to Germany, for example, German companies tend to retain workers because they have put all this money into their workers in training, and they do not want to lose them, so they tend 

to retain them more. U.S. companies do not do that, again, partly 

because of short-term financial pressures. 

Senator CANTWELL. But do you think that the R&D credit for 

training would shore up both the security of the employee and the 

employer’s investment in that employee? 

Dr. ATKINSON. Absolutely. I think it would do two things. The 

company now would have more at stake, if you will, more investment in that person. They would be less likely to let them go unless they really had to. 

But the second thing it would do is, even if the company had to 

let workers go—and that happens all the time for business reasons—the worker themselves would have better skills, stronger 

skills, and it would be easier for them to go and get another job 

at a comparable wage. 

Senator CANTWELL. Thank you. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

Senator Wyden? 

Senator WYDEN. Thank you very much, Mr. Chairman. 

Let me ask this question of you, Dr. Gravelle, because, with your 

textbooks and the writing you have done, you constantly keep coming back to a concept that seems to me to make a lot of sense, and 

that is to simplify the system and try to reduce some of the gaming 

that goes on with it. 

I want to ask you about deferral to start with. I mean, here we 

have this tax code that in effect creates an incentive for an American company to do business overseas. Because of that, and the 

concern about it, we try to kind of fix it by, in effect, inserting tax 

breaks like section 199 that seek to encourage American companies 

to base their operations in the United States. 

Would it not make more sense to kind of junk all of this and figure out a way to come up with a sensible policy with respect to 

business? And I will not get you into the discussion about what the 

rate actually ought to be. 

I will editorialize and say it has to be a competitive rate, but, 

just from the standpoint of simplicity, would it not make more 

sense to get rid of all this that in effect incentivizes deferral and 

27 

tries to compensate for it with section 199, junk that and just come 

up with a sensible and simple kind of process with one rate, adding 

my editorial judgment that it was competitive? 

Dr. GRAVELLE. Well, I think if you just look at the outflow of capital, probably the best way to try to keep capital from flowing out 

of the United States is sort of a double-whammy, as you say: increasing the taxation of the foreign-source income of our own companies. 

The President has proposed a minimum tax. You have provisions 

in the Wyden-Coats bill that will do that. Lowering the tax rate, 

that would shift the—right now we favor investment abroad compared to investment in the United States, within our own tax code 

and with our own multinationals. 

So you would have to make sure that companies could not invert, 

and do things like that, but I think we have the tools to deal with 

all of that. So that is the kind of obvious way to encourage capital 

to stay in the United States without losing revenue. 

Senator WYDEN. Well, thank you for your answer. You have done 

good work. We constantly refer to your books, which for all practical purposes are the texts in this area. But in terms of the concept—I mean, Chairman Baucus, Chairman Camp—as we get into 

all this, we are going to have a host of questions. But the fact that 

you have singled out simplicity is hugely important, and I really 

commend you for your work in this area. 

I think it is highlighted by this issue with respect to deferral, 

and then trying to figure out, after we have created this incentive 

to go overseas, we are trying to play catch-up ball with section 199 

to try to keep our jobs here. So, I thank you for it. 

Dr. Foster, you and I have talked about these issues a lot over 

the years, and you too have done good work. I want to ask you 

about the question that I think goes to the heart of this debate, 

that we are going to have with respect to tax reform, and that is 

trying to do this piecemeal. 

I continue to believe that we have to figure out a way to do the 

business code and the individual code at the same time. Because 

so many are concerned about trying to make their way in this broken, dysfunctional system, we just try to one day do the estate tax 

and one day do corporate tax, and one day this and one day that, 

and I think it just adds more complexity and more dysfunction to 

the system, and we have to get away from dealing with this piecemeal. 

You have spoken and written on these kinds of issues in the 

past. What is your thought with respect to the upcoming tax reform effort and trying to do it in a comprehensive way, and that 

that really is the key to getting it done right? 

Dr. FOSTER. Senator, I think the current tax code is profound evidence of the truth of what you said about doing it piecemeal. We 

have been doing piecemeal reforms now for a great many years, 

and what we have today is the result, and I do not think any of 

us are very satisfied with that result. 

So the question then is, how big of a bite into the tax code do 

you have to take to make real, sensible progress? Do you do the 

whole thing all at once, a truly profound and massive effort? That 

would probably be ideal, because an income tax is itself an inteVerDate Nov 24 2008 21:04 Feb 13, 2013 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 R:\DOCS\78228.000 TIMD
28 

grated organic system. We would hope to have a coherent system 

when we were done with reform. The importance of coherence is 

underscored by the tremendously complex economy that is being influenced by the code today, and would be by the new code. 

It is very hard to break off large chunks of the tax system, reform them in isolation, and produce anything sensible, and it is 

certainly very difficult to do it in the very small pieces that we 

have traditionally done. We can correct one small problem, and 

maybe we succeed, but we have probably created other problems 

elsewhere we did not know about until we enacted the new law and 

found the problems we have created. 

Senator WYDEN. I very much share your view. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

Senator Carper? 

Senator CARPER. Thanks. Thanks, Mr. Chairman. 

To all the witnesses, welcome. It is good to see all of you today. 

Thanks for your input. 

The first question. I often say that the role of government is to 

create a nurturing environment for job creation and job preservation. Our job is not to row the boat, our job is to steer the boat and 

make sure that we have that nurturing environment. I think the 

jobs in the 21st century are probably going to go to those who do 

the best job of creating a world-class workforce, and world-class infrastructure, broadly defined, and also certainty with respect to the 

tax code. 

With that in mind, I would just like to ask you all to consider 

the difference between manufacturing output and manufacturing 

jobs. Over the past 3 decades, manufacturing output, as you know, 

has increased rather considerably, but manufacturing employment 

has declined rather considerably. Obviously, it is because we are 

more productive than we used to be. 

But the recovery from the recent recession has not changed this 

trend significantly, although I am encouraged that we are starting 

to see emergence and creation of new manufacturing jobs in this 

country. But the manufacturing sector has grown, I think, about 17 

percent since the depth of the recession, but employment in that 

sector has increased, I am told, by about 1 percent. 

The most commonly cited reason, of course, is productivity. The 

U.S. has seen an increase in manufacturing productivity. Manufacturing output per hour has increased almost continuously since 

records have been kept, and that is probably a good thing, but then 

so are high-paying jobs, high-quality manufacturing jobs, a good 

thing. 

So my question for—let me just pick on Dr. Gravelle and Dr. Atkinson and Dr. Brannon and ask, is there a way to resolve this apparent tension between productivity and manufacturing and 

growth? Is there a role for tax policy? If so, what shape should tax 

reform take? Again, let us just start with Dr. Gravelle, Dr. Atkinson, and then Dr. Brannon. 

Dr. GRAVELLE. Well, I think that, first of all, the slow growth in 

jobs, again, if we have fewer jobs because we are more productive, 

then that is great. I mean, we used to have a large fraction of the 

29 

workforce in agriculture, and we do not have that anymore. So that 

in itself is not bad. 

There is also a tendency, when people lose jobs, to not recover 

them. It is called hysteresis. There is a lot of discussion about that. 

I think that we need to look at trying to make our tax code simple 

and efficient, and that is really all we can do. We cannot move a 

mountain. You said, steer the boat versus row the boat. Well, the 

big work is rowing the boat, so it is very hard to do a great deal 

with taxes. But again, we need to make them simple, to make them 

efficient, to make them neutral, and to steer them towards any 

spill-over effects that you want to subsidize. 

Senator CARPER. All right. 

Dr. Atkinson? 

Dr. ATKINSON. Yes, Senator Carper. I, like you, for a long, long 

time believed that most of the job loss in U.S. manufacturing came 

from productivity, and that is a very easy thing to say because the 

official top-level government numbers from the Bureau of Economic 

Analysis suggest that. Those numbers are wrong, I would assert, 

as we are releasing a report in 2 weeks showing as much. 

If you know, there are what are called North American Industry 

Classification System (NAICS) codes. Chemicals is a NAICS code, 

computers is a NAICS code. Thirteen of those 19 NAICS codes saw 

absolute declines in output in the last decade, from 2000 to 2010. 

In other words, 13 of 19, which employ 55 percent of manufacturing workers, are producing less than they were. 

We estimate, as I said earlier, that the actual output of U.S. 

manufacturing, when measured properly, did not go up 15.5 percent, as the Federal Government says, it actually fell by 11 percent. Now, again, that is a debatable point, but that is what we believe. 

So, when you compare our productivity in manufacturing to other 

nations, we actually have very low productivity growth when you 

look at these numbers this way. We are behind the Germans, we 

are behind the Japanese, we are behind the Swedes. I think actually that is why I think the tax provisions that we are talking 

about here today could be so important. We need to get American 

companies to invest more in new machinery, more in equipment. 

As I stated earlier, this is the first decade in American history 

where we have seen virtually no growth in manufacturing capital 

stock. How can American companies be more productive when the 

capital that they have is less than what it was a decade ago? I 

think the tax provisions, like accelerated depreciation or first-year 

expensing or an ITC, can play an important role there. 

Senator CARPER. All right. Thanks. 

Dr. Brannon, would you just briefly respond to the same question, please? 

Dr. BRANNON. I think one thing to consider that goes a little bit 

beyond tax policy is, one of the reasons we have increased productivity so much in the United States is we have a very competitive 

retail market. There have been a lot of studies—in fact, some done 

by Democrats—suggesting that what has been driving productivity 

is that we have a wide-open retail market, that Wal-Mart, Target, 

and their presence have really pushed productivity in the retail 

30 

market, and that has pushed productivity down into the wholesale 

market. 

This distinguishes us from most other countries, where a lot of 

the retail sector and a lot of the manufacturing sector is somewhat 

cosseted. So, certainly I think there is a tax aspect—we have talked 

a lot about it—but I think it is important to remember that, even 

if we are worried about specific jobs, the last thing we want to do 

is offer protection to specific industries. 

Senator CARPER. All right. Thanks. 

I have another question. I am going to submit a question in writing to Dr. Hanlon and Dr. Foster. If you all would just take the 

time to respond to me, I would be most grateful. Thank you very, 

very much. Nice to see you all. 

The CHAIRMAN. Thank you, Senator. Did you want to ask that 

question? Go ahead. 

Senator CARPER. If I could, that would be great. Thanks. 

Members of this committee heard a great deal about whether the 

U.S. should adopt a territorial corporate tax system to replace the 

current worldwide system. Those who advocate a territorial system 

point out that it would make U.S. multinational manufacturers 

more competitive with foreign companies. I have to admit that I am 

interested in examining this approach. I think several of us on the 

committee are, Democrats and Republicans. 

However, as you know, the critics of this approach and opponents 

argue that a territorial tax system would encourage companies to 

send jobs overseas to manufacture products that are shipped back 

to the U.S. 

I would just like to ask Dr. Hanlon and Dr. Gravelle to just respond. What is your response to these criticisms? Is there a way 

to thread the needle and design international tax reform so that we 

gain the benefit of a territorial system but avoid any incentives for 

manufacturers to relocate domestic production overseas, which we 

do not want to do? Thank you. 

Thanks, Mr. Chairman. 

[The answers appear in the appendix on pp. 101 and 114.] 

The CHAIRMAN. I have a question. I was confused. Dr. Atkinson, 

you said, if I understood you correctly, that the assumption of U.S. 

productivity gains explains a lot of either job loss or lack of returning jobs. Yet, Dr. Brannon, if I heard correctly, you said, at least 

in the retail sector, there have been great increases in productivity, 

which is a benefit to the United States. I mean, do you both agree, 

one is retail, one is manufacturing, or is there conflict? 

Dr. ATKINSON. I agree with Dr. Brannon that retail productivity 

has been a strength of the U.S. compared to many other nations, 

and precisely for those reasons. We have more competitive marketplaces there. The mismeasurement of our productivity, in my view, 

is mostly concentrated in our manufacturing sector, so I would 

think our retail productivity is better measured. 

The CHAIRMAN. The basic question I have is, well, where do we 

draw the line here? How much to lower rates, how much to broaden the base to cut back some of this, some of these preferences? On 

the other hand, the panel here seems to say we should focus more 

on manufacturing. Other countries have more manufacturing incentives, perhaps, than we. 

31 

I have a lot of sympathy with what Dr. Foster said, namely: simplicity. The basic underpinning of his statement is, keep it simple 

and do not change it very much, get rid of this yo-yo effect, let companies do their thing, et cetera. So we will start on my left, right 

here. Kind of, how do we get at this? Give us some guidelines. Give 

us a path here to where we draw the line if we want, clearly, 

growth and jobs. We do want an incentive for manufacturing in the 

United States. What do we do here? 

Dr. GRAVELLE. Well, I am not sure how much we gain by changing a depreciation system that has served us well, that people have 

been used to more or less, to get rid of accelerated depreciation in 

exchange for a 2 percentage-point rate reduction. I am not sure 

that is going to be beneficial to investment. 

There are some advantages of cutting the corporate rate, but the 

bottom line is, there is not a lot of scope for doing this unless you 

are going to lose money. 

The CHAIRMAN. Right. 

Dr. GRAVELLE. I mean, I estimated that, if you repealed every 

tax expenditure, you could cut the tax rate by about 5.5 percentage 

points. 

The CHAIRMAN. Right. I have seen those numbers. 

Dr. GRAVELLE. That is just the numbers. You cannot get away 

from that. 

The CHAIRMAN. Unless you added debt expense. 

Dr. GRAVELLE. You can do some other things. 

The CHAIRMAN. Right. 

Dr. GRAVELLE. Restrict interest deductibility. 

The CHAIRMAN. Right. 

Dr. GRAVELLE. Some other things like that. But there are just 

real limits to what we can do. 

The CHAIRMAN. All right. 

Dr. Brannon? 

Dr. BRANNON. I think I am with Dr. Gravelle in the sense that, 

if you are constrained by wanting to do some kind of corporate tax 

reform that is revenue-neutral, you cannot go down all that far. 

The 2007 Treasury report that we worked on thought that if you 

got rid of everything, maybe you could get down to 27 or 28 percent. If you want to keep something like bonus depreciation, or 

maybe full expensing, you cannot even go that far. So I think it is 

a very real question: are you willing to sacrifice certain revenues 

to get down to a lower rate? 

The CHAIRMAN. Dr. Atkinson? 

Dr. ATKINSON. I think that I agree with the two other speakers. 

I think that our challenges to do this, in a revenue-neutral way, 

limit what we can do. I would argue we cannot do it in a revenueneutral way because other countries are not doing that. There is 

a lot of debate about what our real effective corporate tax rate is. 

The evidence we looked at suggests that it is higher than the 

middle of the pack of countries. It is not in the middle. We are closer to the top. So, I would argue the way to skin that cat, if you 

will, is to acknowledge that we have to do this in a non-revenueneutral way, and have lower rates and incentives at the same time. 

The CHAIRMAN. Dr. Foster? 

32 

Dr. FOSTER. Mr. Chairman, there are two basic sources of tax 

distortions we have to address in tax reform. One is getting the tax 

base wrong, and the second is high tax rates. To some extent we 

can clean up the base, eliminate some of the tax distortions. But 

even if we go as far as Dr. Gravelle has suggested, it only gets us 

about 5 percentage-points of reduction. 

On the other hand, we could talk about non-revenue-neutral corporate tax reform. But unless the Congress is in a position to talk 

about a major tax cut for the overall economy, that means somebody else aside from corporations has to pay more tax. There is a 

good chance that that additional tax will fall on capital, in which 

case, much of the economic gains that you had hoped for on the corporate side of reform by reducing the cost of capital—the metric 

that governs our ability to invest in new plant and equipment— 

would be lost on the individual side of reform. The basic issue is, 

without looking at the whole picture, as Senator—I forgot his name 

at the moment. 

The CHAIRMAN. Wyden. 

Dr. FOSTER. Wyden. Thank you. I kept thinking of his first name 

and not his second. My apologies, Senator Wyden. 

As Senator Wyden said, unless we look at the whole system, it 

is very hard to achieve sensible reforms. But even in that wholepicture approach, to whom do you want to shift the liability? It is 

hard to fix very much of the corporate tax system without it being 

a revenue loser, and yet, if it is a revenue loser, who gets to pay 

more? 

The CHAIRMAN. All right. 

Dr. Hanlon, you are wrap-up here. You get to sum it all up. 

Dr. HANLON. I agree with all the other panelists. I think making 

this revenue-neutral is the hard part about it. But I think it is very 

important to make our companies competitive with their international competition that are from other countries, and I think 

international reform is very important. 

I think almost any system would be better than the one we have 

right now. So I think, do not let comprehensive reform stop you 

from doing anything. I think it is very important to get our corporations on a more competitive ground. 

The CHAIRMAN. Thank you. 

Senator Rockefeller? 

Senator ROCKEFELLER. Just a thought. We have not talked about 

it this morning, but one of the things that interests me so much 

around this marvelous place that we work in, in this marvelous atmosphere, is that, if you talk about fairness when it applies to individual tax rates, you are immediately accused of class warfare. 

Just speaking completely for myself, but with completely intense 

feelings about it, it is not just the Warren Buffett syndrome. It is 

with the whole concept of everybody playing their part, everybody 

has to do something which is uncomfortable to them, that we have 

grown, almost, in this Congress—and many Congresses—so traumatized by the idea of raising tax rates of people who are not paying virtually anything, that it is called class warfare. 

Just as one member who has been sitting next to the chairman 

of the Finance Committee here for a long, long time, it has nothing 

to do with that, in my mind. In fact, it is nothing of a partisan 

33 

issue, in my mind. It is in the minds of those people who work here 

and vote here, but it is very strange, I would think. I would just 

like a quick comment from maybe two or three of you. What is so 

‘‘class warfare’’ about trying to introduce more fairness into the 

taxes that people pay? 

Dr. ATKINSON. Well, I can start by saying I fully agree with you, 

Senator. I think that higher taxes on the individual side—I disagree with Dr. Foster. I would be more than happy to see a comprehensive tax reform that raises taxes on individuals, and particularly high-income individuals, and lowers them on the corporate 

side. 

Rich people are not going to move to Mexico, or they are not 

going to move to Taiwan. Companies will do that because they are 

looking to maximize returns. So, I think the idea somehow that we 

cannot raise taxes on individuals and it is anti-growth, I think that 

would be a mistake. I do think it is much more important to get 

this right on the corporate side. 

Senator ROCKEFELLER. I agree. But my question stands. Anybody 

else? 

Dr. GRAVELLE. Well, I will take a stab at it, although class warfare is dangerous ground here. But I think the one thing that we 

do know is that inequality in this country has been increasing for 

at least 25, 30 years and that the higher-income people have had 

big increases in their income, and the bottom of the income distribution has been pretty much flat. So I think you need to sort of 

think about that when you are thinking about what kind of role 

taxes can play in it. 

The other thing is, the corporate and individual taxes are tied together. You cut the corporate tax too much, and you are going to 

set in motion a lot of people with a subchapter S or these limited 

liability corporations. 

Since the early 1980s, when 20 percent of business income was 

unincorporated, now it is 50 percent, from the Treasury study in 

2007, so you have to be careful about that. The final thing I would 

say is, when I look at the long-run budget challenges—and I wrote 

a paper about this at CRS—it is very hard to imagine dealing with 

those challenges without eventually increasing taxes somewhere. It 

is just very hard to imagine that. So you have to go where the 

money is. Most of the money is in the individual tax, and most of 

it is in the higher-income individuals. 

Senator ROCKEFELLER. Was it $300 billion of taxes are not paid 

each year? Is that both people and corporations? 

Dr. GRAVELLE. Most of the taxes that are not paid are by small 

businesses, actually. They apparently do not pay about half of their 

taxes. We have already done the credit card reporting. We might 

be able to do some reporting to increase that. But when you are 

exchanging money with cash, when you do not have a record, then 

it is very easy to avoid taxes. That is where the biggest part of the 

tax gap is. It is very little with wages, very little with corporations. 

However, I think there is a lot of international profit-shifting, probably billions and billions, $60 billion, $70 billion. U.S. companies had more profit in Bermuda than 6 times the GDP of Bermuda in a study I looked at. So that would be another place to look 

for money. 

34 

Senator ROCKEFELLER. I guess I will just end, Mr. Chairman, by 

saying that, for forever, I have been in favor of conscription, that 

people—all people—should take their lot, their chance in their local 

draft board, as being fair. That is like taxation, but it is in what 

people have to do, or what people do not have to do. 

To me, that is fair. To me, this business of making income taxes 

more equal, more fair is simply about fairness. It is not about politics. That is what it turns into around here, but that does not make 

the concept of fairness wrong. 

Thank you. 

The CHAIRMAN. Thank you all very, very much. 

What is the best way to get that Bermuda money? 

Dr. GRAVELLE. The money abroad? 

The CHAIRMAN. Yes. 

Dr. GRAVELLE. Well, I mean, the easiest way to do it is to not 

go to a territorial tax, but either to go to a current taxation with 

a limited cross-crediting of the foreign taxes, as in the WydenCoats bill, a minimum tax, something that will keep these companies from shifting all of their income into zero tax rate countries 

like Bermuda, the Cayman Islands, and the BVIs, where there is 

no activity going on. 

I mean, another is a look-back method for intangibles. Another 

is allocation of deductions. There are a lot of ideas out there that 

you could pursue to do that, but it is a free-for-all right now, it 

looks like to me. 

The CHAIRMAN. What is your preferred route? 

Dr. GRAVELLE. I think that both economic analysis and collecting 

this money says that a worldwide tax, without deferral, and with 

a per-country foreign tax credit limit, also separating royalties into 

separate baskets that would impose our taxes on the rest of the 

world, I think we could do that. I think we can prevent—the only 

concerns about that are U.S. firms might want to invert, and we 

have been very successful in keeping them from doing that. 

The CHAIRMAN. I was going to ask that question. So the down 

side of your recommendation is what? 

Dr. GRAVELLE. I do not really see a down side. 

The CHAIRMAN. But what are the other consequences? 

Dr. GRAVELLE. Well, we will have less operations abroad, and 

more in the United States. I mean, as an economist I cannot subscribe to the notion of international competitiveness. That is a 

meaningless concept for a country. 

So, I do not see much of a down side, except we might have to 

police firms a little better. That is classic economic theory. It has 

been going on for 50 years, that capital export neutrality, they call 

it. Taxing U.S. firms at home, and abroad, at the same rates, is the 

way to achieve efficiency. 

The CHAIRMAN. Does anybody want to comment on that? 

Dr. BRANNON. I think the flip side of that is capital import neutrality. If you are Pepsi Cola, and you are operating in Eastern Europe, which they are, quite successfully, and you increase their 

taxes so much that their effective tax rate for operating in Poland 

is much higher than any other company, what are they going to do? 

Pepsi Cola is not going to export Pepsi and potato chips from the 

United States into Europe. 

35 

What they are going to do is, they are going to sell, and they are 

going to get out of there. I think we need to understand that a lot 

of companies have U.S. operations overseas to compete in foreign 

markets, and to suggest blithely that worldwide taxation will take 

care of a lot of issues, simply assumes that that is not the case, 

that all U.S. companies operate overseas solely for tax reasons, or 

to keep employment down in the U.S. 

The CHAIRMAN. Dr. Atkinson? 

Dr. ATKINSON. I would agree 100 percent with Dr. Brannon. I 

think the only way to really deal with this question is to bring our 

effective rate down much lower, so the delta between their rates 

and our rates is lower. 

The idea, as Dr. Gravelle said, that somehow we can impose our 

tax code on the world, those days, if they were ever there, they are 

long, long gone. We cannot, we are not, and we never will be able 

to. If anything, they are imposing their tax rates on us, and we 

have to respond to it. 

The CHAIRMAN. Dr. Foster? 

Dr. FOSTER. Mr. Chairman, if we were to adopt the system Dr. 

Gravelle suggests, we would not have to worry about the complexities of the international tax code any more, because we would have 

virtually no multinational corporations left after a very few years. 

Recall Mercedes-Benz buying Chrysler, Inbev buying Budweiser? 

This would be repeated for every multinational corporation in the 

country, for the very simple reason that we will have imposed a 

very punitive tax system on the foreign earnings of these companies. All these companies have to do, to avoid that burden, is a simple tax arbitrage transaction: be bought by a foreign company. 

Every single one of them would be. 

The CHAIRMAN. Dr. Hanlon? 

Dr. HANLON. I agree. I think that system would be far too harsh, 

and it would put a lot of our companies out of business, and at a 

grave competitive disadvantage. 

On the other hand, I mean, I agree there are some abuses that 

we need to shore up the enforcement on: the foreign tax credit, for 

example; the splitter legislation that has been done I think is good. 

But, on the other hand, I think that system just would be far too 

harsh and would make it very hard on our companies. 

The CHAIRMAN. All right. Thank you very much. 

I intend to pursue tax reform this year, as will others. It is clearly necessary to do, for all the reasons we discussed. It is going to 

be politically difficult this year, but, nevertheless, we have to try. 

I encourage all of you, with me and with many, many others, just 

keep trying. Keep doing your analyses, your studies, your papers, 

your ideas; keep talking out. Be provocative, creative, and so forth, 

because we just have to figure out some solution to this terrible 

mess we are in. But this has been helpful. There will be many 

other hearings like it. But, thank you very much. 

Senator Rockefeller, thank you very much for what you do. I encourage you: keep going. 

Senator ROCKEFELLER. As do I. 

This is completely out of the park, but it is something that 

haunts me. And I may be wrong in my haunting. ‘‘Too big to fail’’ 

ended up with nine banks getting $125 billion of cash injection. All 

36 

of them had assets, and they were given that because they could 

then shield smaller banks elsewhere. 

The understanding throughout the conversation, but not in the 

text, evidently, was that they would use that to help with the housing and mortgage crisis. That was understood by all. The results, 

from what I understand, are that they spent not one dime on housing mortgage problems, but that they kept it all and used it for 

compensation. Am I correct? 

Dr. GRAVELLE. Well, it was too much money to use it for compensation of executives, so I think that it was—first of all, my understanding is a lot of those banks really did not feel like they 

needed the bail-out. They kind of went along with it. It is very hard 

to go from a big institution down to all these many, many mortgages, some of them very risky to take on. 

I just think it is very hard to reach through a central system to 

get down to all of those. So, I am probably not as critical. I think 

it was important to save the financial system, or I think the economy would have had possible—— 

Senator ROCKEFELLER. And it did that. 

Dr. GRAVELLE [continuing]. Disaster. 

Senator ROCKEFELLER. It did that. 

Dr. GRAVELLE. I thought that those policies were probably needed to save us from something far worse. 

Senator ROCKEFELLER. All right. Thank you. 

The CHAIRMAN. Thanks, everybody. I appreciate it very much. 

The hearing is adjourned. 

[Whereupon, at 11:50 a.m., the hearing was concluded.] 

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