What Hath Washington Wrought: Part 2

The first part of this series introduced the Inflation Reduction Act (IRA) and took up its focus on Washington’s preferred green initiatives. This second part will take up the revenue sources that it claims will more than pay for all the legislation’s spending. Going through these details will better explain why the Penn-Wharton Model and the Congressional Budget Office (CBO) independently concluded that the legislation will do little to narrow the federal government’s budget deficit.

To pay for all its huge spending plans, the IRA includes five revenue provisions. The largest of these is the repeal of a Trump-era rule that would have rebate discounts offered by drug makers. The writers of this legislation suggest that this repeal would net the government almost $230 billion additional revenue over five years, almost one-third of the total revenue haul in the law. The problem is that these rebates never went into effect. They were postponed several times and even face a court challenge. It is a bit of a stretch to claim additional revenue by repealing an expense that never went into effect.

The second largest source of revenue is the imposition of a 15% alternative minimum tax (AMT) on corporations. The bill expects that it will raise just under $200 billion over five years. It aims at firms that pay less than the statutory 21% largely because they do a lot of capital spending and so under current law can write off these expenses and the depreciation of facilities against their earnings. The legislation stipulates that the rule will only apply to corporations with $1 billion or more in profits. It will make this AMT applicable to an American firm’s pro-rata share of earnings from a foreign operation after considering foreign taxes. The law will allow some past AMT payments to count against future tax liabilities. Adding to this, a third revenue source in the law imposes limits on non-corporate loss extensions, claiming that this measure will raise an additional $65 billion over five years.

Although these measures seem straightforward enough on the surface, their application will impose complexities that raise questions about whether they will raise as much revenue as the law foresees. To some extent it is these complexities that prompted the Penn-Wharton Model and the CBO question the revenue estimate included in the legislation. But there are more significant economic ramifications than just a dispute over calculations.

The complexity added to the tax code will certainly favor large firms, which can afford well-staffed accounting departments, over smaller firms and so further the drift in American industry toward fewer giants. And though the legislation would seem to burden only large companies by stipulating that the minimum only applies to corporations with $1 billion or more in profits, its failure to index this cutoff to inflation will bring it to apply to more and more corporations over time. At 5% inflation and 3% real growth, today’s company with half a billion in profits will come under the law in only 8 years. Perhaps more significantly, the law’s implicit limit on the tax advantages of capital spending will discourage spending to improve and enlarge productive facilities and in so doing slow growth in the economy’s productive potential. That has implications for jobs growth and by limiting supply will also increase the tendency toward inflation.

The fourth revenue enhancer, a 1% levy on share repurchases, is expected in the legislation to net some $78 billion in additional revenue over five years. It seems likely, however, that the revenue gain will fall short of this figure as corporate managements use alternative ways to compensate shareholders that would avoid the levy. Regular quarterly or special dividend payouts might serve or stock splits that tend to raise the value of holdings.

The most suspect part of plan is the claim that spending some $80 billion to hire some 87,000 new IRS enforcement agents will more than pay for itself and raise $124 billion additional revenue over five years. While insulting to the honesty of the average American and threatening to bully a lot of people, the contention also has a risible quality. It is reminiscent of countless past claims that deficits will shrink through the elimination of “waste and fraud.” These proposals have surfaced so many times in the past and so consistently failed to do what was claimed for them that the phrase and its repetition has become something of a joke.

No doubt, these five revenue enhancers will raise more money for Washington than would otherwise be the case. The question is whether they will raise enough to pay for the law’s huge, planned outlays, much less enough to close deficits, too. Both the Penn-Wharton Model and the CBO are reasonably skeptical.