Does Tres. Secy Snow Get the Difference Between CapEx and Cap Gains?

John Snow seems like a nice enough guy. Problem is, in his ongoing sales pitch for the administration’s economic policy, he tends to gloss over some facts too readily while ignoring other completely.

A perfect example was his piece this week in the WSJ: The Heart of the Economy. In that Op-Ed, Snow argues that the dividend tax cuts have made the nation’s allocation of capital more efficient:

"While officially the recession had ended in late 2001, the pace of the recovery was too slow. Growth was anemic, business confidence low and — of critical importance — capital investment was way down. As a result job growth was nonexistent.

President Bush recognized that something needed to be done to overcome those headwinds and, in particular, to create a more favorable climate for capital investment that would result in job creation. To do so he sent Congress far-reaching proposals to encourage capital formation by lowering taxes on investment returns. Congress responded with the Jobs and Growth Act, which was signed into law in May 2003.

While many factors contributed to the improved performance of the economy, the tax reductions on capital have been at the heart of the progress we have seen."

Snow is out shilling for the extension of the Capital Gains Tax Cut (lowering it to 15% from 20%) and an even bigger cut on dividends (to 15% from ordinary income — top bracket was 38-39%). As proof of the impact of these cuts, a chart of Business Investment was included (see below). 

For some reason, in his discussion on Business Investment, Treasury Secretary Snow quite notably omitted any discussion of what was arguably the most effective tax cut of the 2003 legislation: The Accelerated Depreciation of Capital Spending (ADCS).

This legislation allowed companies to write down an enormous amount of capital costs on purchases of capital goods. This accounting shift sunsetted on December 31, 2004.  As the table below shows, the incentives to make large purchases were tremendous:

50% Accelerated Depreciation vs. Ordinary Depreciation
Capital Purchase Depreciation Schedule 2004 (write down) 2005 (write down)
Laptop 3 years 67% (50% + 1/2 of 33%) 33%
Router 5 years 60% (50% + 1/2 of 20%) 20%
Earth Mover 7 years 57% (50% + 1/2 of 14%) 14%


The key is that in order to qualify for the 2004 depreciation
schedule, the capital equipment must be Placed in Service by that
12/31/04 — not merely ordered, or sitting in a warehouse, but in
actual use. That suggests that capital goods orders would have to be made way in advance of the 12/31/04 deadline, in order to have any hardware, machinary or software installed by that year end date.

Funny thing is, that’s precisely what the chart that Snow included in his Op-Ed reveals: Business Investment peaked mid-year 2004, and continued sliding as the ADCS sunsetted year’s end. If the Capital Gains and Dividend tax cuts were truly responsible for the CapEx increase, then we should NOT see this slide.

Oh, and somehow, the Treasury Secretary seems to have omitted Q4 2005, which saw an even worsening of this trend. (Q3 was quite robust, however).      


graphic courtesy of the WSJ


Ironically, it appears that Snow is arguing for the wrong tax cut. If we want to see Business Investment continue at the prior hot pace of 2004, then perhaps the legislation actually responsible for it is what should be discussed. 

Of course, there is no free lunch, and the trade off was that companies which chose to spend their capital making Business Investments ended up hiring fewer workers. Indeed, since the ADCS expired, hiring, while still below historic trend, has improved notably.

Snow sidesteps this in his pitch for re-upping on the 15% CapGains and Dividend Rates:   

"If Congress fails to extend the 15% rate on capital gains and dividends, what harm will it bring to our economy? To me, the answer is very straightforward: Raising tax rates on capital gains and dividends would strike at the heart of the economy with damaging long-term effects on economic growth. A slowdown in investment would be inevitable, and a slowdown in job growth almost certain to follow."

This may be a case of pre-emptively anticipating a slow down, and trying to assess blame in advance.  Despite the cheerleading, economists and policy analysts know the dope. They can read beneath the headlines and figure out what’s going on. Perhaps part of the problem is that Snow has become (unfortunately) caught in a
never ending battle to retain his postion as Treasury Secretary/Econ

The ideological push for these tax cuts ignores the reason for Business Investment’s rise and more recent slowdown. It has nothing to do with Dividends or Capital Gains . . .

UPDATE:  February 17, 2006 3:33pm

Economics Prof Mark Thoma adds:

"The other thing I find disingenuous about this – beyond whats covered here – is that jobs acts are always passed in the trough of a recession.

Whether it does any good or not because the economy will naturally recover, so it’s really hard to say the policy itself was responsible and not simply the natural course of the recovery. In other words, its difficult to identify the incremental effects beyond the part that would have happened anyway — that’s hard to parse.

The Heart of the Economy                  
February 15, 2006; Page A16

Accelerated Depreciation of Capital Spending          

When Accounting Rules Matter     Contributor
9/1/2004 1:00 PM EDT

The Unintended Effects of Accelerated Depreciation         
9/3/2004 11:32 AM EDT

What's been said:

Discussions found on the web:
  1. lar commented on Feb 17

    Hmm, emphasis on capital gain tax cuts, dividend tax cuts, and inheritance tax cuts, yet items like the a permanent R&D tax credit and now the ADCS languish?

    Maybe they’re feeling their trust funds and personal investment portfolios aren’t doing so great. Or maybe they feel capital expenditures are best done in China, India and Eastern Europe.

  2. spencer commented on Feb 17

    the primary determinate of capital spending is corporate profits. but given the strength of profit growth this cycle the growth of capital spending has actually been much weaker then one would expect.

    this implies the tax cuts actually dampened investments.

  3. nate commented on Feb 17

    A lot of routers and personal computers are financed via “operating leases” and are not purchased and depreciated.

    Stuff acquired through operating leases would not be directly affected by changes in tax depreciation rules. Accelerated depreciation may be irrelevant for large parts of the router and personal computer markets.

  4. B commented on Feb 17

    That chart sucks. I had no idea the accelerated capex depreciation component of the tax cuts was kiboshed. Now you are making me bearish. My head hurts.

    The operating lease statement is changing alot. Especially for IT gear and really especially for PCs. While people may still lease gear, it is less and less booked as an operating lease. Can’t pass the FASB 13 requirements. Fifteen years ago when it was a year or two between turns of the crank in technology, operating leases were still viable. So, the long term trend seems to be away from leasing and away from the ability to book something as an operating lease when doing so………in my experience. Alot of lessors have gone kaput with the captives and specialized being the only survivors. So, you could argue that chart is even more ugly….IMO

  5. DaveL commented on Feb 17

    Snow is a nice guy but knew him when he tried to run a railroad (a customer exec) and he was pretty ineffective. He was scheduled OUT as administration changed over but kept his job because he realll…….ly like it and promised to be a great shill. Unfortunately you’ve got to actually demonstrate a grasp of things.

    What’s really important here is broader issue of corporate profits vs investments (either capex or hiring) which is not happening as you’d expect profits, margins or demands would be. Is it therefore the case that comapnies don’t see an opportunity ?

    As we transition from a stimulas-driven economy to a more ‘normal’ internal dynamics (organic) what are the chances for traction ?

    That’s the question here.

    I judge it much lower then either expected or built into market/economy prognostications.

    So now what do we do ?

  6. Uncle Bob commented on Feb 17

    Can someone explain how cutting cap gains and dividend taxes for me helps stimulate business growth unless I buy an IPO or secondary offfering.

  7. GRL commented on Feb 17

    I hate to rain on your parade, but the dividend and capital gains tax cuts are two things I support.

    In theory, I would not object to equalizing wage income and capital gain tax rates (in fact it makes economic sense, as advocates of the now gutted 1986 Reagan tax reform successfully argued), and I think the double taxation of dividends should have been handled at the corporate, not the individual, level.

    But that is all theory. The reality is that taxes are way, way too high, and taxes, and especially spending, at all levels of government are completely out of control, with no prospect of anyone ever getting a handle on either one.

    If you want to talk about inflation in everything but wages, you also need include the inflation in taxes, federal, state and local, and how upper middle class people like me are paying half their income in taxes, with no end in sight. Taxes are, by many multiples, my largest expense, exceeding by far, for example, the amount I spend on mortgage interest. While I may not be in the majority, I am absolutely certain that I am not alone.

    Given that reality, I’ll take whatever tax relief I can get, even economically unsound policies from schills like John Snow.

    P.S. — For the record, yours is one awesome blog.

  8. Jordan commented on Feb 17

    Snow is the most obvious puppet of the administration.

  9. algernon commented on Feb 17


    You have not made your case with the chart. If it were only a function of the ’04 depreciation advantage, why did capex CONTINUE TO GROW albeit at a slower rate all thru’ ’05.

    The benefits of reduced taxes on capital gains & dividends are indeed too long-range in nature for Snow to try to credit them so strongly for capex spending. But his audience is too shallow to respond to much else.

    Reducing the double taxation of dividends is extremely important to the structure of our economy. There is no better indication of the quality of earnings than dividend growth. Nothing is a better communication between the investor evaluating his risks & the leadership of the company he is trying to evaluate. Had the dividends been taxed but once in the 1990’s, then the dividend-paying company would have been the model of excellence & the .com bubble would have been moderated.

  10. ken commented on Feb 17

    The best constraint on government spending is government taxation. If the public is not willing to pay for something through taxing themselves for it then it is not something the public really values.

    This used to be understood in America as it is understood in all other democracies around the world.

    Unlike other democracies however America suffers from the ‘supply side’ virus that infected the body politic under the guise of Reaganomics. This highly virilent virus severed the link between spending and taxation.

    One of the symtoms of this infection is an insatiable appitite for borrowing money. Borrowing money engorges the economy with ‘pork’, the economic equivilant of useless calories. But it does lead to higher tax revenues as about a third of all that borrowed money getting spent in the economy comes back to the government in the form of tax revenue.

    Until the patient is cured of this desease people like Snow can talk all they want about tinkering with tax cuts, it is all meaningless. But the cure requires an adult perspective and sound reasoning and this is lacking in the ruling party in America. So we will continue to suffer this supply side illness until it weakens our national balance sheet so much we just simply collapse.

  11. Idaho_Spud commented on Feb 17

    Ken, good point! Congress just passed a new bankruptcy law to prevent me from doing with my personal finances *exactly* what they are doing to my country…

  12. DJ commented on Feb 17

    A clarification on your comment that corporate profits are the primary determinate of capital spending. The primary determinate is ‘expected future corporate profits’. So, clearly businesses see something about the future that is not reflected in recent profits. I think what they see is a struggling consumer. The struggling consumer is not going to benefit greatly from capital gains & dividend tax cuts. Now, national health care insurance financed by progressive income taxes, capital gains & dividend taxes, & inheritance taxes on the other hand…

  13. Barry Ritholtz commented on Feb 17

    Dividends and Capital Gains taxes have nothing to do with Corporate Spending

  14. Barry commented on Feb 17

    I think we may also fail to recognize that capex is also gaited by overcapacity/oversuppy/overspending/over everything from the run up to 2000. Much of that overindulgence of corporate America took from 2001 to 2002 to actually become fully implemented or shut down or both.

    Pax Americana delusions and Y2K both contributed to way too much infrastructure. This was the biggest mess in nearly a hundred years. It isn’t fixed in a day. Alot of that crap is just now being rationalized. Just look at the telecom sector. The build out and spending was stupendousidity…. That industry is just now getting its head above water. In addition, Pavlov’s conditioning or human psychology tells us, we don’t want to do something so foolish again. That is, until we compartmentalize it and forget about it. Only then will we be so stupid again.

  15. algernon commented on Feb 17


    Do you really mean to assert that in the long run, the degree of taxation of capital has no effect on the behavior of corporations?

    Try doubling the tax rate on dividends & capital gains, & I don’t think it will even be the long run before CEO’s batten down the hatches. But certainly in the long run they’ll have less capital with which to work.

  16. Kaleberg commented on Feb 17

    Of course, if one looks at the DATA for the last 100 yars or so, it appears that repealing all the tax cuts would STIMULATE the economy. Cutting the tax on dividends just takes money right out of GDP growth. I know this sounds weird, but it helps to look a the data now and then. It’s actually hard to find a tax cut that didn’t slow the economy within a year or two, and it’s hard to find a progressive tax increase that did.

    I also have to agree with that update on jobs acts always being passed in the troughs of recessions. The economy will recover anyway. That’s why I don’t actually have to use the brakes on my car. My car will stop anyway. Mind you, I still tend to jam on my brakes when approaching static objects at high speed. Silly me.

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