Why Is Congress Giving Business Retroactive Tax Breaks?
While Congress is likely to nit-pick the compromise business and child tax credit tax bill designed by top Capitol Hill tax writers, there is broad bipartisan support for its overall framework. But like many compromise bills, it includes some serious flaws.
The biggest may be the provision to retroactively restore key business tax benefits that were curbed in the 2017 Tax Cuts and Jobs Act (TCJA). Some were older tax breaks the TCJA repealed. One was temporarily created by the law but already is phasing out.
The bill generally would bring these subsidies back through 2025. But it also would grant firms tax breaks for decisions they already made—in some cases as far back as 2022. The goal of tax subsidies should be to encourage businesses to engage in activities that benefit the overall economy. But paying firms for decisions they made years ago won’t do that. Rather, it does little more than provide a financial windfall for the shareholders of the firms lucky enough to take advantage of the tax reductions.
What Smith-Wyden Would Do
The new measure, drafted by House Ways & Means Committee Chair Jason Smith (R-MO) and Senate Finance Committee Chair Ron Wyden (D-OR), includes three major retroactive tax breaks. It allows firms to expense, or fully deduct, research costs in the year they were incurred; allows first-year write-offs of capital investments for plant and equipment, and grants firms more flexible rules for deducting interest costs.
The TCJA either made temporary or repealed these tax breaks in an effort to offset some of the costs of its corporate rate cuts and other tax benefits. Ever since, business lobbyists have been urging Congress to restore the more generous versions of these provisions. Typically, instead of thinking about new and better ways to encourage business investment, Congress may simply default to its clumsy and inefficient old methods.
The current bill would do that for all three provisions, as part of a deal that also would temporarily expand the Child Tax Credit (CTC). The cost to taxpayers of these retroactive tax breaks is significant. The congressional Joint Committee on Taxation estimates research expensing alone would reduce federal revenue by $83 billion in Fiscal Year 2024, with most of that for investments made as far back as two years ago.
There may be good arguments for some of these corporate tax breaks. For instance, well-designed tax benefits may encourage firms to make investments that could make workers more productive, thus potentially lowering the costs of goods and increasing wages.
Money Better Spent
However, my TPC colleague Thomas Brosy concludes that tax dollars might be better spent enhancing a separate benefit for corporate research, the better-known research and experimentation (R&E) tax credit, rather than accelerating deductions for these costs.
But there is no serious disagreement about one element of the bill: Effectively paying companies for decisions they made in the past won’t encourage new investment. It simply would allow some fortunate companies to reduce their tax liability. That’s a sweet deal for shareholders, but it would provide little or no benefit to investment, workers, or the overall economy.
That shortcoming is reflected in TPC’s distributional analysis of the Wyden-Smith plan. TPC, along with other analysts, usually allocates the benefits of corporate tax breaks among shareholders, capital, and labor. But because only shareholders benefit from retroactive tax cuts, TPC allocates that portion of tax savings to investors only.
Worse, some of these benefits never were especially well-designed. For example, only firms that owe taxes can deduct their capital or research expenses. That means these tax breaks are of limited or no benefit to start-ups that might have substantial up-front costs but no taxable income.
Similarly, the more flexible interest deduction rules mostly benefit highly leveraged businesses that also owe taxes, such as private equity firms. Same story: A start-up may have debt. But without enough revenue to owe taxes, the deduction does them no good. And some recent research questions economic benefits of the rapid deductions.
This bill is a classic bipartisan compromise. Democrats and some Republicans want to expand the CTC. Republicans and some Democrats want to restore the pre-TCJA’s business tax breaks. This bill does both, at least for the next couple of years. But it does so at a cost. Those billions of dollars in wasted retroactive tax benefits could be better spent elsewhere, or even used to lower the budget deficit.
