Order Code RL32103
CRS Report for Congress
Received through the CRS Web
Comparison of Tax Incentives for Domestic
Manufacturing in Current Legislative Proposals
Updated October 1, 2004
Jane G. Gravelle
Senior Specialist in Economic Policy
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

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Comparison of Tax Incentives for Domestic
Manufacturing in Current Legislative Proposals
Summary
Several tax bills have been introduced to eliminate the extraterritorial income
(ETI) provision of the U.S. tax code that has been found to contravene trade
agreement restrictions against export subsidies by the World Trade Organization
(WTO). These bills contain tax cuts for domestic manufacturing which offset the
loss of the export benefit, but differ in the manufacturing tax benefit. H.R. 1769
(Crane and Rangel), would allow a percentage reduction of the corporate tax rate
proportional to the domestic share of total output. (A similar bill, S. 970, was
sponsored by Senator Hollings.) An initial version of H.R. 2896, sponsored by Ways
and Means Chairman Thomas would have provided accelerated depreciation for
manufacturing equipment (a similar bill, S. 1475, was sponsored by Senator Hatch),
although that provision was replaced by a reduction in the top corporate tax rate on
manufacturing in a later version of the bill. The tax rate reduction is in H.R. 4520,
the current bill passed by the House on June 17, 2004. S. 1637, originally sponsored
by Senate Finance Committee Chairman Grassley and Ranking Member Baucus, and
passed by the Senate on May 11, 2004, would provide a rate cut similar to that in
H.R. 1769. It would incorporate, but then phase out, the provision adjusting the cut
for the share of production that is domestic. This bill also contains a number of other
provisions. The conference bill now under consideration will follow the Senate
version, but with the House’s expanded definition of manufacturing.
Although the overall revenue cost of the rate cuts is larger than the effect of
accelerated depreciation initially proposed in H.R. 2896, the provisions have about
the same magnitude of effects on manufacturing tax burdens on new investment,
reducing them by about 4%. The small revenue cost of accelerated depreciation can
produce a similar incentive effect because it does not benefit the return to existing
capital. These incentive effects would more than offset the lost benefit from the
repeal of ETI. The approach in H.R. 1769 would, however, have a more certain and
larger effect on encouraging domestic investment in manufacturing. Additional
domestic investment would have both a direct tax benefit effect, and an indirect
effect through increasing the ratio of domestic to world production. Within
manufacturing, accelerated depreciation tends to introduce distortions across asset
type, while rate reductions, particularly if confined to corporate rates, reduce
distortions between debt and equity and corporate and noncorporate investment.
Accelerated depreciation and rate cuts have quite different implications for tax
administration and compliance. Although any provision that singles out an activity
to favor will encounter administrative costs in ascertaining the qualified activities,
accelerated depreciation applied to manufacturing assets is probably feasible to
administer without a great deal of additional cost. A rate reduction for a specific
activity would, however, potentially lead to significant increases in these costs as
firms that operate in many different activities attempt to claim manufacturing status
and to transfer taxable income into their manufacturing activities through distortions
in within-company transfer prices and misallocations of deductions and passive
income. This report will be updated to reflect legislative developments.

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Contents
Descriptions of the Proposals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
H.R. 1769 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
H.R. 2896 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
H.R. 4520 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
S. 1637 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Magnitude of Effects on Domestic Manufacturing Investment . . . . . . . . . . . . . . . 5
Other Effects on the Allocation of Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Issues of Administration and Compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

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Comparison of Tax Incentives for Domestic
Manufacturing in Current Legislative
Proposals
Several bills have been introduced which would eliminate the extraterritorial
income tax (ETI) provision that has been found to contravene trade agreement
restrictions against export subsidies by the World Trade 0rganization (WTO). Each
bill includes other provisions, in some cases to offset the revenue gain from the
provision with a tax cut, and in others to go beyond the offset to provide an overall
net tax reduction.1 Each bill has a provision that is specifically focused on
manufacturing, and is either explicitly limited to or will in effect be largely focused
on domestic manufacturing. The argument for providing an offsetting benefit to
manufacturing is that the burden of the repeal of the ETI largely falls on the
manufacture of goods in the United States, and in some ways the provision of
benefits to domestic manufacturing is the closest way to provide general tax cuts to
the firms that lose benefits. In addition, arguments are made that losing the export
subsidy will discourage domestic production and this incentive is needed to offset the
effects of eliminating the ETI.
A conference is currently underway on H.R. 4520, following the passage of the
Senate’s version (then S. 1637) and the House bill (H.R. 4520). The starting point
for the conference would be based on the Senate version, which allows a deduction
and would cover unincorporated firms as well as corporations. However, the
proposal contains the broader definition of manufacturing in the House bill which
includes oil and gas extraction, utilities, construction, and electricity.
The remainder of this report discusses the provisions in these two versions of
the subsidy as well as
In the case of the Crane-Rangel bill (H.R. 1769), the Grassley-Baucus bill (S.
1637) which was reported out of the Senate Finance Committee on October 1, and
the second version of H.R. 2896 (Thomas) reported out of the Ways and Means
Committee on October 28,. this tax benefit is provided through a rate reduction (in
the form of a deduction in H.R. 1769 and S. 1637; through a cut in the top corporate
rate in H.R. 2896). H.R. 4520, passed by the House, also contains the manufacturing
rate cut. In the case of the initial version of Thomas bill (H.R. 2896), the
manufacturing tax benefit was provided via a depreciation deduction. The Hollings
(S. 970) bill is identical to H.R. 1769 and the Hatch (S. 1475) bill is similar in many
respects to the initial version of H.R. 2896. The President did not, however, include
1 See CRS Report RL32066, Taxes, Exports, and International Investment: Proposals in
the 108th Congress, by David Brumbaugh for additional analysis of these proposals.

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CRS-2
such a proposal in his budget proposals. This report focuses on comparing the
manufacturing provisions. It begins with a brief description of the provisions in each
of the four bills, and proceeds with an analysis of the general magnitude of the effect
on investment incentives, the allocational effects across types of investment, and
issues of administration and compliance. A floor amendment during consideration
of S. 1637 that proposed to allow a credit for wages in manufacturing rather than a
rate reduction was defeated on May 5, 2004.
Descriptions of the Proposals
While H.R. 1769 focuses on repealing the ETI and offsetting the gain with a
manufacturer’s subsidy, H.R. 2869, S. 1637, and H.R. 4520 are much broader, with
the ETI repeal and the manufacturing tax benefit only a part of the bill. While this
paper focuses on comparing the domestic manufacturing provisions this section
briefly discusses other provisions that will be referred to in the discussion of
allocational effects.

H.R. 1769
H.R. 1769 proposes to offset the revenue loss from the repeal of ETI with a
deduction of up to 10% of taxable income from domestic production. The deduction
would be multiplied by the share of the total business that is domestic. Thus, if the
capital output ratio were the same in the United States as abroad, the deduction for
total income would be multiplied by the share domestic squared. If a firm had 50%
of its output domestic, the effective deduction rate for domestic income would be
5%, and the effective deduction overall would be 2.5% (10% X(0.5)2).
H.R. 2896
An earlier version of H.R. 2896 contained a provision to allow accelerated
depreciation for manufacturing equipment and did not contain a manufacturing tax
reduction.2 This provision is also discussed in this study.
2 The initial version of H.R. 2896 proposed a series of temporary and permanent provisions
to offset the repeal of ETI. (which gained $49 billion). The depreciation provision cost $35
billion; other provisions would have limited benefits for domestic manufacturing or are
temporary. The largest set of tax cuts was a series of provisions benefitting earnings from
foreign investment which amount to $80 to $90 billion (the higher number includes an $11.3
billion expansion of the alternative minimum tax that would significantly benefit foreign
source income); all provisions were permanent with the exception of a temporary provision
costing $3 billion to provide a tax holiday for the repatriation of earnings from abroad. The
bill also contained $24 billion in provisions that benefitted smaller and medium sized
businesses, with a $2 billion a temporary provision expanding equipment expensing; most
of the cost ($19.5 billion) would reduce corporate tax rates for smaller firms. The remaining
provisions involve removing more small firms from coverage of the AMT and benefits for
Subchapter S corporations (incorporated firms treated as partnerships for tax purposes) ;a
provision providing more rapid depreciation for leasehold improvements and restaurants
(about $8 billion); a one-year extension of bonus depreciation ($12 billion), an extension
(continued...)

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CRS-3
H.R. 2896 proposes a series of temporary and permanent provisions to offset the
phased out repeal of ETI, which would gain $43.1 billion over 2004-2013. (All
revenue estimates mentioned in this report refer to that 10-year period unless
otherwise noted). For domestic manufacturing and certain other production
activities, the top corporate tax rate would be lowered from 35% to (initially) 34%
and then 32% in 2006 and after; this provision costs $61.1 billion. There are a
number of other tax cuts and tax increases in the bill, but most of them would have
limited benefits for domestic manufacturing or are temporary.
The largest set of tax cuts in the bill is a series of provisions benefitting earnings
from foreign investment which amount to $39.2 billion including a $3 billion
provision to allow a more complete offset of foreign tax credits losses against the
alternative minimum tax (AMT). These provisions might provide tax cuts for firms
that manufacture in the U.S. and also manufacture abroad, but their incentive effects
would be to discourage domestic production. Another $4.7 billion is associated with
allowing more net operating losses against the AMT and $1 billion in exempting
smaller firms.
The bill also contains some additional provisions that benefit smaller and
medium sized businesses, amounting to $18.4 billion, with $2 billion a temporary
provision expanding equipment expensing; most of the cost would reduce corporate
tax rates on taxable income, initially on income below $1 million and eventually
below $20 million. Benefits for Subchapter S corporations (incorporated firms
treated as partnerships for tax purposes) amount to $1.3 billion. Since most
manufacturing is carried out by large firms, these benefits are unlikely to be very
important to the industry. A provision providing more rapid depreciation for
leasehold improvements and restaurants for a temporary period, amounting to about
$2.1 billion, would also likely benefit smaller firms and would not benefit domestic
manufacturing. $1.1 billion is associated with employee benefits and about $1 billion
with a series of miscellaneous business provisions. The bill also raises about $9
billion from tax shelter provisions and $16 billion from customs fees.
H.R. 4520
H.R. 4520 proposes a series of temporary and permanent provisions to offset the
phased out repeal of ETI, which would gain $49.6 billion over 2004-2014. (All
revenue estimates in this section refer to that 11-year period). For domestic
manufacturing and certain other production activities, the top corporate tax rate
would be lowered from 35% to (initially) 34% and then 32% in 2007 and after; this
provision costs $63.6 billion. There are a number of other tax cuts and tax increases
in the bill, but most of them would have limited benefits for domestic manufacturing
or are temporary.
2 (...continued)
of the R&D credit ($23 billion); an extension of net operating loss carryforwards ($5
billion); a general provision expanding depreciation for purposes of the AMT and tax
provisions that raise revenues by about $9 billion by addressing tax shelters. (About $12
billion is raised by customs fees). Many of these provisions were retained in the revised
version of the bill.

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CRS-4
Many of the other provisions of H.R. 4520 are similar to those in H.R. 2896.
Provisions affecting earnings on foreign source income are smaller ($33.1 billion
including a $3.4 billion offset for the foreign tax credit against the alternative
minimum tax). The bill also includes a $3.5 billion cost to allow a temporary lower
tax on repatriation of foreign dividends. There is no general net operating provision,
although there is one for small business. For small firms, extension of expensing for
small firms ($1 billion), other rate cuts ($14.9 billion ) and provisions for Subchapter
S firms ($1.3 billion) are retained, as is depreciation for leaseholds and restaurants
($2.3 billion). The bill also contains $0.9 billion of miscellaneous reductions, $0.5
billion excise tax reductions, and a $6.1 billion benefit for alcohol fuels.
H.R. 4520 also extends expiring provisions ($14 billion) and allows a temporary
deduction for state and local sales taxes ($3.6 billion for 2005 and 2006). Tax shelter
provisions are much more extensive ($40.7 billion), due largely to the inclusion of
a leasing provisions (and increasing expectations of revenue gains from restricting
leasing), although an earnings stripping provision was dropped. Customs fees will
raise $18.6 billion.
S. 1637
This bill would provide a repeal of the ETI raising $55.7 billion in revenue,
which would be offset by approximately $10 billion in transition relief. It would be
offset by a deduction of 9% of the profits from U.S. domestic manufacturing
production, costing $45.6 billion. (This deduction would reduce the rate from 35%
to 31.85%). This deduction would be phased in and would initially be affected by
the domestic share of worldwide production as in H.R. 1769 (but that effect would
be eliminated in the long run).
The initial bill also contained some benefits for income from overseas
investment, but in a much smaller amount of $7.1 billion, which included $3.8 billion
for a temporary provision allowing tax free repatriation of foreign source income.
Additional provisions added prior to markup raised the total from $7 billion to $25.5
billion, with an additional $11.3 billion added during markup, for a total of $38
billion. Thus, the permanent provisions for foreign investment are about the same
size as in H.R. 2896 (but considerably smaller than the provisions in the initial
version). There are also numerous provisions to raise revenue, including some that
address tax shelters (and in some cases these tax shelters are related to foreign
activities); these amounted to $25 billion before markup with another $30 billion
added during mark-up.
Additional provisions added before markup expanded the manufacturing
deduction largely by extending it to unincorporated businesses and to oil refining and
timber at a cost of $14.1 billion and a mixture of other minor tax benefits including
benefits for films and timber costing about $3 billion. $14 billion of other tax cuts
were added during mark-up.
A number of amendments were considered during the debate on the Senate
floor; one that would have replaced the rate reduction for manufacturing with a wage
credit was defeated on May 5, 2004.

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CRS-5
On the Senate floor, the manufacturer’s provision was extended to film-making.
A number of other provisions were adopted relating largely to tax shelter provisions.
Magnitude of Effects on Domestic
Manufacturing Investment
While the revenue costs discussed above provide some notion of the magnitude
of effects of the tax provisions, they cannot easily be compared. Rate reductions
occur each year in about the same amounts but accelerated depreciation confers its
benefits primarily in timing effects. The rate reduction in S. 1637 is phased in. At
the same time, the initial years of the accelerated depreciation deductions in the
original version of H.R. 2896 occur in periods when bonus depreciation is in effect;
the revenue cost is larger without bonus depreciation than with it.
Overall, however, the rate reduction in S. 1637 provides a larger tax benefit
during the 10-year revenue estimating period and beyond than the accelerated
depreciation deduction.
The rate reduction in S. 1637 also more than compensates for the effect of the
loss of the export subsidy in manufacturing as a whole (although not necessarily for
very export intensive firms). The repeal of ETI should reduce exports, which are
largely manufacturing, and the domestic manufacturing subsidies that offset it would
probably increase overall domestic manufacturing in the long run since the annual
revenue cost in the last year for the manufacturing deduction is larger than the
revenue gain from repealing ETI (a gain in 2013 of $7 billion compared to a loss
from $10 billion from the original bill and another $2 billion from the additions).
Since both the export deduction and the manufacturing deduction are of the same
type (a reduction in current income taxes) the larger size of the manufacturing
incentive suggests that it more than compensates for the additional burdens. The rate
reduction in H.R. 2896 is slightly smaller, at $9 billion but still larger than the ETI
repeal.
The composition of manufacturing will shift somewhat, however, because firms
with a lot of export business will suffer relative to firms with little export business.
The size of the cash flow effects does not mean that the overall incentive to
invest in domestic manufacturing is smaller than the original accelerated depreciation
provisions. Rate reductions reduce the return to the existing stock of assets, while
accelerated depreciation benefits only investment (net and replacement). To have the
same incentive effect a rate reduction would cost more in present value terms than
accelerated depreciation.
There is a way, however, to assess the general magnitude of the effects of these
provisions, at least in terms of the incentives provided to domestic investment.

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CRS-6
Calculations in a CRS report3 indicate that the initial depreciation provision in H.R.
2896 and the rate reductions in manufacturing in S. 1637 and H.R. 1769 have about
the same overall magnitude of benefits for manufacturing, reducing the effective tax
rate overall by about 1.5 percentage points (assuming no bonus depreciation). Since
corporate investment is subject to a current rate of around 40%, this reduction is
about a 4% reduction. It is small, but so is the overall effect of repealing ETI.
The provisions of H.R. 1769 would, however, have a more pronounced effect
on providing an incentive to invest in domestic manufacturing than the other two
bills, for two reasons. First, because the subsidy is dependent on the domestic share
of value added, an increase in domestic investment has two effects on the tax benefit:
the direct effect of increase in domestic taxable income, and the indirect effect of
increasing the domestic share. (See Appendix for a discussion.) Moreover, there
is a disincentive to invest abroad. There is a temporary effect in S. 1637 of this type
as well. Making an incentive dependent on the domestic share of output is more
feasible with a rate reduction than with accelerated depreciation.
This analysis looks at the manufacturing subsidy in isolation. The relative effect
of H.R. 1769 on encouraging substitution of domestic for foreign investment
compared to the other bills could be greater when considering the benefits for foreign
source investment in S. 1637 and H.R. 2896. Indeed, judging from revenue losses
associated with foreign source income, while H.R. 1769 would offset (and perhaps
slightly more than offset) the discouraging of domestic production from the export
subsidies, S. 1637 and H.R. 2896 could encourage an outflow of capital. Some of
the foreign provisions, however, because of the way they are structured, encourage
domestic investment, so that conclusion is unclear.
Note also that these calculations assume no bonus depreciation. The
independent effects of accelerated depreciation with bonus depreciation already in
place are about 60% as large. The effects are also slightly smaller for the rate
reductions.
Of course, there is an additional policy question: whether it is desirable to
subsidize domestic or foreign production. Under a common standard used by
economists to judge world wide economic efficiency (which suggests that U.S.-
owned capital is allocated most efficiently when rates of return are equated in both
places) the direction of change to increase economic efficiency depends on the extent
to which foreign source income is undertaxed relative to U.S. income (as it is in low
tax countries) or overtaxed (as it is in high tax countries). If the objective is to
maximize U.S. economic welfare, however, it is better to encourage domestic
investment in large part because taxes on returns to domestic investment accrue to
the U.S. Treasury, while taxes on returns to foreign source investment may largely
accrue to foreign governments. (This analysis assumes that foreign governments do
not retaliate against U.S. policies to discourage capital outflow).
3 CRS Report RL32099, Corporate Income Tax Revisions and Effective Tax Rates, by Jane
G. Gravelle.

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CRS-7
There is also a distributional effect: while tax subsidies benefit owners of capital
in general, inducing investment in the United States tends to benefit domestic
workers, but reduces earnings of foreign workers, while the opposite occurs when
investment is encouraged to move abroad.
Other Effects on the Allocation of Capital
The alternative approaches — accelerated depreciation vs. rate reduction — will
have other effects as well. The accelerated depreciation provisions are restricted to
equipment and are available for both debt and equity; therefore, within the
manufacturing sector, they introduce distortions in the allocation of the capital stock
without reducing distortions between debt and equity finance. Rate cuts also reduce
distortions between corporate and non-corporate sectors, although there is relatively
little non-corporate manufacturing. (The rate reduction in H.R. 1769, which is
limited to corporations, would reduce this distortion more.) Thus, based on more
neutral taxation of types of investments and finance within the manufacturing sector,
the rate reduction is more neutral than accelerated depreciation.
Accelerated depreciation, however, reduces effective tax rates more per dollar
of revenue loss and therefore is a more effective method of reducing the overall
distortion between present and future consumption (because it does not benefit
existing capital).

Issues of Administration and Compliance
Carving out a special tax provision for a particular industry will create some
significant administrative costs — both in the definition of the favored activity and
the allocation of income for diversified firms.
No definition of the favored activity can be drawn that will not give rise to some
disputes about what activities are or are not manufacturing. State experience with
manufacturing exemptions is instructive in showing the types of disputes that may
arise. For example, recent cases dealt with whether the mixing of paint in a retail
store was manufacturing, how to determine the extent to which newspapers involve
manufacturing (the printing of the paper is manufacturing, but what about the
gathering and processing of content?), and the extent to which activities such as
broadcasting, on-site pizza dough making in a restaurant, brewing beer for a brew
pub, and blending sand qualified as manufacturing.4 These problems occur with both
accelerated depreciation for manufacturing equipment and with a special tax rate on
manufacturing profits, although they would probably be somewhat more troubling
with a rate reduction because capital intensity in machinery use is probably more
associated with traditional manufacturing activities where little dispute would arise.
4 These cases were provided by Matt Tomalis of the Federation of Tax Administrators.

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CRS-8
A second, and perhaps more serious problem arises with the special rate
reduction. Many firms operate in manufacturing and in other types of business as
well. They may be firms with some amount of vertical integration (e.g. operating
related wholesale and retail sales, or finance, businesses). Firms may also operate
different types of businesses, an approach that reduces risk. And some activities
may have a manufacturing and a non-manufacturing element (such as the newspaper
example discussed above). These different businesses may be branches of the same
entity, or may be separately incorporated affiliates. Because of the variety of
activities, one cannot simply allow any firm that engages in manufacturing to take
a deduction for its taxable income without allocating income to the manufacturing
activity. In many cases, neither firms nor the IRS have existing experience in
allocation of income and deductions across activities.
This problem of allocation of income has been a serious and longstanding
problem in our international tax system, where, because we do not currently tax
foreign source income and do not allow unlimited foreign tax credits, firms have an
incentive to allocate income to the areas that minimize their tax liability. Two
methods are used to achieve this effect. First, when domestic and foreign entities buy
products from each other, taxable income will be affected by the intercompany price
charged — an issue referred to as transfer pricing. Tax rules require an arm’s length
price (the price that would be charged by related parties) but this arm’s length price
is observable only if the items are traded in a general market and in many cases such
comparables do not exist. Secondly, the firm can attempt to allocate deductions and
other payments, such as interest, rents, royalties, and overhead costs, in a way to
minimize taxable income in high tax jurisdictions. A great deal of time and effort on
the part of taxpayers, the Internal Revenue Service, and the courts is devoted to
adjudicating these issues.
There is a contrast between the complexity of accelerated depreciation versus
a rate reduction, therefore, with respect to administrative costs. While carving out a
special depreciation rule is somewhat complicated, the present depreciation system
is actually linked to a more detailed underlying depreciation schedule where many
assets are differentiated not according to type, but according to the industry in which
they are used. Moreover, for manufacturing equipment, its use is relatively clear in
most cases. There are assets used across industries (e.g., computers, furniture and
fixtures) which were not classified by industry but by type (often part of overhead
costs) that could present a problem.

In the case of a deduction for taxable income, however, all of the issues
associated with transfer pricing and the allocation of passive income and deductions
that have created such administrative difficulties in the international tax system
would occur in the domestic U.S. economy. The rate reduction approach, therefore,
would be more costly to administer and comply with than the accelerated
depreciation deductions.

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CRS-9
Conclusion
This analysis suggests that the rate reduction for manufacturing approach in S.
1637 and the current version of H.R. 2896, while costing more revenue than the
accelerated depreciation for manufacturing equipment in the initial version of H.R.
2896 and other bills, has about the same effect on the overall cost of capital and the
incentive to invest abroad. The rate reduction in H.R. 1769 has the larger effect
because it is multiplied by the ratio of domestic to total output, a feature that can be
added to a rate reduction approach easily, but not to an accelerated depreciation
approach. Within the manufacturing sector, the rate reduction approach is more
neutral and reduces other distortions, particularly if confined to a corporate rate
reduction. However, the rate reduction raises much more serious issues with respect
to administration and compliance than does the accelerated depreciation provision.

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CRS-10
Appendix
The benefit, B, of the tax rate provision is, in the case of S. 1637:
(1) B = grtKD
where g is the percentage deduction, t is the tax rate, r is the rate of return and K is the
D
capital stock. For purposes of a small change we can hold the return fixed (one could also
derive the effects by expressing benefits as B = gt(Q -wL ), where Q is output and L is
D
D
D
D
the labor supply, and the last term in parentheses is profits). This example ignores debt
finance.
In the case of H.R. 1769, the benefit is:
(2) B = grtK (D/(F+D))
D
where D is the amount of domestic production and F is foreign production.
Converting to logs and differentiating these equations, which produces
percentage changes, holding g, r and t constant, in the case of S. 1637, and with a hat
(^) denoting percentage change:
^ ^
(3) B = KD
The magnitude of the effects in H.R. 1769 depend on two issues. First, does the
analysis involve examining the substitution of capital between domestic and foreign
uses, holding the total capital stock fixed, or, instead simply involve an additional
amount of capital added. Secondly, is the addition of capital accompanied by the
same percentage addition of other inputs such as labor (referred to as a fixed
technology case) or are other factors fixed. (The truth probably lies somewhere in
the middle.)
In the case of H.R. 1769, and assuming that fixed technology of production, so
that a percentage change in capital stock leads to a percentage change in output, and
also assuming that capital invested in the United States is shifted from abroad (total
capital stock is fixed)
^ ^ ^ ^
(4) B = K + D = 2K
D
D
In this case the effect is twice as large for H.R. 1769.
If the domestic investment adds to the total capital stock the effect is
^ ^ ^ ^
(5) B = K + D (F/(F+D) = K (1+F/(F+D))
D
D
In this case, the incentive to invest domestically is actually greater for firms with a
large amount of foreign activity.

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CRS-11
An investment abroad in isolation, denoting foreign capital as K will lead to a
F,
reduction in the benefit:
^ ^

(6) B = - (F/(F+D)) KF
(and if we measure the change in foreign capital as a percent of domestic capital, the
multiplicative term in (6) will be D/(F+D)).

If capital expands with no matching expansion of other inputs, such as labor, the
additional effects will multiplied by the capital share of income. That is, a
substitution will lead to a new version of equation (4):
^ ^ ^ ^
(7) B = K + aD = (1+a)K
D
D
where a is the share of capital income. Since a is typically about a third, the effect
of the exclusion which is multiplied by the share domestic is to provide an incentive
about 33% larger.
There are similar modifications of the effects in the other equations (5):
^ ^ ^ ^
(8) B = K + a D (F/(F+D) = K (1+aF/(F+D))
D
D
and (6):
^ ^

(9) B = - a (F/(F+D)) K .
F

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