Deficit and Tax Policy

March 14, 2012 By David Morris

No such thing as a temporary tax break

Oh, temporary tax breaks, music to the ears of their beneficiaries and the bane of CBO Director Douglas Elmendorf who must make budget projections accounting for them.

If it weren’t for the recent explosion in the number of tax breaks, they wouldn’t be such pesky pieces of economic policy. In 1998, there were only nine temporary tax breaks. By 2009, there were 73; meaning that in more than 10 years the number of temporary tax breaks built into the tax code has increased by 711%.

Tax breaks and tax cuts lower one’s tax liability. Temporary ones are used to incentivize certain types of economic activity during a given time period, such as an economic downturn. For example, the recent extension of the temporary 2010 payroll tax cut is meant to put more money in the hands of the American taxpayer in the hopes that they would spend it, stimulating demand.

Because these policies usually leave the taxpayer, be it person or business, with more money than before most economists consider these temporary tax breaks (formally known as tax expenditures) as form of government spending. Even Stanley Surrey who created the concept of a tax expenditure “defined tax expenditures as spending programs embedded in the Internal Revenue Code.”

Recently, legislators have found it difficult to create spending programs for two reasons. First, is the gridlock in Congress. Second, is that in the midst of huge federal deficits and public outcry to rein in federal spending it is hard for politicians to justify new spending programs.

So why do politicians favor temporary tax breaks over long-term tax cuts or other types of government spending programs? The biggest advantage is that their ultimate cost can be hidden because the budget must be calculated using current law and since temporary tax expenditures are only temporary the CBO must assume that they end on schedule.

Now, I know what you are thinking, if they're temporary, how do they impact the budget over the long term? The answer is that tax breaks are never really temporary.

Year after year, many of these “temporary” tax cuts are extended. Would you believe that not only are there more temporary tax cuts on the books today than in 1998, but that some of the tax cuts from 1998 are still part of the tax code? Believe it.  As Scott Hodge, president of the Tax Foundation, points out, ‘“Once these things get built in, cooked in to the system, they're awfully difficult to get rid of.’"

To illustrate this point, look at the Bush-Obama tax cuts. This temporary tax cut was put in place in 2001, and has since been renewed twice. However, even though the Bush-Obama tax cuts have been in place for 10 years, the Clinton-era tax rates are still considered the permanent law.  This example is one of many illustrating how these provisions get cooked into the system, allowing politicians to take advantage of budget rules to disguise the true impact of these programs on the long-term budget.

So how ugly do things get? Remember when I said that temporary tax breaks create a budget nightmare for CBO Director Elmendorf? Well, with what Capitol Hill staffers are labeling “Taxmageddon,” (the looming expiration of many temporary tax breaks including the Bush-Obama tax cuts and the payroll tax cut) the CBO had to provide Congress with two versions of the 10-year budget projection; one based on permanent law where these temporary provisions expire, and one based on an alternative scenario where some of these policies continue in effect.

One would assume that if these temporary tax expenditures continuously get extended then Congress must have a reason for it, right? Wrong.

What's supposed to happen is that the looming expiration allows policymakers to regularly check the effectiveness of the policies. With that information in hand, policymakers can abandon or modify the provisions based on their analysis.

In reality, it would appear that this is not how the process actually works. I guess it would be asking too much of Congress to do the logical thing.

Instead of debating their merits, Policymakers lump the expiring temporary provisions into a package known as the “Tax Extenders” and renew them altogether at the end of the year without reviewing their effectiveness or their continuing impact on the economy. As Howard Gleckman of the Tax Policy Center poignantly put it, “The least Congress could do is to call this annual rite what it is: Continuing tax loopholes, not closing them.” 

Don’t get me wrong, temporary tax breaks are not inherently bad policy.

If these provisions were evaluated on a regular basis, they could be very effective. But the fact is, they aren’t reviewed - they are blindly extended. So in the end, what was supposed to be a temporary one-year spending program turns into an un-audited, long-term budget nightmare that impacts our debt for years.

• Taxes

• Tax Cut

• deficit

• Debt

• National Debt

• National

• Spending

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