TAX NEWS - 2010

Tax breaks have share of critics, but nothing changes in Washington

WASHINGTON – Congressional auditors and some senior lawmakers say many tax breaks aren't doing their job and should be overhauled. Yet most years, when Congress has a chance to review the provisions, it extends them instead.

One example: the research tax credit, which auditors say provides a windfall to big companies.

The credit is intended to stimulate research and development spending by U.S. companies. Instead, the Government Accountability Office found last year that the $5.6 billion credit rewards companies for research they would have done without the incentive.

That senior lawmakers acknowledge the research tax credit is flawed – yet still plan to extend it – illustrates the difficulty of reforming tax breaks that have become a favored way to subsidize business and encourage other investments, such as home purchases.

"The business community says they need it. They say it creates jobs," said Rep. Sander Levin , D-Mich., chairman of the tax-writing House Ways and Means Committee. "Where there are problems with it, we are going to take a hard look at it. But that won't work if we don't extend it this year."

Many of the most expensive tax breaks are permanent. But several dozen, including the research credit, must be reauthorized for a year or several years at a time.

Some tax experts think Congress should make most tax breaks temporary, so lawmakers would at least be forced to grapple with their cost. But others are skeptical, saying Congress has not shown itself willing to challenge the lobbying forces that demand annual renewal.

"Once it's in the [tax] code, it just sails on," said Edward D. Kleinbard, former chief of staff to the Congressional Joint Committee on Taxation. "Every one has a champion within Congress. The members find it desirable not to criticize other members' pet [tax] expenditures, so their pet expenditures are not criticized by the other fellow."

Lawmakers are weighing the extension of about 50 expiring tax breaks, including the research credit. The $118 billion package, which includes an extension of unemployment insurance and other non-tax items, has been stuck in the Senate because of objections that it would raise the deficit.

The research tax credit has acquired a wide base of support in Washington, where big companies including Exxon Mobil  , Dean Foods and Texas Instruments champion its renewal. In fact, large corporations have dominated its use. In 2005, more than half of the $6 billion in net credit went to corporations with receipts greater than $1 billion, according to the GAO report.

Issued in November, the GAO report found that most companies claiming the credit "received substantial windfalls." The audit said that research due to the credit "represent[s] less than 15 percent of the total research spending of these claimants."

The GAO blamed the credit's design for causing the windfall. Companies earn the credit for research expenses that exceed an amount set by law, but that amount is determined by spending dating to the 1980s. The GAO recommended that Congress update the calculation to consider the current year's research expenses.

"A lot of them are more flawed than the research tax credit," said Leonard Burman, a Syracuse University professor of public affairs who led the Treasury Department's office of tax analysis during the Clinton administration. "Congress obviously can review tax expenditures. They should. But the fact is a lot of them are on autopilot."

Tax experts often cite tax breaks for health care and energy production as other examples of inefficient tax subsidies. Yet efforts to reform them have mostly failed.

During debate over the new health care law, for instance, lawmakers rejected advice from health economists who wanted to impose a tax on employer-provided health insurance. Since premiums aren't taxed, companies have an incentive to provide more generous plans in lieu of raising wages, which drives up consumption of health care services – and raises costs.

The Information Technology & Innovation Foundation, a high-tech think tank in Washington that supports the research credit, disagreed with the GAO report. The foundation advocates raising the value of the credit, saying it would result in 162,000 new jobs and $90 billion in economic activity. The foundation's funding comes partly from corporations that benefit from the credit.

"It does spur R&D," said Robert D. Atkinson, the foundation's president. "I just simply don't buy the [GAO's] view."

Yet even lawmakers who support the research credit say fiscal worries may soon prompt a re-evaluation of tax breaks. Chairmen of the tax-writing committees in the House and Senate say that tax reform is on the agenda for 2011, and that concern over federal deficits is driving the discussion.

 Even before then, some lawmakers are prodding colleagues to take another look at tax breaks. The legislation that would extend some tax breaks also directs the Joint Committee on Taxation to analyze whether each tax break has fulfilled its purpose. The provision was inserted by Rep. Lloyd Doggett, D-Austin.

"The GAO report I found to be alarming, and should be a reason for Congress to give much more attention to whether we are getting the R&D we need," Doggett said.