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Commentary By Diana Furchtgott-Roth

No Band-Aids, Let's Have Real Tax Reform

Economics Finance

This article originally appeared in RealClearMarkets.

Whatever the results of the election, Congress is planning to reconvene on November 12 for a lame duck session, so-called because the days in office of some members will be numbered. As well as passing a budget for fiscal year 2015, the 113th Congress will try to finish up other bills, including the extension of tax provisions that expired on January 1, 2014.

Yes, even though certain tax provisions expired 10 months ago, Congress is planning to reinstitute them, not just for the future, but retroactively. People who took certain actions without the tax provision in place between January and mid-November would be able to benefit.

Congress should not pass such a tax extenders bill. Rather, the new 114th Congress should take a careful look at the U.S. tax system and propose permanent reforms. Instead of hurtling from one temporary tax provision to another, people and companies need certainty that comes with stable provisions, not just an extension of expired provisions that will then expire again in a year or two, requiring yet another set of tax extenders.

Officially, neither Republicans nor Democrats like tax extenders. According to Republican House Ways and Means Chairman Dave Camp, "The United States is the only country in the world that allows such important pieces of its tax code to expire on a regular basis. Worse yet, this type of tax policy disadvantages U.S. companies, hurting their ability to remain globally competitive."

Senate Finance Committee Chair Ron Wyden, a Democrat, said, "Many of these extenders are well-intentioned and ought to be permanent. Their stop-and-go nature obviously contributes to the lack of certainty and predictability America needs to create more family wage jobs...."

Despite this agreement, the House and Senate are poles apart on tax extenders. The House Ways and Means Committee has approved ten different bills that each made permanent a different extender at a 10-year cost of $609 billion. In May the full House passed one extender, a bill to make the research-and-development tax credit permanent. In contrast, the Senate Finance Committee passed a bill extending more than 50 extenders through December 2015 at a cost of $81 billion over 10 years, but the bill has not moved to the Senate floor.

All sectors of the economy are affected, from teachers in classrooms to entertainment to wind farms and solar panels.

In the field of education, a $250 tax deduction, now expired, allowed a teacher to buy books, supplies, and computer equipment to be used in the classroom. Students have lost a pre-income adjustment deduction for qualified tuition and related expenses.

Twelve energy provisions have expired, mostly dealing with alternative energy. Together, a two-year extension would cost $19.6 billion for ten years. A two-year extension of the tax credits for biodiesel and renewable fuel would cost $2.6 billion. An extension of renewable energy investment tax credits that apply to wind and other renewables (except solar, whose credit has not expired) would cost $13.3 billion for a two-year extension.

Retroactive taxation is legal, but it is poor tax policy nonetheless. With the Revenue Act of 1913, the first income tax law, citizens were taxed on income they made before the bill was signed. In 1918 and 1926, the Revenue Acts were applicable to the entire calendar year before they were passed.

More recently, in January 2013, Congress retroactively renewed 52 tax provisions that expired the prior year. With 56 provisions having expired at the end of 2013, Congress will be tempted to pass a bill in the lame duck session.

Here are five reasons not to pass a tax extenders bill.

Tax extenders would remove the incentive for tax reform. Everyone knows that the United States needs tax reform. When American corporations are more valuable as owned by foreigners than in local hands, as we have seen with the recent spate of inversions, something is very wrong. On the individual side, normal Americans spend hours of their time and billions of dollars filing their tax returns. A failure to pass the tax extenders would put more pressure on Congress to move forward with tax reform. Lobbyists would be calling on the leadership to put it first on the agenda.

Tax extenders would tie the hands of the next Congress. If the 113th Congress passed a package of tax extenders, the 114th Congress would find it more difficult to roll back the provisions. Of course, one Congress can change what another has done. But in practice, a new Congress might be less willing to change a bill passed just a month previously.

Tax extenders exacerbate the climate of uncertainty. The whole concept of tax extenders needs to be revised. Important provisions, such as the research and development credit, go from year to year without permanence. This is no way to help our corporations run their businesses, and no way to run an economy. It puts American firms at a disadvantage vis a vis their foreign competitors.

Why does the United States make greater use of extenders than do other Organisation and Economic Cooperation and Development countries? This is at least partly because of the Congressional Budget Office scoring rules that govern changes in revenues and spending. With CBO calculating 10-year revenue effects, Congress can often only pass a 1- or 2-year credit, because the cost of a 10-year credit would require taxes to be raised elsewhere to maintain revenue neutrality. There's an artificiality about the 10-year window, and there is substantial gaming around the time frame.

Tax extenders corrupt the system. Members have an incentive to pass tax extenders rather than permanent reform because it helps them raise campaign donations from businesses and sectors who benefit from the extenders. It is unfortunate that we have the best government that money can buy. Staffers have incentive to pass tax extenders because it increases their ability to get jobs with lobbying and law firms. Since the tax provision will need to be extended again down the road, firms will hire people who have experience in passing such legislation in prior years.

Tax extenders reinforce negative expectations about the process. The more often Congress passes tax extenders, the more likely members are to do it again. Members of Congress and the public become used to a tax code that is held together by a series of temporary patches.

It is time to end the Band Aids and the duct tape, time for comprehensive tax reform. That is why, when the 113th Congress reconvenes for its last session, the lame ducks should just say no to tax extenders.

 

Diana Furchtgott-Roth, former chief economist of the U.S. Department of Labor, directs Economics21 at the Manhattan Institute. You can follow her on Twitter here.

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