These examples illustrate how the costs of the maritime subsidies might in principle be calculated. Every tax-deferred deposit in the operators' reserve funds caused some immediate saving in operators' taxes, but at a cost of taxes to be paid in the future. If we knew when the taxes would eventually be paid, the cost of deferral could be calculated exactly, just as was done in the examples above. In practice, however, we have no idea when the taxes will be paid, and so cannot calculate this cost precisely. We must therefore resort to other ways of measuring the costs of the tax subsidies. The simplest alternative is to use the cost of tax exemption as an approximation to the cost of tax deferral. This expedient is justified only under certain conditions, these being that the deferral will last a long period of time, and the rate of discount is high. If these conditions are met, as they were in the second example above, the error committed by making this substitution is small. This is exactly how the costs of the maritime tax subsidies were measured in the 1951 report of the Treasury Department.33 After recording that operators had deposited $62.9 million of tax-deferred earnings in their reserve funds between 1947 and 1949, the report stated that "this 'deferment' [of taxes on deposits of earnings] is tantamount to tax exemption so long as the subsidy continues," and went on to identify the cost of deferral with the immediate tax savings that operators enjoyed, as if the deposits were tax exempt.34 The Commerce Department criticized the report for equating deferral with exemption, as the Senate Committee on Interstate and Foreign Commerce had earlier criticized the Comptroller General of the United States for expressing a similar opinion; but time has proved the critics wrong. We see in retrospect that the tax benefits the operators received from the deposits they made between 1947 and 1949 have been virtually those of tax exemption. To understand why, we must notice that since those first deposits were made more than 20 years ago, the amount of tax-deferred earnings contained in reserve funds or invested in ships and equipment has grown to nearly $650 million today. It is immaterial whether the deposits that were made in 1947 were subsequently invested in new ships, whose tax bases were accordingly reduced, or are still in the reserve funds. If they were invested in ships, the reduction of the ships' bases, and the consequent reduction in operators' depreciation deductions, means that in an accounting sense payment of the deferred taxes has already begun. In an economic sense, however, it has not. The steady growth in accumulated tax-deferred earnings during the past 25 years tells us that for every dollar of deferred taxes that the Government has collected, several additional dollars of taxes have been deferred on new deposits of earnings in operators' reserve funds. Hence, there has been no net payment of taxes-only a continuing increase over the years in the amount of taxes that have been postponed. As long as accumulated tax-deferred earnings continue to grow, the taxes that were deferred between 1947 and 1949 will remain unpaid. It is now 24 years since the midpoint of the 1947-49 period. Deferral has lasted nearly a quarter-century, and there is no sign yet that the 33 U.S. Treasury Department, "Scope of Tax Benefits," in U.S. Congress, House, Committee on Merchant Marine and Fisheries, "Long Range Shipping Bill." 34 Ibid., p. 55. accumulation of tax-deferred earnings will soon diminish. Deferral over as long a period as this is indeed "tantamount to tax exemption," unless the rate of discount is unusually low. What rate of discount should be used in calculations like these is sometimes difficult to decide. One candidate is the long-term cost of government borrowing, on the grounds that the nonpayment of these taxes may have added to the amount of outstanding Federal debt. On the other hand, it seems to be common practice now to use for this purpose the opportunity cost of Federal investment activities. A recent statement proposing new standards for the planning of Federal water and land resource projects included a discussion of this opportunity cost.35 The authors concluded that "the appropriate rate for evaluating Government investment decisions is approximately 10 percent, [per annum]," although they went on to propose that a rate of 7 percent per annum should be used in evaluating water resource projects for reasons of no importance here. If we use their rate of 10 percent to calculate the costs of the maritime tax subsidies, we may say that for all intents and purposes the deferral of operators' taxes between 1947 and 1949 has turned out to be about as costly to the Government as full tax exemption. And what of deposits made since 1949? Here the deferral has not been as long. But even if the privilege of depositing tax-deferred earnings were terminated tomorrow, it would take many years before the last deferred taxes on the current accumulation were paid; for payment is made only as ships are depreciated. The first taxes to be paid-again, in an economic sense-would be those that were deferred on the earliest deposits, then those that were deferred on later deposits, and finally those that were deferred on most recent deposits. Therefore, even the taxes on earnings that were put in the funds during the last several years would wind up being deferred for 20 years or longer. And so, what we concluded about deposits made before 1950 will also be true of later deposits: tax deferral has been nearly as costly to the Government as full tax exemption. Costs of Tax Subsidies With this discussion as background, we are ready now to estimate the costs of the maritime tax subsidies. Unpublished data collected by the Maritime Administration disclose that at the end of 1970 $649.3 million of tax-deferred earnings were either contained in operators' reserve funds or invested in ships and equipment. The amount of taxes that these earnings escaped cannot be fixed with precision, because some unknown part of the earnings was of capital gains rather than ordinary corporation income. In 1966, when this fraction was last measured, capital gains composed about a quarter of operators' accumulated tax-deferred earnings, which then totaled $598.0 million. If roughly the same fraction of the current accumulation is capital gains, they totaled about $165 million at the end of 1970. No record is available telling in what years these earnings were deposited. Marginal rates of corporation income tax varied slightly during this period, which means that the tax that was deferred per U.S. Water Resources Council, "Proposed Principles and Standards for Planning Water and Related Land Resources," in Federal Register, Dec. 21, 1971, pp. 24166-67. ar of deposits also varied slightly. It seems sufficiently accurate to sea rate of 50 percent to estimate the taxes that were avoided on deposits of ordinary corporation income after 1949, since in only 1 ver thereafter did the tax rate differ from this by more than a few bercent (in 1950, when it was 42 percent). For deposits of capital sins, we use a rate of 25 percent. Because we have no information about deposits that were made during the Korean war, we can take we secount of the excess profits tax that was in force at that time. Sce $62.8 million of ordinary corporation income was deposited in operators' funds between 1947 and 1949, plus $150,000 of capital sirs, we estimate that about $422 million of ordinary income was deposited after 1949, and $165 million of capital gains. The sexing in taxes that operators realized immediately was therefore about alon. To this figure we must add a tax saving of $23.8 million erators' deposits between 1947 and 1949, for a total saving of $276 million.37 To be sure, operators will eventually have to pay tax on these earnings-unless the law is changed, or the corporation come tax is replaced by another; but for the reasons explained before, the deferral extends over so long a period that it is practically equivalent to full tax exemption. Accordingly, the cost of the maritime tax subsidies since 1947 has been close to $276 million-say, in round numbers, about $250 million. The total cost of the tax subsidies since the program began in 1936 is the sum of the costs between 1936 and 1946 and between 1947 and 1970. Costs in the earlier period were estimated to be $99.3 million.38 Therefore total costs over the past 36 years may be put at approximately $350 million. The current costs of the tax subsidies can be measured by the value of the deferred taxes on recent deposits in tax reserve funds. From 1966 through 1970 the value of operators' accumulated tax-deferred earnings grew from $559.4 million to $649.3 million, an increase of $89.9 million. Perhaps half of the increase was of capital gains, and the other half of ordinary corporation income; we have no ready way of telling. But if these proportions are roughly correct, operators saved about $44 million on deposits of earnings during the past 5 years.39 If we assume as before that tax deferral is in this case substantially equivalent to tax exemption, the tax subsidies have recently been costing the Federal Government around $8 million a year. These figures indicate that past costs of the maritime tax subsidies have been relatively high, but that costs recently have been low. This will change: current costs are bound to increase in the wake of the 1970 legislation. How large they will grow it is impossible to say. Much will depend on conditions that are beyond our power to forecast, such as the state of the shipping business: we expect that in prosperous years owners will make large deposits in their capital construction funds, in lean years smaller deposits. As of this writing, nearly a hundred shipowners, in addition to the currently subsidized operators, have had applications approved by the Maritime Administration to 36 U.S. Treasury Department. "Scope of Tax Benefits," in U.S. Congress, House, Committee on Merchant Marine and Fisheries, "Long Range Shipping Bill," p. 53. 37 Ibid. 38 Ibid. 39 Equal to the product of the corporation income tax rate of 48 percent on one-half of $89.9 million, plus the product of the corporation capital gains tax rate of 25 percent on the balance. There is no point in trying to take account of the various levels of surtax that were in effect during a part of the period, in view of our uncertainty about the capital gains fraction. create and maintain such funds. To get some idea of what their deposits might cost, suppose 75 owners deposited an average of just $1 million of ordinary corporation income in funds every year. The immediate cost to the Treasury would be $36 million a year. If we put the cost of deferral at as little as three-quarters of this amount, the tax subsidies would increase from $8 million a year to $35 million, assuming that subsidized operators maintained their current level of deposits. This is emphatically not a prediction, only an illustration. On the whole, however, it seems more likely to understate than overstate the increase we may expect in the costs of these subsidies. BIBLIOGRAPHY Barker, James R., and Brandwein, Robert. The United States Merchant Marine in Ferguson, Allen R., et al. The Economic Value of the United States Merchant Marine. Goss, R. O. Studies in Maritime Economics. Cambridge: Cambridge University Press, 1968. Lawrence, Samuel A. United States Merchant Shipping Policies and Politics. Washington: The Brookings Institution, 1966. McDowell, Carl E., and Gibbs, Helen M. Ocean Transportation. New York: Mc Graw-Hill Book Company, 1954. Metaxas, B. N. The Economics of Tramp Shipping. London: The Athlone Press, 1971. O'Loughlin, Carleen. The Economics of Sea Transport. Oxford: Pergamon Press, U.S. Congress. House. Committee on Merchant Marine and Fisheries. Subcommittee on Merchant Marine. Independent Federal Maritime Administration: Hearings on H.R. 159 and 105 identical and similar bills, 90th Cong., 1st sess., 1967. Washington: Government Printing Office, 1967. Long-Range Maritime Program: Hearings on Bills to Amend the Merchant Marine Act, 1936, 90th Cong., 2nd sess., 1968. Washington: Government Printing Office, 1968. Passenger Vessels: Hearings on H.R. 10577, 92nd Cong., 1st sess., 1971. Washington: Government Printing Office, 1971. President's Maritime Program, Part 1: Hearings on a Report of the Secretary of Commerce and the Maritime Administrator, 91st Cong., 1st sess., 1969. Washington: Government Printing Office, 1970. President's Maritime Program, Part 2: Hearings on H.R. 15424, H.R. 15425, and H.R. 15640, 91st Cong., 2nd sess., 1970. Washington: Government Printing Office, 1970. U.S. Congress. Senate. Committee on Commerce. Merchant Marine Subcommittee. The Maritime Program: Hearings on S. 3287, 91st Cong., 2nd sess., 1970. Washington: Government Printing Office, 1970. U.S. Department of Commerce. Maritime Administration. Annual Report. Washington: Government Printing Office, annual. Essential United States Foreign Trade Routes. Washington: Government U.S. Treasury Department. Scope and Effect of Tax Benefits Provided the Maritime THE CAPITAL GRANT AS A SUBSIDY DEVICE: THE CASE STUDY OF URBAN MASS TRANSPORTATION By WILLIAM B. TYE* I. CONCLUSIONS AND RECOMMENDATIONS The Capital Grant as an Instrument of Public Policy Legislators are frequently persuaded that public policy objectives are best accomplished by the financial support of certain activities of other governments, private citizens, or firms, even though no good or service is supplied directly to the Government in exchange. A common restriction on this "subsidy" is that all funds be disbursed for the purchase of durable facilities rather than current operating expenses. Grants to State and local governments for highway, hospital, education, public housing, and urban mass transportation improvements and to underdeveloped countries and allies for military and economic assistance are common examples. This paper evaluates the wisdom of restricting a subsidy grant to capital expenditures alone and examines the effects of the capital restriction on the efficiency of the subsidy recipient. The analysis deals solely with the U.S. Department of Transportation urban mass transportation capital grant program, but the implications for other programs of a similar nature are obvious. The method of allocating the subsidy, not the more complex issues of the wisdom of subsidizing mass transit and the appropriate level of Federal support, is the issue being raised. The Mass Transit Capital Grant Program State and local governments and their instrumentalities (such as transit authorities) wishing to make improvements in urban mass transit facilities may apply to the U.S. Department of Transportation for a Federal grant to assume up to two-thirds of the costs of equipment, buildings, rights-of-way, et cetera, but the Urban Mass Transportation Act of 1964 specifically prohibits use of Federal funds to defray operating expenses. The remaining share of the project cost must be financed by the applicant, but not from transit farebox revenues. Although the grant must be directly to a public agency, private firms may receive support if a State or local agency is willing to act as a conduit in a leasing or other agreement. From 1964 to 1970 approximately $735 million was committed by the Federal Government under this program. *Charles River Associates, Inc: NOTE.-This paper pursues the policy implications of the author's Ph.D. thesis, "The Economic Costs of the Urban Mass Transportation Capital Grant Program" (Harvard University Department of Economics, 1969). Details of the mathematical proofs and estimating procedures contained in the thesis are not pursued in this paper. The author wishes to thank John R. Meyer and Mahlon Straszheim for their helpful advice on the thesis and The Joint Center for Urban Studies of M.I.T. and Harvard University for the financial support that made this research possible. The views presented here are the author's and do not represent any organization with which he may have been associated. |