Before the end of the year, Congress will again consider renewal of the “tax extenders,” a collection of more than 50 expired tax breaks for individuals and businesses. These tax breaks, which are often extended a year or two at a time, range from the research and experimentation (R&E) tax credit and a deduction for teachers that buy school supplies to special depreciation for NASCAR tracks and racehorses.
Reinstating the normal tax extenders retroactively for 2015 and extending them through the end of 2016 without offsets would cost nearly $95 billion over ten years. A permanent extension would cost nearly $500 billion. If temporary stimulus-era provisions and refundable tax credits were also continued, the cost would rise to almost $1 trillion. CRFB’s Paying for Reform and Extension Policies (PREP) Plan, originally released in the fall of 2014, offers a better approach.
The PREP Plan includes principles that should be used for tax extenders legislation. It is paid for using $95 billion of offsets that increase tax compliance and decrease avoidance and includes a process for tax reform to happen in 2016.
Principles for Addressing Tax Extenders
- Address tax extenders permanently in the context of tax reform
- Fully offset the cost of any continuations without undermining tax reform
- Include a fast-track process to achieve comprehensive tax reform
|Extend Normal Tax Extenders Through 2016||-$95 billion|
|Improve Tax Reporting and Enforcement
|Increase program integrity spending||$35 billion|
|Improve various reporting and enforcement rules||$5 billion|
|Increase oversight and accountability of the IRS||*|
|Close Loopholes that Promote Tax Avoidance||$50 billion|
|Close the "John Edwards/Newt Gingrich” S-Corp loophole||$15 billion|
|Close the carried interest loophole||$15 billion|
|Tighten deduction limits for executive pay||$10 billion|
|Close other loopholes which encourage evasion||$10 billion|
|Restrict Inversions||$5 billion|
|Enact a one-year inversion ban||*|
|Reduce the profitability of inversions||$5 billion|
|Total Offsets||$95 billion|
|Establish Fast-Track Process for Tax Reform||TBD|
*less than $500 million in costs or savings
Details of the PREP Plan
The PREP Plan assumes policymakers will enact a clean two-year extension of all the expired regular extenders. We assume bonus depreciation, which was originally put in place to help strengthen the economy during the recession, remains expired. In total, this would cost about $95 billion over the next decade, before interest. Note: we are not endorsing the choice to extend all expired regular extenders, just showing how it could be paid for.
The PREP Plan offsets this $95 billion cost by generating an equivalent amount of revenue with enforcement and savings from refundable credits. To ensure this package does not interfere with decisions that should be made in tax reform, its policies increase compliance within the current confines of the tax code (or spirit thereof). In other words, the package does not adjust tax rates, change the design or size of any tax expenditure, or otherwise alter the structure of the code. Instead, it increases enforcement, improves rules, and closes loopholes so that individuals and businesses pay the taxes they should be paying under the current code.
Many components of the plan have bipartisan support and draw from either the President’s budget or former Ways & Means Chairman Dave Camp’s (R-MI) Tax Reform Act of 2014. The PREP Plan also includes a fast-track process for broader tax reform, and it restricts “inversions” to allow time for that reform to be put into place.
Principles for Addressing Tax Extenders
- Address tax extenders permanently in the context of tax reform. With a few exceptions, there is little logic to writing tax policy for one or two years at a time. Comprehensive tax reform should decide whether to repeal, reform, or make permanent most tax extenders, and it should do so in the context of other decisions about tax rates, breaks, and the structure of the code.
- Fully offset the cost of any continuations without undermining tax reform. Tax reform will not be possible before the expired provisions must be addressed. In the meantime, any extension should be not undermine future tax reform efforts and should be fully paid for so as not to add to the debt.
- Include a fast-track process to achieve comprehensive tax reform. The need to act quickly is not an excuse to abandon efforts to reform a tax code that is complicated, anti-growth, and in many ways broken. Temporary action on extenders should advance a plan that would broaden the tax base, lower rates, promote economic growth, and reduce the deficit.
Improve Tax Reporting and Enforcement ($40 billion)
- Increase program integrity spending ($35 billion): The PREP Plan reduces the amount of unpaid taxes by providing dedicated mandatory funding for the Internal Revenue Service (IRS) to audit and enforce tax compliance. The IRS estimates that every $1 spent on program integrity can generate $6 of revenue.
- Improve various reporting and enforcement rules ($5 billion): The PREP Plan makes statutory changes to close the tax gap such as improving reporting on tuition and increasing various tax penalties.
- Increase oversight and accountability of the IRS: The PREP Plan includes increased internal and external oversight over the IRS along with the new funding.
Close Loopholes that Promote Tax Avoidance ($50 billion)
- Close the “John Edwards/Newt Gingrich” S-Corp loophole ($15 billion): The PREP Plan prevents self-employed individuals from avoiding payroll taxes by disguising wages as “business income.”
- Close the carried interest loophole ($15 billion): The PREP Plan prevents hedge fund and private equity partners from paying lower rates by structuring their earned income as capital gains.
- Tighten deduction limits for executive pay ($10 billion): The PREP Plan removes exceptions to limits on the amount of wages a company can deduct as a business expense for its highest-paid employees.
- Close other loopholes which encourage evasion ($10 billion): The PREP Plan closes a variety of other loopholes by preventing investors from using shell companies to evade taxes, stopping cruise ship companies from using rules intended for cargo ships to avoid taxes, banning companies from borrowing simply to buy tax-exempt bonds, and preventing other tax evasion strategies.
Restrict Inversions ($5 billion)
- Enact a one-year inversion ban (<$1 billion): Companies are again showing increased interest in corporate inversions: the practice of an American company moving its headquarters overseas, often to lower its U.S. tax bill. The PREP Plan calls for a one-year ban on inversions to give time for tax reform that will increase the competitiveness of our tax system and reduce the pressure for companies to invert.
- Reduce profitability of inversions ($5 billion): The PREP Plan permanently limits “earnings stripping” among inverted companies, preventing them from deducting interest on intercompany loans designed to move income overseas.
Promote Comprehensive Tax Reform (to be determined by Congress)
- Enact a “fast track” process for tax reform: The current tax code is complex, anti-growth, and in need of an overhaul. Yet tax reform has proved elusive so far. The President and Congress should agree to put tax reform near the top of their agenda and establish a fast-track process for business tax reform, individual tax reform, or both. Any tax reform should broaden the tax base, lower rates, promote economic growth, improve fairness and simplicity, and reduce the deficit.
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In early 2015, the Committee for a Responsible Federal Budget (CRFB) warned of the upcoming Fiscal Speed Bumps, explaining “lawmakers will face a number of important budget related deadlines…that will require legislative action.”
Inaction and postponed deadlines have created a gathering storm where Congress and the President must address four remaining Fiscal Speed Bumps before the end of the year:
- The end of 2015 appropriations and return of sequester caps (October 1)
- The expiration of the highway bill and insolvency of the Highway Trust Fund (October 30 & Summer 2016)
- The exhaustion of extraordinary measures to avoid raising the Debt Ceiling (mid-Fall)
- The deadline to renew tax extenders retroactively (December 31)
Although deadlines vary, political considerations may cause lawmakers to combine these issues – leading to a double, triple, or even quadruple cliff.
An irresponsible approach could add up to $2.5 trillion to the debt by 2025 above what current law allows, after interest. Instead, lawmakers should take advantage of this gathering storm to make sensible reforms to improve policy, accelerate economic growth, and address the overall fiscal situation.
Appropriations End. Sequester-Level Caps Return (October 1)
When the government’s fiscal year ends on September 30, so too will the laws that provide discretionary dollars. In theory, Congress is supposed to pass 12 appropriations bills before October in order to fund the government for Fiscal Year 2016 (FY 2016). However, the House has passed only six so far, while the Senate has not passed any. Failure to pass appropriations bills or a Continuing Resolution (CR) would result in a government shutdown.
Assuming policymakers avoid a shutdown, they will still need to decide at what level to fund the government. The Ryan-Murray Bipartisan Budget Act set spending levels for only FY 2014 and FY 2015. For FY 2016, current law spending caps will be dictated by automatic spending reductions commonly referred to as the “sequester.”
Under sequestration spending levels, nominal discretionary caps will rise only $3 billion (0.3 percent) next year – and remain about $90 billion below the pre-sequester caps set in the Budget Control Act. A number of policymakers and outside analysts have called for repealing or reducing the impact of this sequester.
Permanent sequester repeal would cost $1 trillion before interest over the next decade – although policymakers could enact a partial and/or temporary reduction of the sequester cuts. In any case, lawmakers should fully offset the costs with more thoughtful permanent savings that grow over time, without relying on gimmicks.
Legislation increasing the discretionary caps could also be accompanied by budget process reforms to strengthen their enforcement and restrict the use of gimmicks – such as the use of the Overseas Contingency Operations in the Congressional budget to effectively circumvent the defense caps. We describe such reforms in Strengthening Statutory Budget Enforcement.
In September, CRFB will release a plan to replace a portion of the sequester cuts over the next two years and on a permanent basis with savings elsewhere in the budget.
To learn more, read Everything You Should Know About Government Shutdowns, Appropriations 101, and Understanding the Sequester.
Highway Bill Expires and Trust Fund Runs Low (October 30 & Summer 2016)
At the end of October when the current highway bill expires, no new funds may be obligated to transportation projects without additional legislation. If highway spending is continued at current levels without additional revenue, the Highway Trust Fund will run out of money in the fourth quarter of FY 2016, or next summer.
Ultimately, policymakers should close the structural gap between dedicated tax revenue (e.g., the gas tax) and highway spending, which is projected to total about $13 billion this year and $175 billion through 2025. Preferably, this gap would be closed permanently with structural changes to revenue and/or spending, although a fully-offset general revenue transfer could be used to buy time, as it was this July.
CRFB released an illustrative plan in May: The Road to Sustainable Highway Spending, which included a fully-offset, short-term cash infusion into the trust fund, a process for tax and transportation reform, a scheduled 9-cent per gallon gas tax increase if alternatives were not identified, and a spending limit to keep future highway costs in line with revenue.
For more background, see our paper Trust or Bust: Fixing the Highway Trust Fund.
Federal Debt Ceiling is Reinstated (Mid-Fall)
The federal debt ceiling – which was suspended in February 2014 – was reinstated this March, limiting gross federal debt to its current level of $18.15 trillion. Through “extraordinary measures,” the Department of Treasury has been able to delay the need to address the debt ceiling even as the federal government continues to borrow. However, those measures are estimated to run out sometime after the end of October.
Policymakers must increase or suspend the debt ceiling to avoid a potentially disastrous government default, and should do so in a timely manner because waiting until the 11th hour could have negative economic consequences. At the same time, the debt ceiling can be – and in the past has been – an opportunity to take stock of the nation’s unsustainable fiscal situation and make fiscal reforms. An increase would ideally be accompanied with improvements to reduce the long-term debt.
Reforms to the debt ceiling itself should also be considered. Through our Better Budget Process Initiative, CRFB has presented a number of ideas for Improving the Debt Limit to better promote fiscal responsibility without generating as much economic risk.
To learn more about the debt ceiling, read Q&A: Everything You Should Know About the Debt Ceiling and Understanding the Debt Limit.
“Tax Extenders” Reach Reinstatement Deadline (December 31, 2015)
At the end of last year, over 50 temporary “tax extenders” expired. These include individual and business tax breaks for research and experimentation, wind energy, state and local sales tax, and many others.
Most are renewed regularly and can be reinstated retroactively through the end of 2015, and possibly later. Doing so for 2015 would cost over $40 billion before interest, and extending them into 2016 would cost about $95 billion. Many of these provisions have been enacted temporarily to hide their costs, but the price mounts if they are continued year after year. A permanent extension would cost roughly $500 billion through 2025 for traditional extenders, $245 billion for bonus depreciation, and $200 billion for expiring refundable credits – about $940 billion total, without factoring in interest costs.
Rather than add to the debt, lawmakers should use this deadline as an opportunity for comprehensive, pro-growth tax reform that simplifies the tax code, reduces tax rates and deficits, broadens the tax base, promotes growth, and makes thoughtful choices about how to address each tax extender. Last year, CRFB proposed the PREP Plan, which combined a temporary extension with a fast-track process for tax reform and offset the cost with tax compliance measures.
To read more about the tax extenders, see The Tax Break-Down: Tax Extenders.
* * * * *
The gathering fiscal storm facing our country this fall will require legislation to address the important budgetary issues mentioned above. We hope Congress and the President use this as an opportunity to improve, rather than worsen, the nation’s unsustainable fiscal situation.
Update 9/10/2015: This paper was updated for the Department of Transportation's announcement that the Highway Trust Fund would last through the third quarter of FY 2016, and updated to clarify when listed costs included interest.
In the coming months, Congress and the President will face a number of important decisions with significant fiscal implications. Specifically, they must decide how to address “Sustainable Growth Rate” (SGR) cuts, which threaten to significantly reduce Medicare physician payments next April, and 55 “tax extenders” that expired at the end of last year.
If policymakers address these two issues irresponsibly, they could add up to $1 trillion to the debt over the next decade. Yet policymakers could also use these moments to make a down payment toward tax and entitlement reforms that slow health care cost growth, speed economic growth, and help put the debt on a sustainable long-term path.
To responsibly address the Sustainable Growth Rate, policymakers should:
- Permanently replace the SGR with a value-based payment system
- Fully offset any costs relative to current law
- Enact offsets that bend the health care cost curve and are gimmick-free
To responsibly address the expired tax extenders, policymakers should:
- Address most tax extenders permanently in the context of tax reform
- Fully offset the cost of any continued extenders without undermining tax reform
- Include a fast-track process to achieve comprehensive tax reform
There are many ways to achieve these goals. The Paying for Reform and Extension Policies (PREP) Plan represents one such approach. We assume, but don’t endorse, the Tricommittee SGR bill and two years of tax extenders and propose $170 billion of SGR offsets that bend the health care cost curve, $83 billion of extender offsets that improve tax compliance, and a fast-track process for tax reform. Offsets would total $250 billion over ten years.
Summary of the PREP Plan (Costs/Savings over Ten Years)
|Enact Tricommittee SGR Reform||$170 billion
||Extend "Tax Extenders" to 2015
|Reform Provider Incentives
||-$80 billion||Improve Tax Enforcement||-$35 billion|
|Reform Beneficiary Incentives||-$80 billion||Close Tax Avoidance Loopholes||-$45 billion|
|Reduce Medicaid Costs||-$10 billion||Restrict Inversions||-$3 billion|
|Total Offsets||-$170 billion||Total Offsets||-$83 billion|
|Set Up Fast Track Process for Comprehensive Tax Reform||TBD|
|Ten-Year Deficit Impact : $0|
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An annotated version of this chartbook is available at Want to Understand the Tax Extenders? Here's a Few Charts.
Much more detail about the history, rationale, and cost of the extenders is available at our resource: Tax Break-Down: Tax Extenders