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Will the Republican tax bill be aimed at the economic past, or the future?

Robots weld a vehicle frame on the production line at the Hyundai Motor Manufacturing Alabama facility in Montgomery, Alabama.
Luke Sharrett | Bloomberg | Getty Images
Robots weld a vehicle frame on the production line at the Hyundai Motor Manufacturing Alabama facility in Montgomery, Alabama.

Congress and the Trump administration are said to be hard at work creating a tax bill, aiming for a signature economic policy achievement in the months ahead. As they do so, there is a fundamental tension they will have to resolve: Is this tax legislation about the past, or about the future?

The bill's writers face a series of choices over whether to shovel more money into the pockets of individuals and businesses based on choices they have already made, or to change tax laws that shape economic incentives in the years ahead. In at least a few areas, politics favors the past while theory favors the future.

One example of this is a debate over whether a tax cut will be retroactive. Suppose that a bill passes in November or December cutting individual income tax rates. Should the lower taxes apply to income earned in 2017, or only to that earned in 2018 and beyond?

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It's easy to see why the smart thing politically would be to apply the lower rates to 2017; more money would show up in taxpayers' refund checks in the spring of 2018, ahead of the midterm elections. When the George W. Bush administration passed tax cuts in 2001 and 2003, it took that approach.

But it also defies the economic theory about why tax cuts might be advantageous for the economy. The entire conservative philosophy behind lowering taxes is that when the government takes less, it encourages people to invest more and work harder, increasing the nation's economic potential.

There is a continuing debate over how powerful those effects really are, yet it at least is a coherent theory of how tax cuts can generate economic growth. If a retroactive tax cut passes in November, however, no one can go back in time to January and suddenly put in more hours or invest more.

It might make sense to have a retroactive tax cut if we were in the middle of a recession, because putting some money immediately in taxpayers' pockets could help spur growth. But right now the economy is humming along with a 4.3 percent unemployment rate, a record high stock market and no recession in sight.

"Business lobbyists argue that when companies return money home, they will use it to create jobs and investment in the United States. But the mid-2000s experience suggested they instead used the cash for a merger spree."

On the corporate side of the tax ledger, similar questions arise. Among them: Whether, and how, to incentivize American companies to bring home the trillions of dollars in accumulated profits that they have kept parked overseas to avoid the 35 percent federal tax they would have to pay by repatriating the money.

In the mid-2000s, a repatriation tax holiday allowed companies to bring that money home at a low rate. President Trump's campaign tax plan included letting companies repatriate overseas earnings at a 10 percent rate, as part of a transition to a new system for taxing international income.

Depending on how it is structured, that could amount to a one-time boon for companies with large overseas profits, essentially rewarding past success rather than providing the incentives to invest in future growth.

"With repatriation at a lower rate, you're not only providing a tax cut for choices that have already happened, but you're rewarding choices that involved heavy tax avoidance and gaming of the tax system," said Lily Batchelder, a law professor at New York University. "A lot of the reason so much money is socked away overseas is because of the ability of large mutlitnationals to shift income on paper, so you're kind of rewarding bad behavior."

Business lobbyists argue that when companies return money home, they will use it to create jobs and investment in the United States. But the mid-2000s experience suggested they instead used the cash for a merger spree. And for companies that see promising opportunities, the booming stock market and low interest rates mean that capital is readily available on favorable terms already; it's not clear why a company would invest in a new factory, for example, using repatriated overseas profits but not using money borrowed at a low interest rate by issuing bonds.

But the most interesting area of tension between changes that reward old behavior versus future behavior comes in how the corporate tax code handles capital investments by businesses.

Consider a company that spends $1 million on a piece of equipment expected to last 20 years. Currently, it can deduct the cost of investment spending gradually: in $50,000 annual chunks over two decades, unless covered by exceptions for certain equipment or for smaller businesses.

One idea, embraced by Republicans in the House but not those in the Senate, would be to allow companies to fully deduct capital expenses in the year they are incurred. Suddenly that company that spends $1 million on a piece of equipment could deduct the full million in the first year.

But this would be costly in terms of lost revenue to the treasury, to the tune of a couple trillion dollars over the next decade. And some people would rather that kind of money go toward reducing the corporate tax rate.

That pits two types of companies against each other. For those expecting to make large capital investments in the future, full expensing could be a boon. The ones that made big capital investments in the past and are now harvesting the profits have nothing to gain from full expensing but would win big if the corporate tax rate is cut.

Understandably, those companies would much prefer that those trillions go toward lower rates. Freedom Partners, the advocacy group funded in part by the Koch brothers, has argued this case, and many others agree with them.

Enthusiasts for full expensing, by contrast, argue that giving more favorable treatment to capital spending can help companies that are in growth mode and encourage the kind of investments that create more jobs. That is doubly significant in an era of relatively low capital spending and weak advances in labor productivity.

Think of a trucking company, says Scott Greenberg, a senior analyst at the Tax Foundation. With the ability to fully expense capital investments upfront, a firm that buys more trucks — creating more jobs for both truck drivers and the manufacturing workers who build the truck — benefits. By contrast, if you just cut the tax rate, "even if a trucking company does not expand its fleet, it could still benefit from a lower corporate rate, because the profits from its existing fleet would be taxed less."

There is still a great deal unknown about what type of tax legislation Congress will take up, with negotiations between House and Senate tax-writers and the Trump administration taking place behind closed doors.

But once it is revealed, the questions to ask aren't just whether it would benefit the rich or the middle class, or what it would mean for the deficit. Another big one is whether it is more about the economic future, or the economic past.