The good the bad and the ugly
The latest version of the Biden Build Back Better program, released last week by the House Ways and Means committee (see our estimates of budgetary, economic and distributive impacts), is dense, with too many provisions to be fleshed out completely. Here’s a look at the good, the bad, and the ugly of it.
Improved R&D cost recovery
Most provisions of the Ways and Means Set would increase the cost of capital, thereby reducing both the incentive to invest and long-term productivity growth. Two provisions, however, would improve the tax treatment of the investment, albeit temporarily.
The first is the deferral of the obligation to amortize research and development (R&D) expenditure. Historically, companies have been able to deduct the cost of R&D in the year it is incurred. However, the Tax Cuts and Jobs Act (TCJA) of 2017 provided for R&D expenses to be amortized over five years after 2021. With the impact of inflation and the time value of money, companies would not be able to deduct the full real value of their R&D investments. This would discourage investment in R&D, which in the long run would reduce productivity growth and standard of living, as firms would spend less money on innovation activities.
The Ways and Means plan would postpone the amortization obligation for four years, until 2026. A temporary deferral is not the ideal policy, which would be to make R&D expenses fully and immediately definitively deductible. But at least the Ways and Means proposal would give decision-makers a chance to make it permanent on the road.
Permanence and stability (for some things)
The proposal makes several policies permanent, reducing uncertainty for taxpayers. Recent changes to the Working Income Tax Credit (EITC) and the Child Care and Dependents Tax Credit (CDCTC) would become permanent, as would the New Business Tax Credit (NMTC, which had to be renewed several times since its promulgation in 2000).
The programs have mixed merits. Some, like the EITC, might be better suited as spending programs rather than tax code provisions. Others, like the NMTC, should be eliminated entirely, or, like the CDCTC, would overlap and duplicate the new spending proposals for childcare. However, if the provisions enter into force, it makes sense to follow the fundamental principle of stability.
Repeal of the distribution of expenses for GILTI
The expenditure allocation rules require that certain domestic expenses of U.S. multinational enterprises (MNEs) be partially reclassified as foreign expenses, resulting in the reclassification of certain foreign taxable income as domestic taxable income. Second, if US multinationals face a higher corporate tax rate abroad than at home, they end up having to pay domestic and foreign corporate tax on that income. The TCJA’s Global Intangible Low-Tax Income (GILTI) provision interacted poorly with this policy, increasing the frequency of this type of double taxation. The ways and means plan would repeal the expenditure distribution rules for GILTI.
Increase in corporate tax rate to 26.5 percent
The Biden proposal would raise the top corporate tax rate to 26.5%, while creating three tax brackets for corporations: 18% for corporations with net income below $ 400,000, 21% of $ 400,000 to $ 5 million in net income and 26.5% above $ 5 million.
While this is an improvement on the Biden administration’s proposals to increase the rate to 28%, a rate of 26.5% would still have significant costs. A higher corporate tax rate will reduce capital investment by reducing potential returns from new projects. In the long run, this translates into lower productivity growth and wages, and increased incentives to shift profits and move headquarters out of the United States.
Increase tax rates on top income and capital gains
The plan raises the top marginal personal income tax rate from 37% to 39.6% and the top marginal tax rate on long-term capital gains and dividends from 20% to 25%. It then adds a 3% surtax on income greater than $ 5 million for a married household (or $ 2.5 million for an individual filer) and extends the tax base on net investment income. (NIIT) 3.8% to include active business income. Including state and local taxes, the top federal-state marginal tax rate on capital gains would on average be close to 37%, and on passed-on business income would exceed 50% in most jurisdictions. States. These tax increases reduce incentives to save, invest and work, resulting in a smaller economy and fewer job opportunities.
Higher tax rates for GILTI and FDII
GILTI policy created a minimum tax of 10.5% on foreign income deemed attributable to intangible assets (defined as income exceeding 10% profit from tangible assets). Although it is intended to impose a minimum tax in the range of 10.5 to 13.125 percent, GILTI’s effective tax may exceed this amount. The GILTI provides for a penalty for recognizing profits abroad, but the TCJA has also created a positive incentive to recognize profits in the United States with the deduction for foreign derivative intangible income (FDII), offering a rate 13.125% tax on such income if recognized in the United States. , the lower corporate tax rate, the GILTI incentive and the FDII incentive have significantly reduced the profit shifting incentives for US multinationals.
The Ways and Means Bill would increase GILTI’s tax rate to 16.5% and make several changes to its structure. Likewise, the bill would raise the FDII’s tax rate to 20.7%.
There are many ways to change the international tax rules of the United States, good or bad. Raising tax rates on US multinationals does not necessarily meet the goal of reducing or eliminating profit shifting, and it would in fact make it worse, mainly due to the higher FDII rate. A well-designed international tax reform proposal should alleviate, not aggravate, these problems.
The ugly one
Selectively protect the pledge
The Ways and Means proposal is designed to be consistent with the Biden administration’s promise not to raise taxes for taxpayers earning less than $ 400,000. The biggest problem with the approach is that it focuses only on the legal impact of taxes and not on the economy. But in aiming to keep the commitment in terms of increasing direct taxes, the plan has a very strange conception in several areas, while ignoring it in others.
For example, the proposal to double excise taxes on tobacco would certainly run counter to the promise not to increase taxes for people earning less than $ 400,000. Indeed, tobacco taxes are among the most regressive. In addition, by attempting to establish product neutrality, the policy would end up discouraging much less harmful forms of nicotine consumption and thus worsening public health.
On the other hand, the approach of not directly raising taxes for people earning less than $ 400,000 leads to a tortured conception of certain tax changes, such as broadening the base of the NIIT. The 3.8% tax currently applies to some types of investment income where single taxpayers earn more than $ 200,000 ($ 250,000 jointly), but not all types. The proposal would apply the tax to currently excluded types of income above $ 400,000 for single taxpayers ($ 500,000 for joint tax filers), leaving a gap between $ 200,000 and $ 400,000 where certain types of income would not always be. not subject to 3.8% tax.
A new tax credit in every pot
For every temporary tax credit the bill eliminates or makes permanent, it creates at least four new credits (22 in total), while expanding existing (often temporary) ones. For example, it would expand the existing low-income housing tax credit and create a separate credit for building new homes, even though the credits are not the most effective tax change for creating new ones. housing. Likewise, while some energy credits are simpler than existing policy, the inclusion of current salary and apprenticeship requirements is particularly bureaucratic and unrelated to the goal of reducing carbon emissions.
Drug price control
The House Democrats’ bill includes a provision allowing the government to set the prices of prescription drugs under Medicare Part D. To enforce fixed prices, it would include a heavy excise tax on sales of manufacturers who do not comply with negotiated prices: up to 1900 percent in some cases, making it prohibitive not to participate. Medicare’s price control regime. While this program would reduce public spending on prescription drugs, it would also reduce long-term incentives to invest in medical R&D by lowering potential future returns. According to the Congressional Budget Office (CBO), a drop in pharmaceutical company revenues resulting from such a provision would drop eight to 15 new drugs onto the market over the next decade. Meanwhile, former CBO director Douglas Holtz-Eakin argues that the CBO’s current estimates are closer to the best-case scenario for this proposal’s impact on pharmaceutical innovation.
Lower drug prices would be good, but not at the expense of fewer drugs and less innovation.