Budget debates like this can quickly get complicated, but what’s fundamentally going on here is simple. Two buckets of tax policies are set to expire, one for businesses and one for low-income working families. The business tax cuts are regularly extended, to the point where they’re eponymously labeled “the extenders” and re-added to the tax code at the end of each year when they expire, usually with Democratic support.
The deal on the table is to make some of the extenders permanent tax law such that their renewal would no longer need to re-legislated each year, a change sought by Republicans. In exchange for their support for making the extenders permanent, Democrats are insisting on Republican support for making permanent improvements in working family tax credits that are scheduled to expire in 2017.
Considering that many of the business tax cuts have now been extended dozens of time, admitting their permanence is a move toward more honest, transparent budgeting. The current practice — annual extensions — makes the tax cuts appear less costly over the long term, because they’re added to the deficit a year or two at a time. Yes, accounting for their costs over the longer term inflates the 10-year budget deficit, but since they would have been added to the deficit anyway, any sense of fiscal rectitude from the current practice was illusory anyway.
But are these tax cuts necessary? Are they worth the forgone revenue? Well, there’s dozens of them so that’s not an easy question. I’d argue, and I think most economists would agree, that most of the big ones are “inframarginal goodies” which is economese for giving companies a tax break for stuff they’d do anyway.
Take “bonus depreciation,” the biggest extender, with a 10-year price tag of $280 billion. This break allows businesses to fully deduct the cost of new equipment upon purchase, instead of gradually deducting the costs as the equipment depreciates. As tax analyst Chuck Marr has shown, combining bonus depreciation with the favorable tax treatment of debt financing leads to a negative tax rate, i.e., a government subsidy, on the profits generated by the equipment of a whopping 37 percent. And if your heart bleeds for businesses at the thought of getting rid of this subsidy, consider that without “bonus” the tax/subsidy rate is -19 percent.
I’ll get back to the fate of bonus depreciation in the deal, but what about the low-income family tax credits. Are they worth it?
Here, the forgone revenues are well spent, in that they’re paying for something I and other progressives highly value: significant, pro-work poverty reduction. Back in 2009, improvements were made to the Earned Income Tax Credit and the Child Tax Credit that now benefit more than 50 million people in low- and modest-income working families with incomes up to about $50,000. Together, these additional refundable credits lift 16 million people — including 8 million children — either out of poverty or closer to the poverty line each year. If they expire, a single mother with two children who works full time at the federal minimum wage of $7.25 an hour and makes $14,500 will lose $1,725 — her entire child credit.
If you’re still on the fence re whether this is a deal worth signing on to, here’s the clincher. Rarely before, in the time-worn, annual process of extending the business tax cuts, has Congress done anything for the working poor. This unique alignment of the budget stars is driven by the fact that the family credits have the same non-permanent status as the business breaks, so Democrats have some rare leverage to hitch anti-poverty policies to the business tax breaks. When you consider that the business tax cuts would have been extended either way, this part of the deal looks like a rare, real win for low-income, working families.
But what about the deficit?
Not paying for new tax cuts, even ones you knew were going to happen anyway, adds to the budget deficit. My readers know that I’m no deficit hawk, but I am a self-professed CDSH—cyclical dove, structural hawk. Optimal fiscal policy, I’ve written, “must be flexible, with deficits temporarily rising in recessions to support the weak economy and coming down in recoveries as the economy strengthens.” And, in fact, that’s been the pattern in the Obama administration, with deficits rising to 10 percent of GDP in the worst of the Great Recession, and coming down (too quickly, I’d argue) in the recovery such that the current deficit is 2.5 percent of GDP, a low enough deficit to stabilize the debt ratio (see the link above for details of these relationships).
And yet, here we are, six years into an expansion and probably about to add hundreds of billions to the deficit by not offsetting the tax cuts. By the CDSH code, that is not the optimal fiscal policy. I don’t think it’s hugely problematic either, in the sense of say, hurting the economy by putting upward pressure on interest rates. And, as I’ve argued, adding anti-poverty policy to an unpaid-for package that would have passed regardless of my pristine theorizing re optimal policy is a big plus.
But no one should confuse this package with responsible fiscal governance.
That said, there are a few potential outcomes here (remember, the deal’s still in negotiation) that could mitigate the budget damage. Bonus depreciation may end up with a five year phase out, and since a bunch of “cats and dogs” extenders won’t be made permanent, there’s a chance they’ll die of natural causes, as Congress will have less reason to go through the annual extenders ritual.
On the other hand, the negotiations have put the “Cadillac tax” back in play. I’ve argued strongly in support of this excise tax on high cost insurance plans to help fund Obamacare, but in this case, Democrats want to repeal the tax, as they believe it would hit the plans of many of their union-member constituents (I’ve suggested some ways to improve the tax, including adding geographical price adjustments and, if necessary, a different price index). The tax was supposed to take effect in 2018, but news accounts report an effort to postpone it for another two years. The longer we wait to implement the tax, the less likely it will ever come to fruition (not to mention that repeal would add about $90 billion to the deal’s cost in lost revenues).
So, the upside of the deal — making permanent the anti-poverty improvements in the CTC and EITC — is clear and strong. The downside, especially in a fiscal environment where we’ll need more, not less revenues in the future, is just as clear: We’re putting hundreds of billions of tax cuts on the books (though as I’ve stressed, they would eventually have been there anyway) and delaying, if not repealing, one of the few measures on the books that will raise needed revenues.
In other words, we’re as stuck as ever in the cramped tax debate that has serious and challenging implications for the future of government’s role in the economy. But in the meantime, the unique timing of the deal may well enable us to pull an anti-poverty rabbit out of the hat.