The sweeping tax bill approved by congressional negotiators over the weekend is expected to have a dramatic impact on American industry. Heavy manufacturing and many real estate developers have railed against the loss of cherished tax incentives. But retailers and technology firms, which have long felt overtaxed, generally have cheered the move to lower overall corporate tax rates. While the enthusiasm of some early corporate tax-reform advocates has waned, some opponents have found the process less painful than anticipated.
With approval of a final bill by Congressional negotiators--and expected approval next month by the full House and Senate--American business is now bracing for this massive overhaul of the nation's tax system. Here is a look at how various industries will be affected:
The tax bill is expected to generally benefit the defense industry, even though it will sharply restrict one important tax benefit that contractors have long enjoyed--completed contract accounting.
The defense industry has historically had a low rate of capital investment, which has limited its use of the investment tax credit that is being eliminated. The industry's effective tax rate is about 43%, so a reduction to 34% will provide a substantial benefit, according to Paul Nisbet, financial analyst at Prudential-Bache Securities.
"On balance, the new tax code would be a plus for Lockheed," said Larry Bishop, a Lockheed vice president. "We are picking up a substantial reduction in our tax rate even though we are losing one tax benefit."
The legislation provides for a limitation on the completed contract accounting method, effectively increasing federal tax revenue by $3.5 billion in taxes over the next five years, according to Ira Shapiro, director for tax policy at Coopers & Lybrand, a major accounting firm.
Under completed contract accounting, defense contractors do not pay corporate income taxes on a government contract until work is finished. Thus, the $3.5 billion in additional federal tax revenue does not come from a new tax but represents a one-time windfall of taxes that are owed but deferred.
A House report estimated that complete elimination of the method would bring in $14.2 billion over the five-year period. So, the $3.5 billion represents only about one-fourth of the taxes deferred under the completed cost accounting method.
For defense contractors, the ability to defer tax payments represents, in essence, an interest-free loan by the government. If the industry had to borrow $3.5 billion at the prime interest rate, the interest would cost $280 million in any one year. Since the defense industry is not highly concentrated, the effect on any one company will not be great. McDonnell Douglas, the nation's largest contractor, carried $915.7 million in income tax liabilities on its balance sheet as of Dec. 31, 1985.
Even if McDonnell had to accelerate payment of 24.6% of that--and it would probably face acceleration of much less--it would pay $225 million in taxes, worth about $18 million in annual interest at the prime rate.
In the rush to complete the tax bill, the method for implementing the $3.5-billion acceleration was not specified. The conferees instructed their staff to write language to implement the measure, Shapiro said.
The tax bill will also change the way the defense industry writes off certain research and development expenses. Under the law, it will now spread over several years certain research costs and certain contract proposal costs that it had expensed immediately before.