U.S. Tax Policy Is That Of A Silly Nation

Almost half a year has passed, and renewable energy producers are still in the dark as to whether they will get their 2.3 cents per kilowatt hour tax credit. Racehorses California Chrome and Tonalist might have to be depreciated over seven years, instead of three years. Elementary teachers do not know whether they will be able to write off $250 in expenses for books and school supplies.

Congress is once again asleep on the job, failing to make a decision on tax incentives that expired at the end of 2013. In any well-run system of government, inaction should mean that the tax incentive dies. Not so with the U.S. Congress, which has a habit of stringing out tax provisions until well after their effective date and then renewing them retroactively.

This is terrible tax policy. But it is not new. The Revenue Act of 1913, the nation's first income tax law, had an effective date before the bill was signed. In 1918 and 1926, each of the Revenue Acts was applicable to the entire calendar year preceding enactment, according to legal scholar Daniel Troy. The Supreme Court has repeatedly upheld retroactive taxation.

On January 2, 2013, Congress retroactively renewed 52 tax provisions that expired on January 1, 2012. With 56 provisions having expired at the end of 2013, Congress cannot seem to decide what to do.

This is no way to run a country, especially a country as large and as important as the United States. The uncertainty is harmful for business confidence and economic growth. With clearer guidance, businesses and individuals would have more certainty as to the direction of their investments.

According to House Ways and Means Chairman Dave Camp, "The United States is the only country in the world that allows such important pieces of its tax code to expire on a regular basis. Worse yet, this type of tax policy disadvantages U.S. companies, hurting their ability to remain globally competitive."

Senate Finance Committee Chair Ron Wyden agrees. He said, "Many of these extenders are well-intentioned and ought to be permanent. Their stop-and-go nature obviously contributes to the lack of certainty and predictability America needs to create more family wage jobs...."

Even with agreement among such powerful chairmen, Congress is paralyzed. The House Ways and Means Committee has approved ten different bills that each made permanent a different extender at a ten-year cost of $609 billion. On May 9, the full House passed one extender, a bill to make the research-and-development tax credit permanent, but the Senate is not expected to take it up.

The two major provisions that would be extended by the House are the Subpart F exemption for active financing income and the research credit.

The Subpart F exemption, originally put in place in 1997, would cost $10 billion for a 2-year extension, or $59 billion over ten years if it were made permanent. It allows a U.S. parent company to defer the taxes on a foreign subsidiary's active income earned from banking, financing, or a similar business. The exemption allows U.S. companies to more efficiently structure their subsidiaries, and use foreign earnings to expand abroad instead of domestic earnings.

The research credit, which has been effective in some form since 1981, allows firms to deduct the cost of increases in research spending. The research credit would cost $15 billion for a two-year extension and $156 billion over 10 years if made permanent.

The Senate Finance Committee passed a bill extending more than 50 extenders through December 2015 at a cost of $81 billion over 10 years, but the bill has not moved to the Senate floor.

Since the bills have not passed the full House and Senate, the leadership has not (publically) entered negotiations over the two competing approaches to tax extenders. Analysts say no final actions will occur until after the mid-term elections in November, 11 months after the expiry of the credits. No one knows what compromise will be enacted.

Twelve energy provisions have expired, mostly dealing with alternative energy. Together, a two-year extension would cost $19.6 billion for ten years. A two-year extension of the tax credits for biodiesel and renewable fuel would cost $2.6 billion. An extension of renewable energy investment tax credits that apply to wind and other renewables (except solar, whose credit did not expire) would cost $13.4 billion for a two-year extension.

I have written elsewhere that these tax credits should not be renewed because they lead to more expensive energy, increasing utility bills. Electricity from renewables costs about twice as much as electricity generated by natural gas. Low-income Americans are adversely affected because they spend more on energy as a percent of their income than do upper-income Americans. Those in the lowest fifth of the income distribution spend 24 percent of their income on energy, compared with 4 percent in the top quintile.

Irrespective of the merits of these credits, it is poor tax policy to leave producers and investors in doubt as to their extension. Renewable energy is only viable because of tax credits. The value of investments is already left to the whim of government officials, who are responsible for approving permits for energy exploration. The very least that Congress should do is pass tax incentives in a timely manner.

One of the purposes of tax incentives is to have individuals and businesses change their behavior. This cannot be accomplished if uncertainty surrounds these incentives. Well-structured taxes could provide more efficient investment planning and consequently more effective investment. The Supreme Court might smile on retroactive taxation, but Congress should be aware that it lowers GPD growth-and act accordingly.