TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform is notoriously difficult. It requires making difficult trade-offs that inevitably will upset certain groups of taxpayers and help others. The House Republicans have found this out the hard way. In June of 2016, they introduced a “Blueprint” for tax reform. There is a lot to like about this plan. It would greatly simplify individual income taxes for millions of filers and would eliminate most distortions in business taxation. In addition, the plan’s base broadeners offset most, if not all, of the cost of the rate cuts.
However, different industries and interest groups have been lining up against specific aspects of the GOP’s plan. For instance, while the border adjustment in the Blueprint would go a long way to protect the U.S. corporate tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , the retail industry does not like it. The plan would also eliminate the deduction for net interest expense, which would eliminate the bias toward debt-financed corporate investment and prevent base erosion – but heavily leveraged industries, such as real estate, don’t want to lose this deduction.
Faced with opposition to many of the proposed base broadeners, some lawmakers are thinking about abandoning them altogether. Instead, they are interested in passing straight tax cuts without any offsets and changing budget rules to prevent the tax cuts from expiring after ten years.
Under current Senate rules, lawmakers could pass a tax bill with only 51 votes through a process called “reconciliation” and avoid a possible filibuster. However, this shortcut comes with a catch that is important for would-be tax reformers. Reconciliation bills cannot increase the budget deficit outside of the budget window – currently a ten-year period. As such, any tax cuts would need to be offset with base broadeners or spending cuts of equal size. This is referred to as the “Byrd Rule.”
Alternatively, lawmakers could do what they did in the early 2000s with the Bush tax cuts. Those tax cuts were passed through reconciliation, but did not have sufficient offsets. Congress got around the Byrd Rule by making the tax cuts expire in the ninth year, so that the tax changes would not increase the long-run deficit.
The downside to temporary tax cuts is that they are unlikely to produce significant economic growth, an important goal for lawmakers. Businesses would not be able to make many long-term investment plans knowing that the tax cut they received may only be temporary. In fact, we found that a temporary corporate tax cut would only create a small economic benefit that would flow mostly to shareholders. This is compared to a permanent corporate rate cut, which could permanently lift wages for workers.
Many lawmakers understand the shortcomings of temporary tax policy. But some are interested in passing a temporary tax cut, and are interested in doing so for a period longer than ten years. To accomplish this, some have proposed extending the budget window beyond the current ten-year standard. There is nothing in federal budget rules that states the budget window cannot be longer than ten years — in fact, the length of the window used to be five years. Some lawmakers hope that a longer budget window would solve a lot of their issues.
A longer budget window could help with some aspects of tax reform. But not all.
A longer budget window could help lawmakers better account for long-term costs and benefits of their tax plans. Many tax plans come with large up-front costs. For example, the House GOP’s Blueprint converts the corporate tax into a cash-flow tax. This conversion costs a lot in the first few years, due to the move to full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. of capital investment. However, over time a conversion to a cash-flow tax starts raising revenue, as companies fully lose the ability to deduct their net interest expense.
Under a shorter, ten-year budget window, this conversion looks very expensive. In fact, in the first decade we show that enacting full expensing and eliminating the net interest deduction would lose about $1 trillion. However, in the second decade, these two provisions end up raising nearly $1 trillion. A longer budget window would better account for these transitional budgetary effects.
However, a longer budget window may not allow for a significantly longer temporary tax cut. This is because a tax cut – especially for a rate cut for businesses – may influence revenues long after the initial cut has expired. For example, if lawmakers cut the corporate tax rate for five years, the federal government may lose revenue for many years after the tax cut expires. This is because companies would shift profits and tax payments into years in which the tax rate was lower, reducing the amount of taxable profits in later years when the tax rate is higher.
There is an important distinction between the length of the budget window and the length of a tax cut. It is true that a much longer budget window would allow lawmakers to increase the length of a temporary tax cut. However, the Byrd rule would still require corporate tax cuts to expire well before the end of the budget window. This would put lawmakers back where they started: a temporary corporate tax cut that lasts — at most — ten years and wouldn’t have a permanent positive impact on the economy.
Lawmakers should be realistic about what help they can gain from a longer budget window. It can help them be more fiscally responsible over the long run, by illuminating budget impacts into the future. However, a longer budget window would not enable lawmakers to make a temporary tax cut into a permanent one. Instead, to ensure a pro-growth tax bill, lawmakers should concentrate on working towards permanent tax reform.Share