Assistant Professor Daniel Hemel on the rise and fall of temporary tax laws:
Since the early 2000s, Congress has filled the Internal Revenue Code with numerous sunset provisions. These provisions by their terms apply for a limited period, although Congress regularly renews them through annual “extenders” legislation. Examples have included the tax credit for research and experimentation expenses, the Subpart F exception for active financing, the deduction for state and local sales taxes, and the American Opportunity Tax Credit for the first four years of postsecondary education. Interest groups have devoted significant resources toward ensuring that members of Congress extend these tax breaks from year to year. Tax law scholars, in turn, have channeled considerable energy toward explaining the prevalence of sunset provisions in tax law.
A leading explanation of the “sunset” phenomenon is that lawmakers use temporary tax legislation to extract rents from interest groups. Rebecca Kysar writes that “the continuous threat of expiration allows Congress to extract more rents from interest groups through the use of sunset provisions that require those groups repeatedly to return to the congressional floor to achieve their goals.” Edward McCaffery and Linda Cohen likewise hypothesize that lawmakers will maximize rents through a “stringing-along” strategy, using extenders bills to get “multiple bites at the apple.” Others have offered similar accounts.
The rent-extraction hypothesis might lead one to expect that temporary tax breaks will be a permanent feature of the Code, as lawmakers have little incentive to relinquish the rents they derive from the extenders game. But that prediction has proven wrong: earlier this month, Congress voted to make 22 once-temporary tax breaks permanent, including all four provisions mentioned above. Congress’s recent action gives rise to a puzzle: If temporary legislation allows lawmakers to maximize the rents they can extract from interest groups, why did Congress allow these tax breaks to become permanent? Did DC suffer a sudden outbreak of public spiritedness this holiday season? Or does the rent-extraction hypothesis need updating?
I imagine that others will weigh in on this question in the coming weeks and months. My initial take, though, is that this month’s permanent extensions actually serve as evidence in favor of the rent-extraction hypothesis. This is because the rent-extraction hypothesis hinges upon the existence of campaign finance laws that limit transfers from interest groups to lawmakers in a given election cycle. Recent election law developments effectively lifted some of those limits. As a result, lawmakers can now extract rents from interest groups without using the device of temporary legislation.
In a world without campaign finance laws, the rent-extraction hypothesis would not be terribly compelling. Interest groups presumably assign a higher value to permanent legislation than to temporary legislation, and so would be willing to pay a higher price for permanent provisions. Think of temporary legislation like a lease and permanent legislation like a sale. It’s not immediately obvious why lawmakers will be able to extract more rents by “leasing” tax breaks than by “selling” them. If anything, one might think that selling would be a superior strategy because interest groups value certainty (e.g., corporations want to be able to plan multi-year R&D efforts with the assurance that the research tax credit will remain available throughout), and so may be willing to pay extra for the added certainty that comes with a permanent provision. (To be sure, even a permanent provision doesn’t lead to 100% certainty because of the possibility—however remote—of repeal; however, the costs borne by an interest group in preventing repeal are likely lower than the price of serial extensions, because the legislative coalition necessary to prevent repeal is smaller than the coalition needed to secure an extension.)
This is where campaign finance laws come into the picture. Campaign finance laws impose a cap on the rents that lawmakers can extract from interest groups in any given election cycle. Temporary legislation offers a way for lawmakers and interest groups to circumvent the cap. A stylized example serves to illustrate: Imagine that an interest group is represented by a single political action committee, and that a single lawmaker (we’ll call her Congresswoman X) is the pivotal player in deciding whether a tax break benefitting the interest group is enacted (perhaps she is the chairwoman of the House Ways and Means Committee). Let’s say, moreover, that the interest group is willing to pay $5,000 to Congresswoman X (or to her PAC) for each year in which the tax break is in place. Assume a 10% discount rate on both sides; thus, the interest group and Congresswoman X are indifferent between (a) an arrangement in which the interest group pays $5,000 each year to Congresswoman X’s PAC in exchange for Congresswoman X’s support of a one-year extension of the tax break, and (b) a deal in which the interest group makes a one-time payment of $50,000 to Congresswoman X in exchange for Congresswoman X pushing a permanent provision through.
Federal campaign finance law precludes the interest group and Congresswoman X from selecting option (b). The maximum contribution from one PAC to another is $5,000 per year. So instead of supporting permanent legislation in exchange for a one-time transfer of $50,000, Congressman X will support a temporary tax break (extended each year) in exchange for annual transfers of $5,000. Congressman X might support permanent legislation now if the interest group could guarantee that it would continue to make annual contributions of $5,000 in perpetuity, but such a deal would be unenforceable, and so the interest group and Congressman X settle on the temporary legislation/annual contribution pattern.
Or, at least, that was the status quo until 2010, the year of the Supreme Court’s decision in Citizens United v. FEC and the DC Circuit’s decision in SpeechNow v. FEC. As a consequence of those court decisions, corporations, unions, and individuals can make unlimited contributions to “independent expenditure only committees,” or so-called “super PACs.” Super PACs cannot coordinate expenditures with candidates; however, many lawmakers have strong links to particular super PACs. Four years later, in McCutcheon v. FEC, the Supreme Court struck down limits on the aggregate amount that an individual could donate to all candidates, parties, and PACs in a given election cycle. And in December 2014, Congress passed a provision that effectively increased the amount that a donor can give to a national political party from $129,600 per year to $777,600 per year.
The net effect of these developments is that binding limits on the amount that lawmakers can extract in rents from interest groups in any given election cycle are much less binding now than they were six years ago. And if those campaign finance limits were what stood in the way of interest groups making lump-sum payments to lawmakers in exchange for permanent tax breaks, then we might expect that the weakening of campaign finance laws would result in a shift from temporary tax provisions to permanent legislation. That is exactly what has happened. At the time that Citizens United was handed down, the Joint Committee on Taxation counted 201 temporary tax provisions set to expire in the next decade, up from 44 in the year before the McCain-Feingold campaign finance reform legislation. By January 2015, that figure had fallen to 70. And that count came before Congress made 22 more provisions permanent in this month’s omnibus bill.
It is still too early to declare the death of tax sunsets. Several significant tax provisions are set to expire next year, such as the exclusion for cancelled home mortgage debt, the deductibility of mortgage insurance premiums, and the $4,000 above-the-line deduction for qualified tuition. Still others are set to expire in 2019, including the New Markets Tax Credit, the Work Opportunity Tax Credit, the $500,000 bonus depreciation allowance, and the Subpart F “look-thru” rule. And while the developments described above have relaxed the restrictions on rent extraction in any given election cycle, important limits remain: an individual cannot donate more than $2,700 to a candidate committee per election, and a PAC still cannot donate more than $5,000. Moreover, factors other than campaign finance limits may make temporary legislation attractive under certain circumstances. For example, interest groups and lawmakers may settle on a temporary legislation/annual contribution arrangement if the interest group’s discount rate is higher than the lawmaker’s. And Congress still may use temporary tax breaks for short-term stimulus purposes during downturns.
In sum, it’s still premature for a postmortem. But it does appear that sunset provisions have reached something of a twilight phase. And while no doubt there are multiple reasons why this is so, recent court decisions and legislative changes relaxing campaign finance restrictions appear to be at least part of the story.