Extending Bad Fiscal Policy with Tax Extenders

As we near the end of the calendar year, we’ve once again reached tax extender season—the time of year when senators and representatives set aside their differences to hand out tax breaks, loopholes, credits, and deductions as if they got them at a Black Friday sale. For the uninitiated, “tax extenders” refers to a whole package of supposedly temporary tax breaks that are lumped together and passed into law every year or two, like clockwork.

Tax extender packages are genetically designed to sail through even the most acrimonious Congress. For one thing, there’s something for everyone. Supporters of schoolteachers will vote for the package because it includes a deduction for teachers to buy items for their classrooms, even if it includes tax breaks they don’t like at all, like those that benefit thoroughbred racehorse owners and NASCAR racetrack developers. (Policymakers that like watching fast things race in circles, but don’t care much for teachers, are also happy to vote for the package.) Moreover, the temporary nature of extenders packages allows Congress to simultaneously pretend that the tax breaks will actually expire soon (so as to deflate the budgetary cost of the legislation) while telling key constituencies—most of whom happen to be big businesses—that their cherished tax breaks are effectively permanent because they have always been extended before.

This week, Congress appears to be zeroing on a tax extender deal to be voted on when lawmakers return to Washington after Thanksgiving—and somehow, the biannual tax-cut fest is worse than normal.

Under the emerging deal, Congress will permanently add several provisions to the tax code—including a newly-expanded business credit for research and development, the deduction for state and local sales tax, an incentive for small business investment (section 179), and credits for college tuition (the American Opportunities Tax Credit) and mass-transit commuting. Meanwhile, the deal would phase out the Renewable Electricity Production Tax Credit, and would not extend the Recovery Act’s expansion of the Earned Income Tax Credit or Child Tax Credit beyond their current 2017 expiration date. (The absence of a permanently expanded EITC and CTC has led to veto a threat from President Obama .) The remainder of the package of 55 or so tax provisions would be extended through 2015.

All in all, this package is a mess.

Earlier this year, I put out a report decrying the routine use of tax extender legislation. Specifically, I mentioned four reasons why fiscal policymaking via temporary tax breaks is a bad idea. Let’s see how this deal lives up (or down) to these reasons:

  1. Separate the wheat from the chaff. The current deal certainly didn’t do that—all of the extender package’s provisions will be extended through 2015. In my original paper, I specifically called out the R&D credit (for not providing an incentive for those who really need it), which will now be permanent; the state and local deduction (for being regressive), which will now be permanent); and the Production Tax Credit (for not being a carbon tax or at least a technologically-neutral subsidy), which, in a bad move for the renewable energy industry, is being phased out entirely instead.
  1. Discretionary spending is at historic lows, yet discretionary tax breaks continue. This tentative deal will cost $450 billion over ten years, without offsets for those costs. Meanwhile, Congress can’t find the money to renew badly-needed unemployment insurance expansions or invest in crumbling infrastructure. The cost also forfeits about half of the revenue raised in the “fiscal cliff” deal that increased taxes on high-income earners. This bill lays bare Congress’s misplaced priorities.
  1. The regular extension cycle does a poor job of incentivizing behavior. The entire package of 55 or so separate tax incentives actually expired at the end of 2013. Passing it this year would make these breaks effective retroactively, thereby “incentivizing” decisions that have already been made.
  1. Tax extenders make informed fiscal debate more difficult. The expected continual extension of these provisions makes difficult the creation of a single budget baseline that all parties agree on, and this can damage the prospects for having transparent, evidence-based fiscal policy debates. If this package becomes law, and Congress insists on “revenue neutral” tax reform, they’ll need a lot less revenue than they would today.

The mere existence of tax extender packages shows an abdication of fiscal policymaking. Instead of routinely extending these breaks, Congress should figure out which ones have a good bang-to-buck ratio, and which should be scrapped. And those that are deemed worthy to stick around should be made better, which, in most instances, means adding them to the spending side of the government’s ledger. (Helping out teachers and/or providing supplies for schoolchildren are great ideas—a tax deduction is a terrible way to accomplish this.)

Over its two years in existence, the 113th Congress has shown an unwillingness to address the biggest problems of the day—just look at pressing issues as disparate as immigration, climate change, and an economic recovery that has left behind the middle- and working-classes. But they have wrung their hands consistently about deficits and invoked them for why we can’t have economic policies that would help families. But when push comes to shove, there’s always one item on the national to-do list our fearless lawmakers make sure to cross off—handing out unpaid-for tax breaks to their favorite causes, which tend to be big businesses.