TCS Daily

Tax Bill Would Stimulate High Tech

By Kevin Hassett - October 15, 2001 12:00 AM

Our elected leaders are mobilizing to offset any damage the terrorist attacks might have on the economy. Last Friday, the House Ways and Means Committee passed a stimulus tax bill that, if it becomes law, will provide a solid boost to the economy and to the high-tech sector in particular. There were a number of important details in the bill, but the most important are: a tax refund check mailed to individuals who did not receive them this summer; the repeal of the corporate Alternative Minimum Tax (AMT), and a change in depreciation rules to allow firms to deduct more of their capital expenditures in the year that they are made.

While the individual refund is very straightforward, the corporate stuff may look technical and boring. However, the economic impact of these policies may be quite significant if they become law, and the reeling high-tech sector in particular may benefit from them. A look at the details explains why.

First, the repeal of the AMT is welcome relief for firms that have spent a great deal of money in recent years on capital equipment. Under the current law, firms must calculate their taxes under two sets of rules. The "standard" law allows them to make significant depreciation deductions if they have made capital purchases. The "alternative" law, which was originally designed to catch tax evaders, allows smaller deductions for capital and other expenses. A firm pays whichever tax liability is higher, and the AMT law generally binds if there are "too many" deductions relative to income. The problem with the law is that many firms are pushed on to the AMT and end up paying tax surcharges if there is a recession. During a recession, low income, rather than high deductions, causes the tax penalties to kick in. This perverse tax penalty affected about half of all firms in the last recession, and fixing it now seems a prudent precaution.

There is another angle to this that is especially interesting. If a firm pays the AMT, then it carries forward a credit that refunds some of its payments if it ever becomes taxable under the normal law again. This is the sense in which the AMT targets "tax dodgers." One has to be on it continuously for it to really hurt. With the repeal, the Ways and Means Committee has made the credits refundable, which are currently being carried forward. This means firms with credits will get the cash if the law is passed. Some estimates suggest that about $25 billion of AMT credits are outstanding, so this will put a significant amount of cash in the pockets of firms just when they need it the most.

The second major feature provides a tax break that is especially potent for firms that purchase capital goods but are not on the AMT. When a firm purchases a machine, it is not allowed to deduct the entire cost of that machine against its taxable income, but rather must claim only the "depreciation" of that machine. This depreciation is determined by the tax schedules and spreads the deductions out over the life of the capital good, which can be decades. Conservative tax reforms often call for this law to be changed so that firms can deduct the entire expense incurred in the year that it happens, just as the firm is allowed to subtract labor expenses. Many believe that expensing would significantly stimulate business investment. This reform takes a big step in the direction of expensing.

The two of these together are very good news for the high-tech sector. Many customers of high-tech firms were about to be hit with AMT surcharges, thus stifling investment. Canceling those, and at the same time expanding the tax benefit for capital purchases, will stimulate a significant amount of extra activity.

Historically, the share prices of capital goods manufacturers have soared when Congress has passed legislation to stimulate business investment. This happens because the short-term upswing in demand gives suppliers additional pricing power, and profits benefit commensurately. One would expect to see the same pattern this time provided that the economy continues to show signs of improvement. Indeed, there are already signs that an upswing is in train. Bellwether capital goods suppliers, such as Applied Materials and Intel have seen their share price increase sharply in the past two weeks.

For those increases to continue, however, the Senate will have to pass a similar bill. There is a significant amount of uncertainty about that at this point, with Senate Democrats condemning the House bill over the weekend for being too targeted toward "those who don't need tax relief." Given that the House bill had the tax rebates that Senate Democrats desire, one can fairly comfortably forecast that some horse trading will go on over the next few weeks, and that the eventual outcome of that trading will provide tax relief to the battered high-tech sector.

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