Revenue neutrality has traditionally been among the stated goals of Congressional Republicans with respect to tax reform. This goal generally requires that any rate reduction, new tax incentives, or policy changes (e.g., territoriality) be funded with new revenues from elsewhere in the system. Recently, though, some lawmakers have started asking how to properly define “revenue-neutrality” (and whether it can be defined in a way that requires less new revenue to offset the revenue lost as a result of tax reform). (Others are now questioning whether revenue neutrality is a worthwhile goal at all.)
At issue is how the status quo or “baseline” is defined for purposes of comparing proposed reforms. The baseline is a representation of the current tax system and is essentially a set of assumptions about what the tax system will look like over the next ten years absent tax reform. For tax reform to be revenue neutral, it must produce the same amount of revenue as the baseline would have produced.
As Senate Budget Chairman Michael Enzi (R-Wyo.) prepares to mark up a budget resolution for fiscal year 2018, Chairman Enzi is reported to be considering using a “current policy” baseline instead of a “current law” baseline for purposes of determining revenue-neutrality. House Republicans also stated that they favor a change in baselines in their 2016 Blueprint for tax reform, arguing that “the current law baseline is not the proper standard for determining whether tax reform is revenue neutral.”
Divergence of Policy and Law. The difference between “current policy” and “current law” arises from tax provisions that are set to expire within the next ten years and that have a history of being extended. These tax provisions reduce revenue while they are in effect, and so current-law budget projections reflect an increase in revenue following their expiration. However, Congress in the past has extended these provisions (often called “tax extenders”) for a few years at a time. This allows Congress to keep the provisions in place and avoid finding revenues to pay for a permanent extension. Under “current law,” these tax extenders expire and revenue therefore increases. However, under Congress’s “current policy” of continuously extending these provisions, future revenues are permanently lower. Advocates for a current policy baseline argue that lawmakers should just write off these future revenues because they are phantom revenues that will never come into existence.
Tax Extenders. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) made permanent many of the largest and long-standing tax extenders, including Section 179 expensing for small businesses and the research tax credit. However, some tax extenders remain.
Bonus Depreciation. One of the most significant of the remaining extenders is “bonus depreciation”, which allows companies to expense 50 percent of investments in equipment. Bonus depreciation was originally enacted as a stimulus measure after the financial crisis and has been repeatedly extended since. The PATH Act phases out bonus depreciation, reducing the percentage that can be expensed to 40 percent in 2018, 30 percent in 2019, and then zero after that. According to the Congressional Budget Office (CBO), permanently extending 50 percent bonus depreciation would cost $247 billion over the 2018 to 2027 budget window. If, however, bonus depreciation is considered part of the baseline tax system under a “current policy” framework, lawmakers would be able to permanently extend the provision without needing to find $247 billion of offsets or could use that additional $247 to accomplish other tax reform goals if they were willing to let bonus depreciation expire.
Other Extenders. Additionally, as of the beginning of the year, CBO identified about 50 other tax provisions that expired or are scheduled to expire between December 31, 2016, and December 31, 2027. (The provisions that have expired on or since December 31, 2016 may still be retroactively extended for the 2017 tax year.) Some examples of these expiring tax provisions are incentives for renewable energy, the New Markets Tax Credit and look-through treatment of certain payments between related controlled foreign corporations. Making these extenders permanent would cost a total of $199 billion from 2018 to 2027.
Healthcare Taxes? Finally, a current policy baseline could also include repeal of certain healthcare related taxes that have been temporarily delayed or suspended under current law. These taxes are not yet considered tax extenders because they do not have a history of being continuously extended, but they may become extenders in the coming years. The medical device excise tax went into effect in 2013 but was suspended for 2016 and 2017 by the Consolidated Appropriations Act, 2016. The excise tax on high-premium healthcare plans was postponed for two years to 2020 by the same Act. Republicans had hoped to address these taxes and a tax on health insurance providers through a healthcare bill this summer. Although Congress appears to have moved on from these efforts, assuming that these taxes are already repealed in the baseline would make it easier to address these taxes through tax reform. The CBO estimates that repealing these taxes would cost $311 billion over the 2018 to 2027 budget window.
Action Items. It remains to be seen if Chairman Enzi and Congressional Republicans will choose a current policy baseline for enacting tax reform. If he chooses to use the current policy baseline, Chairman Enzi could implement this baseline in his markup of the budget resolution for fiscal year 2018. This budget resolution sets spending and revenue levels for reconciliation—the process through which Republicans hope to pass tax reform.
While a current policy baseline would certainly make it easier for Republicans to achieve many of their tax reform goals, it is not clear if redefining revenue neutrality is the same as achieving revenue neutrality. Chairman Enzi already faces criticism for the proposal and could be accused of “playing games” with budget scoring. Of course, this would be far from the first time budget scoring games have been part of the legislative process legislation.