Federal tax and budget policy during the Lame Duck

Two weeks after the 2022 midterm elections, it is becoming increasingly clear where fiscal policy will be headed for the rest of the year and into 2023. In the short term, Congress must grapple with tax deferrals and expiring business tax provisions that can undermine the economy.

Next year, the return of divided government and an increasingly unsustainable budget situation will come into tension, and policymakers are likely to seek “agenda setting” legislation to make the case for bringing fiscal policy into the preferred direction. Setting the federal budget on a sustainable course while prioritizing growth-friendly and stable fiscal policy must remain a top priority.

Disabled The session of Congress will focus on short-term negotiation

During this session of Congress, lawmakers will determine the fate of tax extensions that will expire at the end of the year, along with business tax increases that were scheduled as part of the Tax Cuts and Jobs Act of 2017 (TCJA). Last year, there were no extension agreements, and many small provisions that are normally renewed each year expired. So instead of debating whether to extend these provisions, policymakers are faced with the decision of bringing them back.

The path to deal with business tax increases, including the amortization of R&D expenses, the stricter net interest deduction limit, and the gradual reduction from 100 percent to 80 percent of additional depreciation starting in 2023 , it is in the air. While there has been bipartisan interest in canceling the R&D write-off and potentially delaying the phasing out of bonus spending, it may require a broader deal that includes expanded social benefits, such as an expanded child tax credit (CTC).

Concerns about how these potential tax changes would affect the federal deficit may also be a challenge unless policymakers agree to additional trade-offs. Renewing extensions and lowering taxes would worsen the deficit and could worsen inflation. Rising interest rates and the worsening long-term federal debt picture make this a bigger issue to be addressed over the next two years.

One opportunity for bipartisanship is retirement tax policy reform, which has resulted in the Improving America’s Retirement Now (EARN) Act in the Senate and similar legislation in the House. Among other changes, this legislation would relax rules related to employer retirement and pension plans, expand retirement plans for part-time workers, and expand saver credit. Congress is reconciling the legislation between the two Houses, and an updated version is likely to be included in a larger tax package.

How Divided Government Will Affect Fiscal Policy

While some congressional races remain uncalled, Republicans have officially shifted control of the House of Representatives and Democrats will retain control of the Senate, signifying a return to divided government.

We would expect a divided government to end the legislative prospects for major reform packages, including a major tax reform. However, there are two types of legislation to monitor in the next Congress in 2023.

The first type is a specific fiscal policy designed to support a specific sector or industry of the economy. Earlier this year, President Biden signed the CHIPS and Science Act, a package focused on supporting domestic semiconductor manufacturing. The package created a significant semiconductor investment tax credit and passed with a substantial number of Republican votes. As the push to bring in certain industries from abroad continues, there may be a continued push for specific tax incentives like those in CHIPS and the Science Act for some other important (or politically connected, depending on your perspective) industries.

The second type of legislation we might see is “agenda setting” legislation. While neither party will be able to enact a broad agenda, both will begin developing legislative packages that they hope to enact the next time they get a united government. For example, in 2016, then-House Speaker Paul Ryan (R-WI) released the House’s 2016 bill for tax reform, which was the basis for the TCJA in 2017.

On the Democratic side, although the Green New Deal and other massive tax increase and environmental proposals crafted during the 2020 Democratic presidential primary were never enacted, the focus on climate ended up being reflected in the Reduced Inflation Act passed in early this year, which was largely a climate policy package.

Agenda setting is likely to be a large part of the tax debate in the coming years before the fiscal cliff that will occur at the end of 2025, when most of the individual provisions of the TCJA will expire.

Prospects for a long-term budget agreement

In the early 2010s, both sides were (at least on paper) committed to deficit reduction. In 2010, President Obama established the Simpson-Bowles Commission, which issued a series of recommendations that included a combination of entitlement reform, discretionary spending cuts, and positive income tax reform. And while government spending growth slowed during the last six years of Obama’s presidency under a divided government due to discretionary budget limits set in the Budget Control Act, the big bipartisan budget deal never came to fruition.

In some ways, the prospects for such a deal may seem even more remote today. Democratic spending proposals have gotten much more ambitious since the Obama years. Meanwhile, the Tea Party’s limited government zeal is no longer a driving force in the Republican Party. And relations between parties look even worse than under the Obama administration.

However, today’s economic circumstances are also different from the economic circumstances of the 2010s, and may still force politicians less inclined to deficit reduction to the table. After the Great Recession, the Federal Reserve kept interest rates relatively low. This was possible because inflation was not a problem; indeed, given the slow recovery in the unemployment rate after the Great Recession, many economists argue that the Fed should have maintained monetary policy. plus relaxed, and that more stimulus spending could have sped up the recovery without exacerbating inflation. Clearly, we had some fiscal space in the 2010s.

Wanting to avoid the pitfalls of the Great Recession, policymakers were extremely aggressive in responding to the recession induced by the COVID-19 pandemic. Three major rounds of stimulus dwarfed the fiscal response to the Great Recession, along with support for the financial system from the Federal Reserve.

They crossed the line. Inflation returned with a vengeance, forcing the Federal Reserve to dramatically increase interest rates. On the fiscal side, although most stimulus programs have expired as planned, deficits are projected to be higher than in the 2010s.

The shift toward higher inflation, interest rates, and federal debt will affect tax and budget discussions for years to come. This will make tax and spending reform a bigger part of the political debate.

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