Tax deal could get new life under top-line spending agreement

Senate and House tax experts met Wednesday as they pushed to strike a tax deal that could reinstate business deductions in exchange for an enlargement of the child tax credit (CTC).

After failing to emerge from the yearly tax extenders debate at the ends of 2023 and 2022, the potential deal is getting new life as Congress attempts to pass a bipartisan spending bill ahead of a Jan. 19 deadline to avoid a partial shutdown.

Experts say the tax deal is closer to happening now in the wake of a $1.66 trillion top-line spending agreement announced over the weekend and a flurry of House and Senate meetings.

IRS Commissioner Danny Werfel was on Capitol Hill on Wednesday to brief the Senate Finance Committee on the employee retention tax credit (ERC). The ERC has been a locus of bogus business activity, and experts have considered changes as a way to pay for the CTC and business credit trade-off.

Werfel told Senate Finance about the effect of pausing ERC claims processing following concerns about fraud, which resulted in a 40-percent decline in average weekly claims, according to a readout provided to The Hill.

“This month, the IRS will be sending more than 3,000 new compliance-related letters to companies with both processed and unprocessed claims. At the same time, we are working to put in place protections against fraud that will eventually allow us to process additional legitimate ERC claims,” Werfel told the committee.

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Tax experts say they think a deal could be just around the corner and that the ERC could factor into it.

“We feel closer to a bipartisan agreement on the CTC and these big three business provisions than at any point in the last two and a half years, going back to late 2021,” Andrew Lautz, a fiscal policy analyst with the Bipartisan Policy Center, a Washington think tank, told The Hill.

Lautz said he thought lawmakers were considering making changes to the ERC to help pay for the tax cuts coming out of the potential deal.

“The trend with the ERC is that it started as a pandemic-era tax break targeted at employers to make sure they kept workers on payroll during that really challenging time, and now it’s morphed into something different for the claimants, given the aggressive marketing and promotion around the credit,” he said.

However, political and practical obstacles to a deal remain, including potential resistance from state and local tax advocates as well as pushback on changing the tax code right before tax filing season opens on Jan. 29. What exactly the legislative vehicle would be is another open question, as House conservatives revolt against the agreement struck by Speaker Mike Johnson (R-La.) and Senate Majority Leader Chuck Schumer (D-N.Y.)

Despite the House tension, staffers on Capitol Hill tell The Hill that the broad contours of the tax deal are still in place.

“Senator Wyden is focused on getting the biggest possible cut to child poverty through the CTC in exchange for a handful of business provisions,” a Democratic aide on the Senate Finance Committee told The Hill on Wednesday morning ahead of a meeting of the committee’s Democrats, led by Sen. Ron Wyden (D-Ore.)

Sen. Ron Wyden (D-Ore.) speaks to reporters as he arrives to the Capitol for a vote Thursday, January 11, 2024. (Greg Nash)

The CTC was expanded during the pandemic shutdown and raised millions of children above the poverty line, motivating many economic progressives, as well as some Republicans, to argue for a more permanent expansion.

The credit was made fully refundable under the 2021 American Rescue Plan and was boosted from $2,000 to $3,600 for children younger than 6 years old and to $3,000 for children under the age of 18.

“One year on, the Census Bureau confirmed child poverty in 2021 was cut almost in half (a 46 percent reduction) from 2020 levels, down to the lowest levels on record. Census notes that approximately 90 percent of this historic reduction can be attributed to the expanded credit,” researchers from Columbia University wrote in a 2022 study of the CTC.

Child poverty rose fast in that year after the expiration of the expanded credit, with 3.7 million more American children below the poverty line in January 2022 than in December 2021, the researchers noted.

Of the 2.9 million additional children kept above the poverty line by the CTC in 2021, about two-thirds were Black or Hispanic, with 716,000 Black children and 1.2 million Hispanic children lifted from poverty, according to a census study.

The Joint Committee on Taxation (JCT) found that after accounting for macroeconomic effects, the expanded CTC would reduce federal revenues by $1.4 trillion between 2022 and 2032.

The JCT analysis admits that it ignores “potential human capital losses from parents leaving the workforce” as well as “any potential long-run benefits from a reduction in child poverty.” 

“Policymakers should prioritize the 19 million children who currently get only a partial Child Tax Credit or none at all because their families earn too little,” Chuck Marr, a vice president for tax policy at the Center for Budget and Policy Priorities, a left-leaning nonprofit, wrote in a Wednesday policy note.

The business deductions up for discussion in the deal are for research and experimentation costs, interest payments, and sped-up depreciation scheduling. While they apply to businesses across the economy, each provision has advantages for particular sectors.

Research and experimentation write-offs are favored by companies with intensive research and development, such those in the pharmaceutical and technology industries.

The interest deduction can boost profits for companies that use a lot of debt to transact their business, such as the leveraged buyouts undertaken by private equity firms.

Deducting depreciation costs more quickly helps companies with a lot of fixed capital investment, like those in manufacturing and real estate.

All three deductions were taken away in the 2017 Tax Cut and Jobs Act (TCJA) — the Republican tax cut bill enacted by former President Trump — to help pay for the large reduction to the U.S. corporate tax rate, which was slashed to 21 percent from 35 percent.

All told, the TCJA will have added $1.46 trillion to the national deficit between 2018 and 2027, with $653 billion of that due to business tax reforms, according to the JCT.

Taking away the research write-offs gave the government $119.7 billion in revenue through 2027, while limiting interest deductions produced $253.4 billion, according to the JCT, though these numbers are likely to change substantially in the current deal-making process, especially if the timing of it is limited to 2025 when the larger provisions in the TCJA are set to expire.

“The research credit … is by far the biggest,” Howard Gleckman, a tax analyst with the Urban-Brookings Tax Policy Center, told The Hill in an interview. “JCT estimates it’s around $140 billion between 2023 and 2025. The bonus depreciation is about half that, about $65 to $70 billion between ‘23 and ‘25. Business interest deduction is about $14 billion.”

Beyond speculation about the ERC, it’s not clear how the resumed business deductions or the CTC expansion would be paid for, or whether the tax cuts will simply be added to the deficit.

“I would be shocked if they paid for it,” Gleckman said. “This is why the budget deficit keeps going up. Instead of paying for new tax cuts, the deal that they make is, ‘You get yours and we get ours.’”