Reports have surfaced that the federal debt commission (officially known as the National Commission on Fiscal Responsibility and Reform) is considering the heretofore unimaginable elimination of popular tax breaks, including deductions on mortgage interest, as part of its report due on December 1.
To be sure, President Obama told the bipartisan commission that everything has to be on the table when the commission opened its first meeting in April. Proposals already offered include an overhaul of the Tax Code to raise more revenue, which undoubtedly would be done under the guise of tax reform. But while everyone agrees that the current deficit/debt level is unsustainable, there is no real appreciation of the effect of dynamic tax scoring for Tax Code initiatives.
For example, a proposal by Stephen J. Entin of the National Center for Policy Analysis suggests that permanent 100 percent expensing would lower taxes on investments, allowing more capital to be created and employed. Such a proposal is unlikely to garner much support due to the requirement of a pay-for to make up for the revenue stream the Treasury would lose.
If Congress and the Obama administration do not extend the 2003 tax reforms, further economic slowdown is likely, Entin said. By raising expensing from 50 percent to 100 percent, the after-tax return on capital would be increased by about 2.5 percentage points. That alone, if permanent, would boost investment, according to Entin.
Businesses are typically required to depreciate their investments in plant, equipment and other buildings over many years, he explained. Depreciation means that a business cannot deduct from that years taxable income the full cost of the investment, but must write it off over a number of years, according to a fixed schedule, said Entin. Since the present value of a dollar written off in the future is worth less than a dollar write-off today, business income is overstated and overtaxed.
Nevertheless, given the static method of scoring tax proposals, which requires a pay-for for each proposed tax break, its unlikely that well see 100 percent write-offs on a permanent basis anytime soon. And the effect on investment and the economy depends on whether expensing is permanent or temporary, according to Entin.
Temporary expensing makes it worthwhile for businesses to hasten investment to take advantage of the better tax treatment, he observed.
But that means less investment in the year after the provision expires, and no permanent increase in the quantity of capital created and employed. Temporarily allowing businesses and individuals to expense business investments would boost near-term spending, but much of this increase would be in the form of a step up in construction and capital purchase that were already planed for future years with no net gain, he said. By contrast, permanent expensing would encourage additional capital formation, and raise labor productivity, wages and employment thereafter.
The deficit commission is simply doing the job that Congress should be doing, according to Pam Villarreal, senior policy analyst at NCPA and a colleague of Entins. Its highly unlikely that any of the tax breaks are going away without a fight, she said. Mortgage interest would be particularly difficult to take away, because the government has worked so hard to get people to buy homes. Since 60 percent of the federal budget is mandated spending, there is no way that we can balance the budget without addressing that 60 percent. Eventually they will have to look at some type of long-term entitlement reform.
