Earlier today, the House of Representatives passed a 233-page tax bill (the PATH Act), which includes over $620 billion in 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. reductions for families and businesses. The provisions are a mixed bag: some are principled, sound tax policy, while others are giveaways to narrow interests.
Notably, the bill renews all of the tax extenders – temporary tax provisions that have been renewed year after year and have been expired since January 1st. In fact, nineteen of the provisions have been made permanent parts of the tax code. Thirty of the provisions have been extended until the end of 2016, while four have been extended until the end of 2019. Because long-term, stable tax laws are almost always better than temporary measures, the PATH Act is a win for predictable policy and honest accounting.
Several news sources have described the bill as an “early Christmas present” for business and individual taxpayers. With this in mind, we’ve gone through the 115 revenue provisions in the PATH Act and picked out twelve of the most significant – one for each of the days of Christmas.
1. The bill makes the expansion of Section 179 permanent (cost: $77.1 billion)
Section 179 of the tax code allows small businesses to immediately deduct up to $500,000 of investments. However, without Congressional action, this provision would have been scaled back significantly, and small businesses would only have been allowed to deduct $25,000 of investments. The PATH Act will make the expanded Section 179 limits permanent, while also indexing them to inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. .
This provision is important because businesses are usually required to deduct their investment spending over long periods of time, which discourages them from making new investments. Section 179 helps reverse the tax code’s harmful treatment of investment and encourages economic growth. It’s also a provision that is designed to benefit small businesses, rather than large corporations.
2. Bonus depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. is phased out over five years (cost: $28.3 billion)
Perhaps the most important tax extender is bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings, in the first year. Allowing businesses to write off more investments partially 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. , which allows all businesses to immediately deduct 50 percent of some investment costs. Bonus depreciation applies to a larger share of investments than Section 179 does, covering over $470 billion in capital expenditures. Because bonus depreciation encourages investment, a Tax Foundation analysis found that making the provision permanent would grow the economy by 1 percent over the long run.
Unfortunately, the PATH Act only extends bonus depreciation until the end of 2019, rather than making it permanent. However, several presidential candidates have committed to moving 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. – which would allow businesses to deduct all of their investments as soon as they are made. Hopefully, Congress will move in this direction in coming years and build on the five-year extension of bonus depreciation.
3. The Child Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. is permanently expanded (cost: $87.8 billion)
During the recent recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. , Congress expanded the Child Tax Credit to families earning over $3,000. However, without Congressional action, the credit would only apply to families making over $14,000, beginning in 2018, meaning that many families would stop receiving the credit.
While the Child Tax Credit expansion was meant to be a temporary stimulus measure, many members of Congress hoped to preserve a tax provision targeted toward the lowest-income Americans. As a result, the PATH Act makes the $3,000 eligibility threshold permanent – the second-most costly provision in the bill.
4. The Earned Income Tax Credit is also permanently expanded (cost: $30.4 billion)
Another tax provision that benefits low-income families and was expanded during the latest recession is the Earned Income Tax Credit. The EITC is calculated through a formula that varies based on filing status and number of children. Over the past few years, two temporary provisions have made the EITC more generous for married couples and taxpayers with three or more children.
The PATH Act makes the EITC expansion permanent, to prevent its expiration in 2018. This measure is accompanied by several anti-fraud provisions, to help alleviate the credit’s high rate of improper payments.
5. The American Opportunity Credit is made permanent (cost: $79.9 billion)
The federal tax code contains over a dozen education incentives. In 2009, Congress added the American Opportunity Credit, which covers up to $2,500 of education expenses and is almost twice as generous as its predecessor, the Hope Credit. However, absent Congressional action, the American Opportunity Credit is set to expire in 2018.
The PATH Act makes the American Opportunity Credit a permanent part of the federal tax code. This is an ill-advised move: while education tax incentives have grown steadily over the last decade, there is little evidence that these provisions encourage college enrollment. Instead, education credits are complex, poorly-targeted, and often counter-productive. The only bright side of making the American Opportunity Credit permanent is that the budget baseline now reflects the full, ten-year cost of the provision.
6. The research and experimentation credit is made permanent (cost: $113.2 billion)
The most expensive provision in the PATH Act is the one that makes the research and experimentation credit permanent. The R&E credit allows businesses that engage in certain research activities to lower their overall tax burden. Since 1981, this credit has expired and been renewed 16 times, making it one of the most unstable parts of the tax code.
Opponents of the credit argue that it has no proven results, favors big business, and does not successfully target beneficial research. Proponents often respond that the research credit has never been allowed to work properly, because businesses have never been certain enough about its future to pursue long-term research projects. Either way, making the credit permanent is a positive development, if only so that its costs are accurately reflected in the budget baseline.
7. The active financing exception is made permanent (cost: $78.0 billion)
The U.S. has a worldwide tax system, which means U.S. businesses operating overseas are taxed by both foreign governments and the U.S. government. To mitigate the competitive disadvantage to U.S. corporations, the tax code allows corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). s to defer taxes on some income earned by their foreign subsidiaries. As part of the Taxpayer Relief Act of 1997, Congress instituted the active financing exception, which allows businesses with certain overseas financial activities to defer taxes as well.
The PATH Act makes the active financing exception a permanent part of the tax code. Because this helps move U.S. taxation of international income further towards a territorial system, this is a positive development.
8. The Cadillac TaxThe Cadillac Tax is a 40 percent tax on employer-sponsored health care coverage that exceeds a certain value. The aim: to curb health-care cost growth, reduce favorable tax treatment of employer-provided insurance, and help fund the Affordable Care Act (ACA). It was repealed in late 2019 before taking effect. is delayed for two years (cost: $15.9 billion)
To pay for the Affordable Care Act, Congress instituted several new taxes, including the Cadillac Tax, a tax on expensive health plans. Almost immediately, the tax faced bipartisan opposition, driven by both business groups and unions. As a result of this opposition, the implementation of the Cadillac tax will likely be delayed until 2020.
While the Cadillac tax is poorly designed, the idea behind it is quite reasonable: employer-provided health plans are not currently taxed, which encourages employers to offer overly generous health benefits. The Cadillac Tax is an attempt to fix this fundamental distortion in the U.S. tax code. But pundits have already speculated that the delay of the Cadillac Tax might “spell the beginning of its demise.”
9. The medical device tax is also delayed (cost: $3.9 billion)
The Affordable Care Act also included a new excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. on medical devices. This tax has also faced significant, bipartisan opposition. As part of the PATH Act, the medical device tax will be delayed for two years, until 2018.
10. A new, temporary giveaway for refineries is created (cost: $1.9 billion)
Over the past few weeks, Congress has been negotiating over lifting the ban on U.S. crude oil exports, which has been in place since the 1970s. While repealing the ban has pros and cons, it would almost certainly hurt U.S. oil refineries, who have been heretofore shielded from international competition. To compensate refineries for their expected losses, one senator proposed a new tax credit for refineries. By the time this idea reached the final bill, it had changed slightly; now, the PATH Act gives refineries a more generous Section 199 manufacturing deduction.
Tax policies aimed at helping at specific industries are rarely ideal policy. The best justification for this provision is that it is a transition policy, helping refineries recoup the costs of the transition away from the oil export ban. If so, Congress should make sure that when this provision expires in 2022, it is not renewed again.
11. New rules for real estate investment trusts are created (cost: $1.0 billion)
In recent years, it’s become increasingly common for companies to spin off their real estate assets into real estate investment trusts, to gain more favorable tax treatment. The PATH Act cracks down on this strategy, by imposing several limits on spinoffs involving real estate investment trusts (which are mostly similar to the ones I described last week).
Simultaneously, the PATH Act makes it easier for real estate investment trusts to attract foreign investments by relaxing some of the provisions of FIRPTA – a 1980s bill that imposed high taxes on foreign investment in U.S. real estate. Because there’s not much of a justification for the existence of FIRPTA (the law was born out of fears that foreign investors would buy up U.S. farm land), these provisions are positive changes to the tax code.
12. Charitable distributions from IRAs are now permanently tax-free (cost: $8.8 billion)
One of the most popular tax extenders has been a provision allowing seniors over 70 ½ years old to distribute money directly from an IRA to a charitable organization without facing taxes. Because this provision has been renewed several times at the last minute, seniors have often been left scrambling at the end of the year to plan their finances.
The PATH Act makes the tax-free treatment of charitable IRA distributions permanent. This will likely decrease seniors’ financial planning uncertainty.
In addition to these twelve measures, there are another one hundred or so smaller tax provisions in the PATH Act that are also worth attention. Because of the sheer scope of the bill, it looks like the PATH Act will be a particularly consequential piece of tax legislation.
 The Cadillac Tax provision is included, not in the PATH Act, but the accompanying spending bill, which the House is expected to pass tomorrow.