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assumes that the economy is at or near its long-term growth path. If the tax changes were adopted in a recession, the effects would be somewhat altered. While 1973 was not a normal year in many respects, industrial utilization, economic growth, and the level of unemployment were close to generally considered long-term full employment growth levels and consistent with the assumptions of the long-term model that was used. Inflation increased dramatically throughout 1973 and was at rates quite above the assumptions of the model. However, since the results of the survey were interpreted in real terms, much of this bias was eliminated.

The survey data on each change in tax liability were compiled by SIC code. It was assumed that such changes in tax liability result in equal dollar changes in corporate cash flow. Also, a constant ratio of total investment to cash flow was assumed for determining the initial impact of a change in cash flow on investment. Once the feedback mechanism of the interrelationships within the economy is felt, however, the process becomes much more complex. While the initial impact on investment is determined by the change in cash flow, the subsequent impact is determined by changes in demand, the movement of interest rates, the cost of capital, the change in dividend payments and other factors. (See APPENDIX C, pp. 31-32 for a fuller discussion.) Once the change in investment was determined in each SIC code, these changes were weighted to represent the relative importance of investment in that ŠIC code to total investment in the economy. Then the initial changes in tax liabilities and investment in each industry flowed into the macroeconomic model (see CHART 2) where the feedback effects began to work. The changes ripple throughout various sectors of the economy (see CHART 1 on p. 14) and the macroeconomic impact is determined.

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NOTE:

It was assumed that the existing ratio between domestic and foreign investment will remain the same after any tax change. The findings represent only the changes which would occur in the domestic economy based on the exist ing relationship. While long-term adjustments to foreign investments could be expected to follow significant changes in tax treatment of foreign source income, it is beyond the scope or capacity of the project to make assumptions in this regard.

The results. The table on page 18 illustrates the format in which all of the TIP findings are presented in this report in pp. 1-9. The results are in terms of fixed investment, manufacturing employment, total employment, GNP and federal tax receipts for the simulation period. These have been selected as the economic factors which best illustrate the overall impact of each tax proposal. It should be noted that changes in GNP and fixed investment are based on constant (1958) dollars while federal government tax receipts are based on current dollars. The reason for this difference is to show GNP and fixed investment without distortion due to inflation while federal government tax receipts are depicted in actual dollars received. Thus, the numbers cannot be analyzed in terms of each other without first "deflating" government tax receipts.

The tables present the economy-wide effects of each tax proposal, both on a percentage change basis (the rows of figures designated (%)) and on a dollar and jobs basis (the rows of figures designated ($) and (jobs)). The percentage change reflects the change in the total economy as a result of the tax proposal as compared to economic conditions in the absence of any tax change. Note that these are differences from what otherwise would occur. The percentages are not intended to represent absolute changes from conditions in 1975.

The percentage effect of each of the tax proposals on the total economy is shown on an annual basis over a five-year period. It is assumed that the tax change remains in effect during the entire five-year period of the study. It is also assumed that the proposal has been in place for a period of approximately 18 months so that its full impact is realized. To translate the percentage changes into real figures, the percentages were applied to the long-term growth model of the U.S. economy. The differences between the basic model (assuming no changes due to tax policy) and the new simulations (based on the impact of the tax proposals) were calculated.

It should be noted that the multiple impact of all of the various feedbacks from the interrelationships within the economic system produce different results depending upon the time framework. For example, manufacturing employment is generally impacted more than total employment during the first year of full impact. This, of course, is what one would expect as employees are initially pulled into manufacturing from other sectors when the effect is positive or find jobs in other sectors when the effect is negative. After the "first round," however, the impact on investment is felt in other sectors of the economy as well, and output and employment react in these areas. Thus, the later effects on total employment are greater than in manufacturing alone.

For purposes of illustration, the five-year period of 1977-1981 was selected to illustrate the effects of the seventeen TIP proposals. This assumes that these proposals were adopted in mid 1975 and that an eighteen month interim period will allow the full effect of the change to be realized. This assumption was made for illustrative purposes only. It is recognized that the appropriate

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periods for any given proposals can vary widely.

It should be noted that TIP does not assume that there will be no impact in 1975 or 1976, merely that the full effect is assumed to be reached beginning in 1977.

It should also be noted that the TIP findings were based on tax law prior to P.L. 94-12. Therefore, the findings have been calculated by a model which did not take into account a 10% investment tax credit, except with respect to that specific proposal.

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APPENDIX A: DESCRIPTIONS OF THE TAX PROPOSALS

The Tax Impact Project Report discusses the economic impact of 17 specific tax proposals. These proposals are described below in the order in which they are presented in the report.

Major Proposals Affecting Domestic Source Income

10% Investment Tax Credit (p.1)

The investment tax credit for qualified section 38 property has been raised to 10% across the board during 1975-1976 for all taxpayers, including utilities, by P.L. 94-12, the Tax Reduction Act of 1975. At the time of the TIP survey in 1974, the investment tax credit rate was 7% generally, 4% for utilities. The TIP results represent the effects which the higher rate alone will have, assuming that it is made permanent. This assumes no other changes in credit rules, such as the 50% tax liability limitation, the 3-5-7 rule or any other credit-related provisions. The 10% rate would apply to all qualified property placed in service during the taxable year covered by the survey and to the basis of qualified property attributable to construction, reconstruction or erection during such taxable year.

40% ADR (p. 2)

Under existing law, the Asset Depreciation Range (ADR) allows a 20% variance from the asset guideline period (depreciable life) established for property within each asset guideline class. This allows the taxpayer to select a depreciation period which is up to 20% shorter (or longer) than the guideline period. The proposal would increase the allowable variance to 40%. No changes in the guideline periods or in any other ADR-related provisions would occur. The 40% variance would be applicable beginning with assets on which depreciation began during the taxable year covered by the survey.

Repeal of the Investment Tax Credit (p. 2)

At the time of the TIP survey in 1974, the investment tax credit rate was 7% generally, 4% for utilities. Therefore, the proposal contemplates repeal of a 7% credit as it existed prior to enactment of the 10% rate in P.L. 94-12, the Tax Reduction Act of 1975. Repeal would be effective on the first day of the taxable year covered by the survey. Thus, the TIP results assume that the taxpayer could not have taken any investment tax credit for that year. Repeal of ADR (p. 3)

The Asset Depreciation Range (ADR), which allows a 20% variance from the asset guideline period (depreciable life) for each class of depreciable property, would be repealed, effective as of the first day of the taxable year covered by the survey. Depreciation deductions would be based on the full guideline lives as established in Treasury Regulations for all property on which depreciation began during that year.

At the time of the TIP survey in 1974, the corporate tax rate was composed of a 22% normal tax on all corporate income and a 26% surtax on all corporate income in excess of $25,000, creating a 48% tax rate on income above $25,000. The proposal would increase the surtax rate to 28%, thereby creating a 50% rate. This 50% rate would be effective for the taxable year covered by the survey. The TIP results do not take into account certain provisions of P.L. 94-12 which altered the normal tax and the corporate surtax exemption.

Major Proposals Affecting Foreign Source Income

Current Taxation of CFC Earnings (p. 4)

Under existing law, the earnings of foreign subsidiaries of U.S. companies, often called controlled foreign corporations or CFC's, generally are taxable by the United States only when paid as dividends to domestic parents or other domestic shareholders. The only exceptions are found in Subpart F (sections 951-964) which was enacted to reach so-called "tax haven" income.

Under the proposal, 100% of the annual earnings of CFC's (any foreign corporations which are more than 50% controlled by U.S. persons) would be deemed paid as dividends in the year earned without regard to whether they are in fact distributed. The U.S. shareholders would be taxable on their pro rata share of such earnings. The foreign tax credit would remain intact and would be available with respect to such deemed-paid dividends. This proposal would be in effect for CFC earnings during the taxable year covered by the survey, but not for previously accumulated earnings.

Repeal of the Foreign Tax Credit (p. 4)

Under existing law, U.S. persons who have foreign source income must include it in gross income and pay U.S. income tax thereon. If that income has also been subject to income, war profits or excess profits taxes in foreign countries, the taxpayer may credit such taxes against the U.S. tax due on the same income, subject to certain computation rules. (Foreign taxes may not be credited against federal taxes due on U.S. source income.) This credit is available both for taxes paid directly by the U.S. taxpayer and for taxes paid by various levels of foreign subsidiaries and then deemed paid by the U.S. taxpayer.

Under the proposal, the credit would be completely repealed. Foreign taxes would be allowed only as a business deduction in computing taxable income. This would be effective with respect to all foreign taxes which would otherwise be creditable during the taxable year covered by the survey. This proposal would not require current taxation of 100% of CFC earnings.

Current Taxation of CFC Earnings coupled with Repeal of the Foreign Tax
Credit (p. 5)

Under this proposal, the current taxation of CFC earnings and repeal of the
foreign tax credit, as described above, would occur simultaneously. All subsidiary
earnings would be taxable directly to U.S. shareholders and foreign taxes could
be taken only as a deduction, not as a credit. This would be effective for
CFC earnings and foreign taxes thereon during the taxable year covered by the