New Tax Deal Imperfectly Invests in Our Future
By Laura Duffy
After years of uncertainty, Congress may be on the verge of passing a $78 billion tax package to partially revive an expanded Child Tax Credit and business tax incentives for research and development that expired at the end of 2021. These popular — yet costly — provisions became linked in 2022 by Democrats arguing that benefits for working families should accompany tax breaks for businesses, but compromise has remained elusive until now. Although the deal, introduced Monday by Senate Finance Committee Chairman Ron Wyden (D-Ore.) and House Ways and Means Chairman Jason Smith (R-Mo.), is imperfect, it would temporarily reduce child poverty, incentivize innovation and minimally add to the national debt.
Expanding the Child Tax Credit (CTC) can play a key role in reducing child poverty, which is both a moral imperative and a smart investment in children’s health, educational and economic outcomes later in life. In 2021, Congress temporarily provided a pandemic-era expansion to the CTC to all families. These changes were expensive: If made permanent, they would have cost $1.6 trillion between 2022 and 2031. Yet, instead of adjusting the policy to provide more targeted support, lawmakers allowed the changes to completely expire.
Currently, the full $2,000-per-child value of the CTC isn’t available to many families that need it most.
Families with incomes below $2,500 are ineligible, and it phases in at a slow rate of 15% and is only refundable up to $1,600 per child. This tax package partially remedies these shortcomings by indexing the CTC to inflation, incrementally making it fully refundable, allowing families to use prior-year income to claim it, and phasing it in faster for families with multiple kids.
These changes are matched by the return of three business tax breaks, including incentives for research and development (R&D) spending. Prior to the 2017 Trump tax bill, businesses could deduct R&D expenses the year they occurred. Such “full expensing” of R&D costs is widespread across developed nations because R&D drives innovation and economic growth. But to reduce the sticker price of their controversial tax bill, Congress began requiring firms to spread out, or amortize, their R&D expenses across future years in 2022. Because of inflation and businesses’ preference for money now over the same amount in the future, this short-sighted gimmick pushes businesses (especially small businesses, which may have limited resources on hand) away from R&D spending.
The new tax deal before Congress now would restore full expensing for domestic R&D performed in 2022 through 2025, putting the U.S. back in line with its peer countries. It also reverts to similar tax rules for short-lived physical investments, increases thresholds for reporting payments to independent contractors, and raises limits on the deductibility of business interest expenses.
Also included are other provisions to make disaster relief payments tax-exempt and expand the size of and eligibility criteria for the Low-Income Housing Tax Credit program, which incentivizes affordable housing development. Plus, reflecting growing national security concerns, the deal paves the way for creating treaty-like tax agreements with Taiwan.
The cost of these tax breaks is mostly offset by changes to the Employee Retention Tax Credit (ERTC). The ERTC was available to qualifying businesses for retaining employees during the height of the COVID-19 pandemic. Although well-intentioned, the ERTC has been widely promoted to ineligible businesses. This tax deal would close the window for ERTC claims early, increase penalties for fraudulently promoting the ERTC, as well as extend the statute of limitations for the IRS to prosecute fraudulent claims. In isolation, this pay-for is certainly preferable to saddling future generations with more debt. Yet, Congress is also contemplating additional cuts to the IRS as part of a broader budget deal, which will limit the agency’s ability to collect new revenue through enforcement action.
This contradiction is one of many imperfections in what is otherwise a largely good tax deal. Because lawmakers could only agree on a one-time offset, most of the tax deal’s provisions only extend through 2025, which creates unnecessary uncertainty for businesses and working families alike. This approach also increases the risk that Congress makes these changes permanent without offset as part of a broad extension of the Trump tax cuts expiring the same year.
Not only are the changes temporary, they’re also incomplete. Currently, the CTC is set to drop to $1,000 per child, with a maximum value of $3,000 in 2026. Congress should develop a fiscally responsible plan for making some form of an expanded CTC permanent, as well as increasing the credit value for families with younger children, who may need more support to pay for expenses like child care.
On the business side, the deal still requires R&D spending conducted abroad by U.S. companies, which represented over 18% of their R&D spending in 2021, to be amortized over 15 years. This myopic provision loses sight of how R&D is often an international effort whose spill-over benefits do not stop at national borders. Moreover, domestic R&D cannot always easily replace foreign R&D, as the latter allows businesses to gain access to new markets and talented workers who may be unable to come to the United States. And while the expensing provisions are common-sense changes, loosening limits on interest deductibility is more troubling, as doing so exacerbates the unequal tax treatment of debt- and equity-financed investment.
Leadership from both chambers of Congress has yet to weigh in on the deal, and it faces an uncertain path toward passage. But despite its shortcomings, this tax deal’s CTC expansion will support working families and meaningfully address child poverty, while the business tax provisions will bolster innovation and increase prosperity for current and future generations. Congress should seize this opportunity to invest in America’s future and pass the package by Jan. 29 so it takes effect before the upcoming tax filing season begins.
Laura Duffy is a policy analyst at the Progressive Policy Institute’s Center for Funding America’s Future. This story originally ran in The Messenger on January 20, 2024.
