Retirement and Social Security Reform
Fundamental Flaws in the Minimum Tax Depreciation
July 14, 1986
By Ernest S. Christian Jr., George J.Shutzer and Kathleen
Ernest S. Christian, Jr., George J. Schutzer, and Kathleen
M. Nilles are attorneys with Patton, Boggs & Blow, Washington,
D.C. Mr. Christian served as Deputy Assistant Secretary of
Treasury (Tax Policy) in 1974-1975 and held other Treasury
tax policy positions in prior years.
In this special report, the authors illustrate the adverse
consequences of the depreciation recalculation required under
the alternative minimum tax systems contained in the House
and Senate tax bills. These consequences include the imposition
of disproportionately high effective tax rates on capital-intensive
companies and the creation of new tax-oriented merger incentives.
The authors also track the impact of the minimum tax on a
capital- intensive company with declining earnings, pointing
out that as the earnings of such a company drop, its effective
tax rate will increase, unless it engages in the self-defeating
process of cutting back on capital investments.
The authors attribute these undesirable consequences to flaws
in the calculation of depreciation preference, principally
a baseline that significantly understates economic depreciation,
and the system's failure to allow taxpayers to fully "net"
their depreciation allowances. The authors argue that these
defects could be easily corrected by the Conference Committee,
and suggest several approaches the Conference Committee could
Table of Contents
II. Consequences of the AMT
A. Methodology and Assumptions
B. Overtaxation of Capital-Intensive Companies
C. Tax Consequences of an Earnings Change
D. Tax Incentives for Mergers and Acquisitions
III. Underlying Defects in the AMT
A. Redefinition of the Depreciation Preference
B. Extension of the Netting Concept
The alternative minimum tax ("AMT") systems included
in the tax bills passed by the House and Senate contain serious
structural flaws that run counter to sound tax and economic
policy. This analysis illustrates, by numerical examples,
those defects and their negative consequences, particularly
for capital-intensive companies.
Under the proposed minimum tax systems, the more a company
spends on capital equipment, the greater is the percentage
of its income that will be subject to tax. All other things
being equal, if two minimum-taxpaying corporations have the
same economic income, the more capital-intensive company will
pay more tax. Under the minimum tax, declines in income will
not cause proportionate declines in taxes. If a capital-intensive
company's earnings decline to marginal levels for a year,
its effective tax rate will increase, even to a level where
taxes exceed economic income.
These results violate established principles of tax policy.
First, they compromise the principle of horizontal neutrality.
Companies with the same net earnings should pay a comparable
amount in taxes each year, not vastly different amounts. Second,
the imposition of higher effective rates of tax on companies
with declining or marginal earnings is perverse, especially
since such declines may be caused by a recession, a labor
strike, some new thrust of subsidized foreign competition,
or even by actions of our own government. Third, the disparate
effective tax rates imposed under the AMT create tax incentives
for companies to engage in corporate reorganizations that
lack a bona fide business purpose.
The impact of the AMT on capital-intensive companies also
raises serious questions of economic policy. To the extent
that the minimum tax nullifies the benefits of depreciation,
it will work to deter capital investment. This result will
constrain future growth in sectors of the U.S. economy. Ultimately,
decreased capital investment will spur the movement overseas
of U.S. jobs, as well as production facilities. Do the drafters
of tax reform really intend to encourage capital flight and
to accelerate the shift to a services-based economy?
These consequences stem from a flawed depreciation preference.
Both the House and Senate tax bills compute alternative minimum
taxable income ("AMTI") by adding back certain preferences
and recomputing certain deductions. In the case of depreciation,
both bills require that AMTI be determined using an alternative
depreciation system.(1) In general, that system requires taxpayers
to compute depreciation using the straight-line method over
the ADR midpoint life of the asset. Thus, the depreciation
"preference" consists of the excess of regular tax
depreciation over alternative system ("baseline")
depreciation. The preference is computed with respect to all
property placed in service after the effective date, and not
on an item-by-item basis.
There are at least two major problems with the computation
of depreciation under the minimum tax. First, the proposed
definition of baseline depreciation (straight line over the
ADR midpoint of an asset) stretches out depreciation over
too long a period of time in proportion to the decline in
productive output or value of the machinery and equipment.
Second, because taxpayers are not permitted to "net"
their depreciation on assets placed in service prior to the
effective date, the calculation will produce artificially
inflated preference amounts in the first three to 10 years
after the AMT is enacted.
II. Consequences of the AMT
Largely as a result of the flawed computation of the depreciation
preference, application of the minimum tax will place a disproportionate
burden on capital-intensive companies. The examples illustrate
that as companies' capital-intensity ratios increase, they
will be increasingly subject to high effective tax rates under
the minimum tax.(2)Moreover, when such companies encounter
periods of declining profitability, their effective tax rates
can still be expected to rise.
The examples focus primarily on the Senate bill, but the negative
consequences they illustrate are equally applicable to the
House bill; indeed, the impact of the AMT on capital-intensive
companies would be even more punitive in nature if the House
bill's 25 percent AMT formed the basis for a Conference Committee
bill that included the Senate bill's regular tax depreciation
A. Methodology and Assumptions.
The first part of the analysis compares the tax obligations
of companies of varying capital intensity that have the same
net earnings. The second part focuses on a particular company
that experiences a decline in earnings. The hypothetical corporations
have only one preference for minimum tax purposes -- "excess"
depreciation on equipment that has an ADR midpoint of 14 years.(3)
The corporations acquire a constant amount of equipment each
The key variable in the first part of the analysis is the
amount of equipment each corporation acquires annually in
order to earn the same net profit. Use of the variable reflects
common business realities. Whereas some corporations are forced
to acquire substantial amounts of capital equipment to maintain
profitability, others are able to earn the same profit while
acquiring less equipment. For example, a company engaged in
manufacturing tires cannot avoid making substantial capital
outlays for depreciable equipment and plant; by contrast,
a company that produces computer software would be able to
earn an equivalent profit at a much lower capital-intensity
This analysis treats the excess of a corporation's predepreciation
earnings over the amount it spends on capital equipment each
year as the corporation's "economic income" for
purposes of measuring its real tax rate. If a corporation
earns x dollars before depreciation, but spends y dollars
on equipment each year, it seems clear that its economic income
equals x - y. Thus, a corporation that earns $100 before depreciation
each year and spends $85 annually on capital equipment would
have economic income of $15.
The corporation's minimum tax liabilities are calculated using
the Senate bill's rate of 20 percent; the regular corporate
tax is calculated at a 33 percent rate for the entire period
(including the first six months of 1987). Table E provides
background computations of the depreciation preference.
B. Overtaxation of Capital-Intensive Companies.
Graphs A and B and Tables A and B compare the tax obligations
of companies of varying capital intensity. Graph A and Table
A provide comparisons for 1991. Graph B and Table B provide
comparisons for the period 1987-1992.
In general, the analysis shows that as corporations' capital-
intensity ratios increase, their exposure to the minimum tax
will also increase. The analysis also shows that such minimum-taxpaying
corporations will pay tax at effective rates substantially
in excess of 33 percent of taxable income, and in many cases,
in excess of 20 percent of economic income. For example, suppose
a company (Delta) earns $45 million annually before depreciation
and invests $30 million each year. As Table A indicates, Delta
(having a capital- intensity ratio of 2.00) would pay taxes
of $6.9 million or 46 percent of its $15 million economic
income in 1991. If another company (Gamma) earns $75 million
each year before depreciation, but spends $60 million per
year on equipment (resulting in a capital- intensity ratio
of 4.00), it would pay taxes of $10.8 million in 1991, or
an astronomical 71.9 percent of its $15 million economic income.
Table B shows that over the period 1987-1992, Gamma would
pay taxes of $40.2 million or 44.7 percent of the company's
$90 million economic income over that period; by contrast,
the less capital- intensive Delta would pay 32.4 percent in
The analysis also illustrates the potential for gross disparities
in effective tax rates under the minimum tax. For example,
in 1991, a corporation (Sigma) that acquires $90 million of
machinery and equipment each year and earns $105 million each
year before depreciation will pay a minimum tax/6/ of $14.7
million, or 97.9 percent of its economic income. Over the
six-year period from 1987 to 1992, Sigma would pay $51.4 million
in tax, or 57.1 percent of its economic income. At the other
extreme, a company (Kappa) that earns $20 million before depreciation
and invests $5 million each year would pay only $5.0 million
in taxes -- an amount which equals 33.3 percent of its net
earnings in 1991. Over the period 1987-1992, Kappa would be
taxed at a real tax rate of only 31.1 percent, paying a total
of $28.0 million of its $90 million economic income in taxes.
C. Tax Consequences of an Earnings
Change. Another major concern is the AMT's reverse response
to declines in corporate earnings. As earnings of a capital-intensive
company drop, it will become increasingly subject to the minimum
tax as a result of the depreciation "preference"
-- unless it engages in the self-defeating process of cutting
back on productive capital investments. If a company maintains
its level of investment in an unprofitable year, its tax base
will consist largely of preference amounts, as opposed to
Companies decide on the annual amount of their equipment expenditures
at least partially on the basis of their company's projected
earnings for that year. It would be entirely possible for
a company to spend $15x on the basis of projected earnings
of $35x, and then to find itself in a particular year with
net earnings that barely cover those expenditures. For example,
an airline may face unexpected, new competition on major routes,
causing profits to plummet. An industrial company may be hit
by a strike that shuts down an entire plant or, alternatively,
forecloses an otherwise economical source of input. Profit
levels in the energy sector are also highly variable and somewhat
unpredictable: In one year, an oil embargo may depress profits
for high-volume dealers, while in another year, an unexpected
oil glut may cause both prices and profit margins to drop
Table C and Graph C illustrate the impact of a change in earnings
in 1991 on a company that acquires $15 million of equipment
each year. If the company's earnings (before depreciation)
decline to $15 million, the company would incur a relatively
small regular tax ($200,000), but would pay a minimum tax
of almost $2 million. Since the latter amount would be payable
on no economic income, the resulting effective tax rate would
be infinite. By contrast, if the company had been able to
earn $35 million before depreciation, it would pay $6.8 million
in tax on its $20 million of economic income -- a real tax
rate of only 34 percent. As Graph C illustrates, there is
even a range where a company's taxes will exceed its economic
The failure of the minimum tax to decrease in proportion to
declines in earnings will exacerbate the financial woes of
individual companies and contribute to recessionary trends.
In an unprofitable year, companies often face a number of
difficult choices. In order to meet payroll and other obligations,
a company may have to cut back on production or lay off substantial
numbers of its workers. It may also have to rely on borrowed
funds to meet its obligations. These difficulties will be
compounded if a substantial tax obligation must be met in
an unprofitable year. The tax obligation may force high- cost
borrowing or result in a level of capital investment that
is substantially less than the amount needed to maintain or
enhance business productivity. Moreover, if a major segment
of the business community endures a bad year, cutbacks in
capital investment and employment will further fuel the recession.
In addition, the tax impact of a change in earnings will intensify
the pressure on capital-intensive companies to participate
in tax-motivated mergers and acquisitions. As illustrated
below, a company that has already made substantial investments
in capital equipment can move itself out of a minimum tax
position most easily by consolidating with a high profit-margin,
less capital-intensive company. A company with declining earnings
will be under even greater pressure to consolidate for tax
In theory, taxes should not compound cyclical economical problems.
Rather, taxes should be higher in good years when they can
be paid out of profits, instead of out of jobs and investment.
Companies should not be forced to engage in economically wasteful
acquisitions and reorganizations merely to reduce taxes.
D. Tax Incentives for Mergers/Acquisitions
The prospect of being subject to high effective tax rates
under the minimum tax will put American companies under increasing
pressure to merge, to acquire other corporations, or simply
to sell off capital-intensive businesses. Both the Senate
and House bills include provisions explicitly designed to
reduce incentives for mergers -- e.g., additional limitations
on the use of NOL carryovers following a change in ownership.
Operation of the proposed AMT, however, would create new incentives
for precisely such behavior.
A simple example illustrates how the proposed AMT under either
the Senate bill or the House bill would give companies a strong
incentive to merge in order to reduce their collective tax
liability. Alpha Corporation is a capital- intensive company
which must make substantial annual investments in depreciable
equipment in order to earn a profit. In 1991, under either
of the proposed minimum tax systems, Alpha will pay a minimum
tax of at least 50 percent of its taxable income. Beta Corporation
is a high profit-margin company with virtually no depreciable
assets; it is able to produce its product relatively cheaply,
relying on patented processes and advertising to capture its
share of the market. Beta will pay tax at the regular corporate
Collectively, Alpha and Beta would pay $1,590 in taxes for
1991 under the Senate bill ($1,830 under the House bill).(7)
If Alpha and Beta merge, their total tax liability will be
By merging, Alpha and Beta would save, in 1991 alone, $270,
or 17.0 percent under the Senate bill; in 1991, the two corporations
would save $305, or 16.7 percent, under the House bill.
III. Underlying Defects in the Proposed AMT
The imposition of excessive rates of tax on capital-intensive
companies and the creation of tax-oriented merger incentives
are caused by two fundamental defects in the proposed AMT:
1) the baseline for determining the depreciation preference
and 2) the failure to allow full netting of depreciation on
all assets placed in service by the taxpayer.
A. Towards a Redefinition of Baseline Depreciation.
To properly reflect economic depreciation, a depreciation
system should be accelerated and indexed for inflation. Economists
generally agree that depreciation occurs on an accelerated
basis.(8) Thus, the use of the straight-line method over long
lives fails to approximate economic depreciation.
Another flaw in the baseline used to compute allowable depreciation
under the minimum tax is the system's use of ADR midpoint
lives as the applicable recovery periods. The ADR midpoint
is not an appropriate measure of an asset's economic or useful
life. Most of the current Asset Depreciation Ranges were developed
decades ago and have not been updated to reflect technological
and economic change. Consequently, many of the stated lives
are too long. The use of longer lives would be partially mitigated
if the baseline system were indexed, or if an accelerated
depreciation method were substituted for the straight-line
method. However, given the lack of those two features, the
use of ADR midpoint lives produces particularly distorted
Prior to 1981, taxpayers were permitted to depreciate their
equipment using the 200 percent declining balance method over
the ADR lower limit. The lower limit was approximately 80
percent of the ADR midpoint. For argument's sake, assume that
200 percent declining balance depreciation over the ADR lower
limit with full indexing might now approximate economic depreciation.
Table D illustrates the extent to which straight-line depreciation
over the ADR midpoint produces an excess preference for property
with an ADR midpoint of 14 years under the Senate bill.
Table D shows that during the first five years such property
is in service, the preference will be overstated by an amount
equal to approximately 33 percent of the cost of the asset,
or approximately 102 percent of the depreciation allowed under
the baseline system over the five-year period. The preference
would be overstated by 21 percent of asset cost if an overly
conservative 150 percent declining balance rate were used
in the preceding example instead of a 200 percent declining
B. Extension of the Netting Concept
A major technical problem in both the Senate and House tax
bills is the exclusion of pre-1987 assets from the taxpayer's
computation of the depreciation preference. If the provision
is not modified in the Conference Committee, many corporations'
depreciation preference amounts will be artificially inflated
for the sole reason that older assets initially will be excluded
from the calculation. The exclusion will impose a particularly
harsh penalty on companies that have made steady investments
in depreciable property over the past decade.(9)
Conceptually, if a minimum tax is to include a depreciation
preference, the preference amount should be a measure of the
extent to which a taxpayer's total tax depreciation exceeds
total economic depreciation. In order to compute such a preference
fairly, one must determine the taxpayer's economic depreciation
in a consistent manner.
A simple example is illustrative. A taxpayer places one $100
machine in service each year. The item loses 25 percent of
its original value per year, but assume the tax law allows
the cost to be recovered in two years.
The taxpayer has no "excess" depreciation when
its entire tax depreciation is netted against its entire economic
depreciation. On the other hand, if the depreciation preference
computation applies only to post-1986 property, the taxpayer
would have a preference of $25 for 1987 and $50 for 1988.
Thus, the taxpayer's AMT base would be increased by those
amounts even though the taxpayer's total depreciation deductions
are no greater than they would be if the taxpayer had used
economic depreciation for tax purposes throughout the period.
In mandating that the depreciation preference be calculated
with respect to all post-1986 depreciable assets held by the
taxpayer (rather than on an item-by-item basis), the taxwriters
explicitly recognized that the preference should be computed
using a netting concept.(10) The only purpose served by excluding
pre-1987 assets is to avoid retroactively penalizing new investments
-- i.e., assets placed in service just prior to the effective
date of the new minimum tax system. However, the provision
penalizes taxpayers in another way: It will artificially inflate
the amount of the preference in the first three to 10 years
after the new tax system goes into effect, especially for
those companies that have made investments in depreciable
assets on a steady basis.
The calculations included in Table E illustrate the magnitude
of the netting problem with respect to a taxpayer that places
in service each year a constant amount of equipment with a
14-year ADR midpoint.(11) If full netting were allowed, the
taxpayer's depreciation preference would equal $106 over the
period 1987-1992 (assuming constant investment of $100 per
year). However, since the preference computation excludes
depreciation on pre-1987 assets, the taxpayer's preference
will total $291, or approximately 175 percent more than if
full netting were allowed. Over the period 1987-1992, the
limitation on netting will produce a depreciation preference
that equals almost 300 percent of the taxpayer's yearly investment
amount. In 1991, the depreciation preference will exceed 60
percent of capital investment for that year.
There are several ways the tension between netting and retroactivity
could be resolved by the Conference Committee. As one commentator
has suggested, the taxwriters could make the effective date
elective with the taxpayer.(12) A taxpayer thus could choose
to calculate the depreciation preference either with regard
to all depreciable assets or with regard to post-1986 assets
A second approach avoids the ancillary problems often associated
with taxpayer elections. The Conference Committee could adopt
a statutory formula providing that the preference amount,
as calculated with respect to property placed in service after
the effective date, shall in no case be greater than the preference
calculated with respect to all property placed in service
by the taxpayer. Under this statutory limitation on the amount
of the preference, the appropriate calculations would be made
by taxpayers each year and the lesser amount would automatically
constitute the preference amount for that year. The formula
would effectively allow for full netting of depreciation and,
at the same time, avoid imposing a retroactive penalty on
A third approach involves adopting a substantially improved
definition of baseline depreciation -- at least in part, as
a proxy for the system's lack of full netting. As Table E
indicates, adopting unindexed 200 percent declining balance
depreciation (using the asset's lower limit as the applicable
recovery period) would reduce somewhat the amount of the depreciation
preference. The proxy approach, however, would still fail
to adequately compensate for the limitation on netting: Full
netting reduces the taxpayer's six-year preference total from
291.4 to 106; adopting a modified baseline (using the 200
percent declining balance method as described above) reduces
the total by a much lesser amount, to 170. If the Conference
Committee chooses to address the netting problem by modifying
the baseline, perhaps it should consider adopting a baseline
depreciation system that is more favorable than 200 percent
declining balance depreciation.(13)
The primary purpose of the minimum tax system is to ensure
that all financially profitable corporations pay a reasonable
amount of tax. The minimum tax provisions contained in the
Senate bill and in the House bill go beyond that legitimate
objective: The proposed AMT will subject some capital-intensive
companies to excessive real tax rates, especially over the
next three to 10 years.
By definition, companies that fall under the minimum tax will
pay in excess of 33 percent of their taxable income in tax
(in excess of 36 percent under the House bill). The fact that
minimum-taxpaying companies have a higher ratio of tax to
regular taxable income than companies that do not pay a minimum
tax is inherent in any alternative minimum tax. The rationale
for such a system assumes that the regular tax income of some
companies understates economic income. Based on this assumption,
certain deductions (or a portion thereof) are required to
be added back to the tax base. However, the theory behind
the minimum tax does not mandate certain results which flow
from the proposed recalculation of depreciation, such as (i)
the significant and disproportionate minimum tax burden on
companies with declining or marginal earnings and (ii) the
disproportionately high effective rates of tax borne by some
capital-intensive companies in comparison with their less
In effect, companies that are thrown into the minimum tax
because of the depreciation preference will be denied full
use of one of the keystones of the Senate bill -- 200 percent
declining balance ACRS depreciation. Instead, these minimum-taxpaying
companies will be forced to use a depreciation system that
severely understates economic depreciation. In addition, the
system's lack of full netting will artificially inflate preference
amounts for a significant number of taxpayers in the early
years of the new system's operation.
It is widely recognized that the operation of an inadequate
depreciation system will impair capital formation and retard
economic growth and productivity.(14) Although the Senate
bill contains a much improved depreciation system compared
to the one contained in the House bill, the depreciation recomputation
required under the minimum tax would nullify its benefits
for many companies.
The adverse effects of the proposed minimum tax could be mitigated
if the Conference Committee proves willing to make at least
one of the minor technical changes outlined above. None of
the suggested changes will undermine the intended purpose
of the minimum tax; rather they will merely blunt certain
adverse consequences which the taxwriters probably did not
For prior Tax Notes coverage of tax incentives in general,
"The Impact of the Tax Reform on the Slope of the Playing
Field" by Patric Hendershott, June 16, 1986, p. 1107.
"Investment Incentives: Do They Work?" by Margo
Thorning, May 5, 1986, p. 515.
"McIntyre Responds to Thorning Article" May 19,
1986, p. 711.
"The Depreciation Debate: Have Bulow and Summers Suggested
a Viable Compromise" by Michael G. Durst, January 20,
1986, p. 259.
"How Tax Reform Would Affect Companies with Different
Growth and Profitability Characteristics," by Gilbert
A. Harter, April 21, 1986, p. 297.
"Recapture of Excess Depreciation: What Are the Issues"
by Emil Sunley and C. Clinton Stretch, June 24, 1985, p. 1501.
"The Treasury Tax Reform Proposal and the Prospects for
Long-Run Growth" by Charles R. Hulten, May 6, 1985, p.
"A Federal Income Tax Designed for Revenue Only"
by Hugh Calkins, April 9, 1984, p. 201.
For prior Tax Notes coverage of the pending alternative minimum
"What Tax Shelter Transition Phase-In Rule? The Senate
is Fooling the Public on Existing Investments" by Byrle
M. Abbin and James Sharp, July 7, 1986, p. 57.
"Thinking About Senator Packwood's Alternative Minimum
Tax For Corporations," by Emil M. Sunley, April 28, 1986,
"Making Timing Adjustments Subject to the Alternative
Minimum Tax Requires a Principled Transition Rule," by
John B. Jones, Jr., April 21, 1986, p. 285.
"A Brief Critique of the Ways and Means Alternative Minimum
Tax Proposal," by Byrle M. Abbin, October 28, 1985, p.
"Tax Reform and the Not So Minimum Tax Proposals,"
by Byrle M. Abbin, Stephen R. Corrick, and Linda Goold, July
22, 1985, p. 443.
"Major Tax Proposals Before the 99th Congress,"
by Margo Thorning, July 8, 1985, p. 195.
"Proposal for an Alternative Minimum Tax for Corporations,"
by Emil M. Sunley, February 15, 1982, p. 363.
1. Under current law, the alternative depreciation system
is applicable only to property leased to tax-exempt entities.
2. The term "capital-intensity ratio" signifies
the ratio of a company's investment in depreciable equipment
to its economic income.
3. The following types of equipment have ADR midpoints of
14 years: petroleum and natural gas production equipment;
equipment used in the manufacture of rubber products, primary
nonferrous metals, and foundry products; and railroad machinery
and equipment. The cost of such property may be recovered
over five years under ACRS depreciation. The analysis would
be applicable even if a higher or lower ADR midpoint were
used, but the magnitude of the results would differ from those
4. The analysis reflects a constant nominal amount of investment,
as opposed to a constant real amount. Thus the effects of
inflation are disregarded. If inflation were taken into account,
the general conclusions reached here would not be altered,
but the magnitude of the results would change.
5. The incidence of effective tax rates below 33 percent is
caused by a combination of factors including the fact that
if the regular tax depreciation system contained in the Senate
bill is adopted, on two occasions in the past decade (in 1981
and again in 1987), a more accelerated depreciation system
will have replaced a less accelerated depreciation system.
It also reflects the failure of the analysis to take inflation
6. T his analysis uses the term "minimum tax" or
"AMT" to refer to the tentative minimum tax, 20
percent (Senate version) or 25 percent (House version) of
alternative minimum taxable income (reduced by the alternative
foreign tax credit), rather than the excess of the tentative
minimum tax over the regular tax.
7. Alpha's taxable income is higher under the House bill because
the regular tax depreciation system in the House bill is less
favorable than the depreciation system contained in the Senate
8. See e.g., C. Hulten and F. Wykoff, The Measurement of Economic
Depreciation, in Depreciation, Inflation, and the Taxation
of Income from Capital 85 (C. Hulten ed. 1981) (noting that
the largest rate of price decline occurs in the early years
of an asset's life). See also The President's Tax Proposals
to the Congress for Fairness, Growth and Simplicity 144 (May
1985). Although we question the appropriateness of the rates
and lives in the Administration's tax reform proposal, it
clearly recognized that an economic depreciation system should
be accelerated (e.g., through use of declining balance methods,
9. The point is illustrated by the examples developed in Section
II, supra; it was first made in this publication by John B.
Jones, Jr., "Making Timing Adjustments Subject to the
Alternative Minimum Tax Requires a Principled Transition Rule,"
31 Tax Notes 285 (April 21, 1986).
10. See H.R. Rep. No. 426, 99th Cong., 1st Sess. 309-310 (1985);
and S. Rep. No. 313, 99th Cong., 2nd Sess. 522-523 (1986).
11. For an explanation of the impact of this assumption, see
supra note 4.
12. Jones, supra note 9 at 286.
13. The figures in Table E, including the computation of 200
percent declining balance depreciation, are not indexed for
inflation. At a minimum, the baseline should be indexed for
inflation in order to approximate economic depreciation. Conversely,
the use of shorter lives could be employed to compensate for
the lack of full netting.
14. See, e.g., The President's Report, supra note 8 at 134
(noting that if depreciation allowances understate economic
depreciation, "income from the investment is overtaxed
and a tax disincentive is created which impairs capital formation
. . .").
EFFECT OF CAPITAL INTENSITY (1991)
Effect of Capital Intensity (1991)
(Assumed Economic Income of $15/year)
C = A - .97(B)
D = .33(C)
E = C + .619(B)
F = .20(E)
G = B/15
Tax = Greater of F or D
H = Tax/15
FOOTNOTES TO TABLE A
1. These formulae are derived from Table E. For example,
Table E shows that the 1991 depreciation allowance for a company
that acquires the same amount of equipment each year is 97
percent of equipment cost. Thus, taxable income (C) equals
earnings (A) minus 97 percent of equipment cost (B).
EFFECT OF CAPITAL INTENSITY (1987-19920
Effect of Capital Intensity (1987-1992)
(Assumed Economic Income of $15/year)
C = 6(A) - 7.06(B) = 6(A) - 7.06(A-15) = 105.9 - 1.06(A)
D = .33(C)
E = C + 2.914(B)
F = .20(E)
G = B/15
Tax = Greater of D or F
H = Tax/90
FOOTNOTES TO TABLE B
1. Assumes a 33 percent rate for 1987.
2. Reflects the fact that taxpayer would pay a regular tax
1987, and a minimum tax thereafter.
3. These formulae are derived from Table E.
MINIMUM TAX'S RESPONSE TO CHANGES IN REAL EARNINGS
OF A CAPITAL-INTENSIVE COMPANY (1991
Minimum Tax's Response to Changes in Real Earnings
of a Capital-Intensive Company (1991)
B = A - 15
C = .33(A - .97(15)) = .33(A) - 4.8
D = .20(A - .97(15) + .6187(15)) = .20(A) - 1.05
Tax = Greater of C or D
FOOTNOTE TO TABLE C
1. These formulae are derived from Table E.
Measurement of the Overstatement of Depreciation Preference(1)
FOOTNOTE TO TABLE D
1. Indexed figures developed in Table D assume a five percent
inflation rate. The cost of the hypothetical asset is $100x.
Depreciation Allowances and Preferences(1)
FOOTNOTE TO TABLE E
1. All numbers are expressed as percentages of the constant
annual investment in depreciable equipment. The depreciable
property has an ADR midpoint of 14 years and an ADR lower
limit of 11 years.