2023 Tax Extenders: Details & Analysis
For many years, December in Washington, D.C., has been taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
extender season. Tax extenders are temporary tax provisions typically renewed on a regular basis, in many cases annually. However, instead of the usual exercise of extending a bunch of relatively small expiring provisions, this year Congress faces major lingering issues that have been left unaddressed since the end of 2021, most notably relating to business deductions for research and development (R&D), machinery and equipment investment, and interest expense.
In Congress, both parties have expressed widespread support for improving the treatment of R&D and potentially extending some or all of the major business provisions, while the White House and congressional Democrats have indicated interest in an expanded child tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.
, suggesting potential for a deal.
For background, tax extenders in recent years have generally fallen into three categories: perennial extenders that typically have small fiscal costs, temporary and expiring provisions of the Tax Cuts and Jobs Act (TCJA), and pandemic-era relief policies. In December 2021, Congress faced all three types, including perennial items such as rum excise taxes, deductions for racehorse expenses, and a slew of renewable energy credits. Congress also considered the expiration of many COVID-era relief policies, most notably the supercharged fully refundable child tax credit passed in the American Rescue Plan Act (ARPA) of 2021.
In addition, two TCJA business tax hikes were scheduled to go into effect as offsets to the law’s tax cuts beginning in 2022. For the first time ever, rather than fully and immediately deducting R&D costs (which are mainly salaries for scientists, engineers, and researchers), businesses would be required to amortize the costs over 5 years for domestic investment and 15 years for foreign investment. As well, TCJA’s limitation on business deductions for interest expense, initially limited to 30 percent of earnings before interest, tax, depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment.
, and amortization (EBITDA), was set to be tightened to 30 percent of earnings before interest and tax (EBIT).
Proposed fixes or extensions for many policies were included in different versions of the Build Back Better legislative package. However, negotiations fell apart before the end of 2021, and no separate extenders package was agreed upon either. As a result, all the extenders expired, and the amortization of R&D expenses and the tighter interest limitation took effect.
In December 2022, the situation was somewhat different. The Inflation Reduction Act of August 2022 expanded, reformed, or replaced many of the perennial energy tax extenders that had expired at the end of 2021. They, for better or worse, are now relatively stable parts of the tax code. A few COVID-era relief policies were set to expire at the end of 2022, such as the 100 percent deduction for business meals. The two major TCJA policies left unaddressed in 2021 (the deductibility of interest and R&D amortization) remained, and another major TCJA policy began phasing out at the beginning of 2023: 100 percent bonus depreciationBonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings, in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs.
, allowing full and immediate deductions (expensing) for short-lived assets including equipment and machinery, was set to drop to 80 percent in 2023, then 60 percent in 2024, and fully phase out by 2027.
Congress did not agree to an extenders deal in December 2022 either, meaning the major TCJA issues remained unaddressed and the few COVID-era policies left in 2022 also expired.
This year, while some of the smaller extenders may be added to the mix, policymakers are mainly considering the three major temporary business tax provisions of the TCJA and a potential expansion of the child tax credit.
A primary concern is the fiscal cost of such a package, particularly in the context of a $2 trillion deficit in FY 2023 on top of $7.3 trillion in deficits over the three years prior, which many economists argue triggered the highest inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.
in four decades. Related is the concern that further adding to deficits will risk an extended period of high interest rates, or even higher interest rates, as the Federal Reserve battles a resurgence of inflation.
We have estimated that extending the three major business provisions permanently would reduce federal tax revenue by about $724 billion over 10 years, before accounting for impacts on economic growth. Most of the cost, about $427 billion, is due to the extension of 100 percent bonus depreciation. However, the provisions, particularly expensing, would improve incentives for businesses to invest, leading to a larger economy over the long run. We estimate GDP would increase over the long run by about 0.5 percent while the capital stock would increase by about 1 percent and more than 100,000 jobs would be added. The higher economic output reduces the fiscal cost of extending the three major business provisions to about $572 billion over 10 years.
While such a large fiscal cost could put upward pressure on inflation if not offset by deficit reduction elsewhere, the boost in investment and the capital stock would counter this effect to some degree by increasing supply and production and growing the size of the economy over the long run. We find that extending the three major TCJA business provisions permanently would have a small impact on the debt-to-GDP ratio over the long run, increasing it by less than half a percentage point on a dynamic basis.
In contrast, expanding the child tax credit would have little to no impact on investment and, depending on the design, could reduce incentives to work. As such, the fiscal cost of expanding the credit (the pandemic-era child credit expansion cost roughly $100 billion per year) and the attendant inflationary pressure are not likely to be offset by any substantial increase in supply, production, or economic growth.
One potential deal would involve extending the items on a temporary basis, for instance through 2025 when much of the rest of TCJA expires. While a temporary extension would reduce the revenue cost, it would add more instability to the tax code and have little impact on incentives to invest over the long run.
However, some argue that a temporary fix would be better than no fixes at all to keep the policies alive in the 2025 tax debate. Policymakers will also need to decide whether to apply the tax extenders retroactively for 2022 and 2023.
At the end of the day, permanent fixes to the TCJA policies are needed—and would be pro-growth—but making them permanent will be expensive.
Fortunately, Congress has no shortage of sound revenue options to pay for permanent business provisions. Raising the gas taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline.
closer to its 1993 levels in real terms would generate significant revenue, as would fully eliminating the deduction for state and local taxes (also known as the SALT deduction). Going after industry-specific tax breaks like the credit union exemption or paring back some of the Inflation Reduction Act tax credits that have increased dramatically in cost would help as well. Smaller changes to the child tax credit, particularly around its phase-in and refundability levels, would cost less than the full pandemic-era expansions.
Congress should not delay a long-term fix for the major business tax issues. Two years from now, at the end of 2025, the major individual tax cuts from the TCJA will expire, along with many other major tax policies. Establishing permanent fixes to the business tax system before then will make Congress’s job slightly easier when the other expirations come.
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