Donald Marron, Director of the Tax Policy Center, was recently asked to testify before the House of Representatives about the messy state of affairs that is the annual “tax extenders” dance.
As we discussed here, our current Internal Revenue Code is not a static document; rather it is in a constant state of flux, with provisions often being established with a finite life, expiring, and then retroactively being reinstated. Over the years, enough of these provisions have come along that each year, they are grouped together in what is commonly referred to as a “tax extenders” package, and the nation breathlessly awaits to see if they will be granted another year.
Obviously, this is no way to administer tax policy. While some of the extenders are of little monetary consequence to taxpayer — take, for example, the $250 deduction for supplies for K-12 teachers — others, like the R&D credit, represent billions of dollars in annual tax benefit. With companies uncertain from year to year whether the R&D credit will be extended, the tax benefit related to any research endeavors becomes tenuous, thereby stifling innovation.
To illustrate, the R&D credit expired at the end of 2011. It is now June 2012, and the fate of the credit for 2012 is still undecided. Now, perhaps businesses will carry on R&D activities in the absence of any tax incentive, but perhaps not. This is why the annual extenders dance has to change.
To do so, Marron explains, we must embrace fundamental tax reform that would create a simpler, fairer Code that “eliminates the pointless expiration of tax provisions that deserve longer lives.” Since reform is highly unlikely given the current political quagmire, however, Marron offers some additional ideas for grappling with the extenders, starting with differentiating between the different classes of provisions included in the annual extender package.
For those extenders originally enacted to address a national or regional emergency — such as bonus depreciation, the COD exclusion for primary residence mortgages, and certain Hurricane benefits — Congress should permit them to expire if no rationalization continues to exist for their inclusion in the statute.
Other groups of extenders, Marron adds, should be subject to a sunset congressional review to determine the necessity of keeping them in the Code.
Lastly, a group of extenders that represent good policy and would have been permanent or long-lived if not for budgetary resources — such as the aforementioned teachers deduction and the R&D credit — should be made permanent or renewed for a prolonged period.
Marron goes on to advise Congress to change the way it addresses the extenders, starting with their default mindset. The presumption, Marron argues, needs to be that the extenders will expire, rather than be extended. That way, special interest groups will have to establish why the provision continue to have merit, rather than placing the burden of proof on those who want to see outdated or unfair provisions expire.
In addition, Marron makes a point shared by many, explaining that in order to expedite the extension of necessary provisions, the “extender package” has to be broken into smaller parts, even if that means that lesser known provisions will die off without the protection afforded by their more popular brethren.
Finally, Marron points out that many provisions have been given a short life because it is easier to “pay” for a one year deduction in a budget proposal than a longer-lived provision. To remove this incentive to create provisions with an annual expiration date, Marron suggests changing the budget rules to require that any temporary tax provision be assumed to last no less than five years in the official budget baseline. Thus, if a policymaker wants to enact a new deduction, they will have to account for it in the budget for a minimum of five years, making it more difficult to rationalize with budget offsets.
Personally, we love Marron’s testimony, and agree wholeheartedly with his take on the ridiculousness of the annual extender package. From the perspective of a tax adviser, it becomes very difficult to explain to clients that certain provisions of the Code expire on a year to year basis, and it puts us in a precarious position where we are forced to predict whether expired provisions will continue to be extended. All it takes to lose an important client, of course, is to be wrong once.