Double Counting: The Tax Reform Act and the Highway Trust Fund

The Tax Reform Act of 2014, House Ways and Means Chairman Dave Camp's (R-MI) discussion draft, is a sizeable document touching almost all parts of the tax code. However, one fiscally concerning piece of the legislation that we brought up in our analysis of the draft has to do with transportation spending: the transfer of general revenue to the Highway Trust Fund (HTF). In short, the bill double counts temporary revenue from taxation of foreign earnings held overseas to both extend the life of the HTF—a variation of which has been proposed in Congress and by President Obama—and to meet the goal of revenue neutrality over ten years.

To understand this proposal, one must first understand the international tax system and how the draft reforms it. Currently, foreign earnings of U.S. multinational companies are not taxed by the federal government until their profits are repatriated into the U.S., although certain financial income is taxed in the year it is earned. This "deferral" encourages companies to retain trillions of dollars of earnings overseas that are not subject to U.S. taxation. The draft proposes to move to a territorial system, which would essentially exempt foreign earnings from taxation that would under current law be taxed upon repatriation. To prevent companies from reaping a significant tax windfall on previous earnings, the draft enacts a 8.75 percent tax on foreign earnings held since 1986, payable over eight years. Because much of these earnings would have likely never been taxed by the U.S., JCT scores this transition tax as increasing revenue by $170 billion through 2023 and devotes $126.5 billion of it to the HTF.

Because the tax is payable over eight years, this revenue stream would disappear beyond the ten-year window. The draft decides to dedicate this temporary revenue to the Highway Trust Fund, with 80 percent going to the Highway Account and 20 percent going to the Mass Transit Account. According to the summary released by the Ways and Means Committee, these revenues would allow the Highway Trust Fund to cover projected spending through 2021.

^{Source: CBO, JCT}

CBO projects that the HTF will be exhausted in 2015 and the Department of Transportation may be required to begin slowing reimbursements to limit spending from the HTF as early as the latter half of 2014. The highway account of the HTF faces a cumulative shortfall of $129 billion in projected spending above revenues through 2024, and the mass transit account faces a cumulative shortfall of $43 billion. The looming "funding cliff" facing highway programs has placed pressure on Congress to act this year to avoid reductions in highway spending by closing the HTF funding shortfall. But increasing the gas tax faces intense opposition, and proposals for alternative funding sources for the HTF are similarly controversial, so exploiting trust fund accounting and scoring conventions to bail out the HTF without increasing revenues or reducing spending becomes a tempting option for lawmakers. 

The budgetary impact of trust funds can be complicated. We've discussed this issue previously in general and as it related to the Affordable Care Act and Medicare Part A. CBO treats different trust funds in different ways, in some cases not counting savings that improve trust fund solvency, in some cases counting savings but not trust fund solvency improvement, and in some cases counting both. Like Part A, the Highway Trust Fund falls in the latter category. CBO assumes in its baseline that lawmakers will always act to fund the HTF, so transferring general revenue has no budgetary effect. Lawmakers can also claim to extend the life of the HTF without being charged a cost for doing so or identifying new revenues or spending cuts to cover the shortfall. Legally, the HTF is not allowed to run a negative balance and does not have authority to borrow money to cover obligations in excess of revenues after the trust fund has been exhausted, so transferring money to the HTF to extend trust fund solvency allows spending to be greater than it otherwise would have been.

In reality, though, money can only be used once. By transferring the revenue raised from the repatriation tax to the HTF, lawmakers allow the HTF to spend $126.5 billion more through 2023 than it otherwise would. But the proposal does not generate net new revenues to cover the HTF shortfall; it essentially reallocates a portion of corporate tax revenues to the HTF.

Critically, the increased revenues from the repatriation provision are also used to offset other provisions that reduce revenues to maintain the proposal's revenue-neutrality. In essence, the revenue from taxation of accumulated overseas earnings and profits can be used to make the Tax Reform Act revenue-neutral over ten years, or it can be used to close the HTF shortfall. It cannot do both.

There is merit in dedicating temporary revenues from repatriation to cover a portion of the HTF shortfall instead of using them to offset permanent revenue losses. However, this bill has no room to spare to be diverting revenue for specific purposes. If Congress were to enact the repatriation provision as part of a highway bill reauthorization in order to close the HTF funding shortfall, the tax reform proposal would no longer be revenue neutral. President Obama has made a similar proposal to cover HTF shortfalls with revenues generated by repatriation of overseas earnings as part of corporate tax reform, but with the key difference that the money dedicated to the HTF would come from the net increase in revenues over the ten year window from his corporate tax reform proposal, and the tax reform proposal would still be revenue-neutral without those revenues.

While increasing transportation spending by closing the HTF shortfall is a worthy goal, it should be done within the program by increasing the gas tax or other dedicated revenues and/or reducing projected spending levels. If lawmakers want to dedicate revenues from outside of the program to shore up the trust fund, they should do so with new revenues and not simply reallocate existing revenues.