How Our Tax Policy Can Kill Jobs and Stifle Innovation
Policy + Politics

How Our Tax Policy Can Kill Jobs and Stifle Innovation

Sometime this week, perhaps as soon as today, the Senate will, likely with little argument or discussion, pass a version of a House bill retroactively extending some 55 tax breaks for 2014. Actual productive legislation may have been rare in this Congress, but the fact that lawmakers appear to have agreed on this particular bill is hardly reason for celebration. 

Tax experts look at this package of tax breaks and cringe. The extenders are not paid for, meaning their cost will be added to the deficit, and experts agree that the practice of annual retroactive extensions and revisiting of various tax breaks are a terrible way to make tax law.

Related: Tax Extenders Are Budget Busters

The point is that tax policy is not just about raising revenue for the government. Legislators often use it to encourage or discourage certain behaviors. That’s why we have “sin taxes” on alcohol and cigarettes in some states, and why many charitable donations can be used to offset taxable income.

But any policy designed to create incentives for people to behave in certain ways requires taxpayers – both individuals and corporations – to believe that policy will continue to be in force when they file their next tax return. Congress’s now-longstanding habit of allowing tax breaks to expire and then retroactively reinstating them turns that theory on its head.

“It’s just impossibly bad tax policy,” said Howard Gleckman, a senior fellow at the Tax Policy Center in Washington. “It’s hard to imagine worse tax policy. If you believe that these subsidies do encourage companies to change their behavior, the only way they work is if the companies know in advance that they are going to get the credit.”

“You can think about these as incentives,” said Joshua Smith, senior policy analyst with the Economic Policy Institute, “but clearly, if they are given retroactively, they don’t incentivize anything. It’s just a windfall.”

Related: House Poised to Kick the Can Again on Tax Extenders

The Research and Experimentation credit, for example, is meant to encourage companies to invest resources in the creation of new and innovative products. Gleckman and many other economists doubt that it has the effect its proponents claim in the first place. “But if you think it has any benefit at all, the company has to know they’ll get the credit so they can plan the research,” he said. “Rarely is a research project a year-long project. It’s a multi-year project.”

When the House passed the bill last week, a spokesman for the conservative Heritage Action for America sharply criticized it for just that problem. “Today’s vote illustrates how dysfunctional and broken Washington has become. Lawmakers are being asked to incentivize retroactively investments made during the past 11 months. Each provision should be allowed stand or fall on its own merit, and the vast majority of these provisions would not survive such scrutiny.”

The R&E credit has, in fact, been renewed seven times since 1998 – each time retroactively. In 2012, a Treasury Department analysis found, “Keeping this tax incentive under constant threat of expiration means that businesses planning for long-term research projects have to account for the risk that the credit will not be available, blunting its effectiveness as an incentive.”

“Clearly when you are dealing with research projects that have years-long time horizons, it makes zero sense doing it this way,” said EPI’s Smith.

Related: Congress Gears Up to Fight Obama on Tax Breaks 

To be sure, once that particular cut had been allowed to expire and been renewed the first half dozen times, corporate tax planners likely began taking its perpetual extension for granted. But for businesses that benefit from lower-profile benefits, such as a break for the fuel costs of low-emission vehicles, the situation is much more complicated. 

“I presume most tax planners in corporate America assume [the R&E credit] is going to happen anyway,” said William Hoagland, a senior vice president at the Bipartisan Policy Center. “But on these others it must be a nightmare. It’s got to affect their behavior. It’s a terrible way for businesses to have to operate.” 

Why This Matters: Tax policy is something that almost everyone prefers to ignore, but which also affects virtually every person in the country in one way or another. As Congress allows the policymaking process to become more and more ad hoc, not only do the tax breaks it passes become less effective, the burden of the national debt on future generations becomes more onerous.

Hoagland spent 25 years working on Capitol Hill -- much of it as senior staffer to top Republicans, including Majority Leader Bill Frist (R-TN) -- said it has been “very discouraging” to watch the failure of Congress to deal with the tax extenders in a responsible manner. Which are worth keeping and how do we pay for them?

“They’ve had plenty of time to address these throughout the year,” he said. “Now we’re adding about $45 billion to the deficit.” 

Related: Agency Doesn’t Know Why It Approved $26 Million in Federal Contracts 

And when lawmakers are constantly railing against the “uncertainty” businesses face when trying to predict government policy, annual battles over tax extenders reinforce that argument.

“Rational policy would have been, earlier in the year to decide which of these work, which don’t, which should be made permanent, and how to pay for them,” said Chuck Marr, Director of Federal Tax Policy at the Center on Budget and Policy Priorities in Washington. “Policy should provide as much certainty as possible.”

Maybe next year.

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