Outlining a Path for Tax Policy Compromises

December 1, 2020

The 116th Congress has few legislative days remaining in the lame duck session to address a relatively long list of priorities, including additional pandemic relief, expiring tax provisions, and economic stimulus. Whether this Congress will accomplish the remaining tasks is highly uncertain, leaving the next Congress and President-elect Joe Biden to likely start the new year with unfinished tax policy business. While a large tax bill is unlikely to happen in 2021, pending the result of the two Georgia Senate runoffs, there may be smaller compromises lawmakers could make similar to a tax policy compromise reached in 2015.

At the end of 2015, the Protecting Americans from Tax Hikes (PATH) Act was passed by a Republican-controlled House and Senate and signed into law by President Barack Obama (D). Roughly 50 temporary tax breaks for businesses and individuals had expired at the end of 2014 and Congress had not yet acted on them.

The PATH Act renewed all the tax extenders that expired at the end of 2014, most on a temporary basis, but several were made a permanent part of the tax code. Of most relevance to our current situation, Congress granted permanence to business provisions related to cost recovery and research & development as well as making permanent several individual tax credits, including the Child Tax Credit (CTC) and Earned Income Tax Credit (EITC). At that time, bonus depreciation was set at 50 percent, and rather than make it permanent with other cost recovery provisions, Congress set it to phase out over five years.

There are several parallels between then and now.

In the coming years, a Biden administration may have to work with a Republican Senate majority and a Democrat-controlled House. At the end of this year, 33 temporary tax breaks are scheduled to expire. Over the next few years, upcoming tax law changes are scheduled to take effect under the 2017 Tax Cuts and Jobs Act (TCJA). These include a requirement for R&D costs to be amortized over five years and the phaseout of 100 percent bonus depreciation—both of which would increase the cost of domestic investment during a nascent economic recovery.

In addition, further relief is needed for the ongoing coronavirus-related downturn, and Congress may choose to extend a host of newly created pandemic-relief provisions, likely to include changes to the tax code. For example, President-elect Biden has supported the idea of expanding the CTC for the duration of the pandemic, and House Democrats have included CTC and EITC expansions in their pandemic relief proposals. As my colleague Taylor LaJoie notes, there is some skepticism over whether expanding credits is the best use of revenue given their complexity, timing, and narrowness, but nevertheless they remain a possible option in the context of relief proposals. 

This sets lawmakers up to reach a compromise like that of the PATH Act. Such a bargain could pair canceling the upcoming changes in tax law that would work against a swift economic recovery—these include the requirement to amortize R&D costs and the phaseout of bonus depreciation—with expansions in the CTC and EITC that would support vulnerable households. At the same time, additional relief measures, such as extended unemployment insurance, recovery payments, and liquidity measures for businesses are also warranted given the ongoing public health crisis and economic conditions.

There is a growing refrain among tax policy circles that pairing these groups of policies together—canceling TCJA expirations and expanding individual tax relief—could help lawmakers on both sides of the aisle come together to reach a deal.

Lawmakers have an opportunity to do even better than the PATH Act, in which most extenders remained extenders. Instead of continuing the status quo, this new bargain could be the inflection point of a decades long ritual of kicking the temporary tax policy can down the road. Rather than changing the expiration date, temporary provisions ought to be dealt with permanently.

For example, the PATH Act only provided a temporary extension of 50 percent bonus depreciation, much like the 2017 TCJA provided temporary 100 percent bonus depreciation. Instead, 100 percent bonus depreciation should be a permanent feature of the tax code. As such, it would permanently reduce the cost of capital, incentivizing a higher level of investment and economic output. On a temporary basis, these positive effects do not persist. Ultimately, each temporary provision ought to be analyzed and decided upon once for all (though this is not a likely scenario given the many more pressing priorities).

While a sweeping tax policy bill is unlikely in the near future, lawmakers may be able to come together on a smaller scale. Pairing better cost recovery on a permanent basis with support for vulnerable households as well as additional pandemic-related relief would help promote a more rapid return to growth and help businesses and households weather the ongoing crisis. Such a bargain has been struck before. It seems like the model could be used again to deliver relief and recovery now.

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The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by $1.47 trillion over 10 years before accounting for economic growth.

Depreciation 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.

Cost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. 

Bonus 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.