President Trump and top Republican leaders may soon be forced to decide on whether the massive tax cuts being promised through tax reform should be made permanent or temporary, and economists and other stakeholders are weighing in on the effects of those types of tax policy changes.
Republicans say they will use the budget reconciliation process to pass tax reform, which would make it possible for their majorities in Congress to pass a filibuster-proof, party-line bill with only 51 votes in the Senate. As part of that process, they’ll also have to reckon with the Senate’s Byrd rule prohibiting the bill from increasing deficits outside of the budget window — traditionally 10 years. That rule has spurred some lawmakers and White House officials to consider enacting temporary tax cuts that expire just shy of the end of the 10-year window in order to technically comply with the rule.
“If we have [tax cuts] for 10 years, that’s better than nothing,” Treasury Secretary Steven Mnuchin said April 26 when the White House released its one-page tax plan outline, adding, “But we’d like to have permanency here.” National Economic Council Director Gary Cohn echoed those remarks, saying that permanent tax reform is preferable, but “we have to do what we have to do.”
Still, most of the Republican leadership in Congress remain unenthusiastic about the prospect of a temporary tax cut. And with ambitious tax cuts still on the agenda and the constraints of the reconciliation process limiting how deep the cuts can go, lawmakers may soon begin discussing which provisions will get an expiration date. House Speaker Paul D. Ryan, R-Wis., who has long emphasized the need to enact permanent tax cuts, told reporters June 21 that there are “provisions in tax reform that don’t have to be permanent.”
Going After Rates
In deciding what provisions to make temporary, some options are more politically and practically feasible than others.
Ryan alluded to this in comments to reporters, saying that key tax reform components like tax rates — “the things that businesses plan on” — need to be permanent if they’re going to retain their growth-promoting effect, an essential element for Republicans counting on economic growth to largely offset revenue losses.
Alan Cole, an independent policy analyst at the University of Pennsylvania's Wharton School, agreed with that assessment, telling Tax Analysts, “If the benefit of the tax provision is that it's supposed to change long-run, forward-thinking behavior — like investment or saving — then it needs to be permanent to have an effect.”
Cole argued in a June 12 Tax Foundation report that permanent corporate tax cuts are generally more beneficial to workers than temporary cuts, which offer a greater benefit to shareholders because the cuts are more likely to reward preexisting capital. A permanent tax cut would reward both old and new capital, which would then offer benefits to workers as new capital is constructed, he wrote.
“A large but short-lived reduction in corporate income taxes may be largely a windfall for investors, pension funds, and retirement accounts, with precious few broader benefits to the economy at large,” Cole concluded in the report.
Cole also predicted that any large changes to the tax base — like switching to territoriality, eliminating the interest deduction, or implementing border adjustment — would be left untouched because “that would be more of an accounting hassle than it’s worth.”
Ray Beeman of EY came to a similar conclusion about major tax code changes at a June 14 panel in New York, saying, “What we definitely don’t want to do is . . . adopt a territorial system only to have it go back to a worldwide system 10 years from now.”
However, Beeman suggested that making tax rate cuts temporary may not be too economically disruptive, adding that the 2001 and 2003 Bush tax cuts provided temporary individual rate changes. “Conceivably you could do the same thing on the corporate side without doing a lot of damage to business planning,” he said.
And Diane Lim, an economist with the Conference Board Inc. told Tax Analysts that she thinks that temporary tax rate changes are relatively easy to do and that “they’re not harmful, because the rates we start at are not harmfully high tax rates.” At a June 29 panel in Washington, Lim contended that most individuals don’t have a significant response to changes in their marginal tax rates, and while businesses may generally be more responsive to tax changes than individuals, other issues such as regulation or workforce availability typically have a more significant economic effect.
Cole acknowledged that the growth effects of a temporary individual tax rate reduction would be less disruptive than a temporary business tax rate cut. “If your goal is just to put money in people’s pockets, then obviously a temporary tax cut is just fine on the individual side,” he said.
If business tax rates and fundamental tax reforms prove too difficult to sunset, other provisions that make comparatively smaller changes to the tax code could get stamped with an expiration date.
Both Cole and Steve Rosenthal of the Urban-Brookings Tax Policy Center agreed that repeal of the estate tax might be a target for sunsetting, because taxpayers are unlikely to be able to plan around the tax changes. “You don’t usually plan to die,” Rosenthal said.
Cole also said that temporary changes to cost recovery, like full expensing, “are a little easier to handle” and have been done in the past, he said.
Playing by the Rule
A corporate tax rate cut could have more staying power with the help of the Byrd rule.
In an April 25 response to a letter from Ryan, the Joint Committee on Taxation revealed that even a two- or three-year corporate tax rate cut would have a deficit-increasing effect outside of the 10-year budget window, unless that deficit increase is offset with a permanent revenue-raiser elsewhere.
There are consequences to having two different sets of tax rules — one for the next 10 years, and another for the following years — and “there’s a lot of gamesmanship that happens when tax rules change,” Rosenthal said.
“Our tax system allows a lot of selectivity on timing of income, and deductions. . . . And so naturally, taxpayers will accelerate income into lower tax years and push out deductions into higher tax years,” Rosenthal explained. He said that the JCT’s corporate tax rate estimate reflected a concern that when rates on corporate or repatriated earnings are reduced, “you would see some tax reduction in the out budget years just because some of the income that you might have expected to be realized in those out budget years would be accelerated to the lower tax years.”
The anticipation of tax cuts is already having an effect on the selective timing of reporting income, Rosenthal said, pointing to the unexpected decline in tax receipts so far for fiscal 2017. “We allow investors a lot of selectivity on realizing [capital gains from] their appreciated stock,” he said, and the slowdown in tax receipts this year “is attributable at least in large part to the slowdown of capital gains realizations.” The expectation of tax cuts could be causing people to “hold their stock a little longer, or perhaps to use installment sales to extend the gains further out.”
Just as a temporary corporate tax rate cut could have deficit-increasing effects outside of the budget window, if a tax cut on capital gains is allowed to expire, “you’ll see a lot of accelerating and of realization events in the budget window, and a slowdown of realization once rates go back up,” Rosenthal said.
Rosenthal also pointed out that if Republicans succeed in enacting full expensing but have business tax rates that expire after 10 years, that could cause troubling disruptions in how businesses plan their investment timing. “You might expect that the deductions would be worth more in out years when the rates go back up than they would be in the budget window, so potentially, near the end of the 10-year budget window, you might expect some deferral of business investment to push it into a year in which deductions are larger,” he explained.
Likewise, if taxpayers are given the option of choosing either the interest deduction or full expensing as proposed by the Trump tax plan, “they [may] choose the smaller interest deductions for the years of lower tax rates in the budget window and the full expensing deductions later,” Rosenthal said.
The complicated out-year timing effects of making tax provisions temporary means the Byrd rule’s constraints could be what lead lawmakers to embrace revenue-neutral tax reform, Beeman suggested. “Just doing a big tax cut, I think you could almost argue it would be harder both politically and substantively than trying to do revenue-neutral [tax reform, and] making policy permanent,” he told Tax Analysts.
Backdoor to Permanence?
Lawmakers could take a page from history by making a gamble on the big provisions and sunsetting them so that they comply with the Byrd Rule now, and then making them permanent at a later date before they expire.
“The fact is that any kind of tax policy that you make that lasts more than a year or two, that’s not obviously a temporary kind of tax provision, it’s politically very difficult to sunset it,” Lim said
She cited the endurance of the Bush tax cuts, which were passed in 2001 and 2003, extended in 2011, and in large part made permanent in 2013. According to a report by the Center on Budget and Policy Priorities, 82 percent of the Bush tax cuts were made permanent after President Obama signed into law the American Taxpayer Relief Act of 2012, with $624 billion of the $3.4 trillion in tax cuts being allowed to expire.
Lim said that before his 2008 election, Obama and other Democrats railed against the Bush tax cuts, calling them reckless and fiscally irresponsible. But after taking control of the White House and Congress, Democrats who suggested letting the tax cuts expire were accused by Republicans of supporting the largest tax increase in American history.
“Once you put a tax cut in place, you cannot take it away,” Lim said.