Is tax policy after the fact really policy?

It is good news for many individuals and businesses that the U.S. House and Senate have passed H.R. 5771 (the Tax Increase Prevention Act of 2014). The so called tax extender package will extend a multitude of tax credits, deductions, and exclusions through 2014, including items like a deduction for expenses of elementary and secondary school teachers, a deduction for mortgage insurance premiums, accelerated depreciation of certain business property, and a tax credit for residential energy efficiency improvements.

All of these items were set to expire at the end of 2013, and now they will be renewed retroactively back to January 1, 2014 through the end of the current tax year, meaning that taxpayers can claim these items on their 2014 tax returns. This is great news for many people, right? But let's look at the situation from a tax-policy point of view. Many of the items in the tax extender package are tax expenditures, which although some people call them loopholes are really a vehicle by which the government spends money to encourage behaviors that lawmakers consider desirable. Let's take the tax deduction for 'qualified tuition and related expenses (also part of the tax extender package) as an example. In providing for this deduction, Congress determined that pursuing higher education was a good behavior that it wanted to encourage. For that reason, it created a financial incentive a deduction to help people afford their tuition. If Alexa (who is in the 25% tax bracket) spends $10,000 on qualified tuition in 2014, then she will be able to deduct $10,000 from her income (which would otherwise be taxed), saving $2500 in taxes for 2014. Thus, Congress effectively made her tuition less expensive. From a policy point of view, we would expect that Alexa, and more individuals like her, would be more likely to attend college thanks to this deduction. Let's explore a different example: the tax credit for producing electricity using wind, biomass, geothermal, or other renewable energy facilities. The purpose behind this credit is to incentivize the use of renewable resources in generating our nation's energy. From wind turbines in Iowa and Texas to projects being developed to harness the energy of offshore waves, tides, and currents; this credit makes it possible to explore new energy options some of them nascent industries. The credit becomes part of the economic circumstances that businesses consider (ideally 4 to 5 years out) in determining whether to go forward with these projects. These examples get me to the crux of my commentary: if tax expenditures are intended to influence the way that people act, they cannot fulfill their intended purpose if they are not extended until the very end of the tax year to which they apply. How can Congress encourage the use of renewable energy if businesses do not know ahead of time whether the credit will be available? How can a teacher on a budget know whether he can afford to spend his own money on classroom supplies, if he doesn't know whether the expense will cost him $200 or $150? And what about bonus depreciation, which might be the deciding factor in whether to purchase new equipment? Although some may argue that these items 'usually end up being extended anyway,' is that really an effective way to govern? While these extenders will certainly benefit many individuals and businesses in 2014, the way in which these items are being extended just makes them a nice reward after the behavior is finished, rather than encouragement on the front end. And what about 2015, which is only two weeks away: why would Congress go through the trouble of passing this legislation without preparing for the coming tax year? Taxpayers should not have to hedge their bets in determining whether a certain behavior will be 'rewarded' with a tax break at the end of the year. A better policy makes these tax breaks clear from the get-go, and ideally gives businesses a few years to plan having all the facts on the table.

About the Tax Café Blog: The Tax Café was created as a forum where we can share our ideas, updates, and insights into the world of tax law. While paying taxes isn’t all that exciting, reading about them can be! Many government policies are accomplished through tax laws (even the choice not to tax something or someone), and it is something that affects all of us. We hope you'll stop by, find an interesting article or two, and stay a while.  While many of our posts deal with legal issues of state and federal tax law, this blog does not offer legal advice. If you need legal advice concerning your tax liability, please consult with a tax lawyer.