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Thursday, September 30, 2010

Tax Treatment of Net Operating Losses


Mark P. Keightley
Analyst in Public Finance

A net operating loss (NOL) is incurred when a business taxpayer has negative taxable income. An NOL can be used to obtain a refund for taxes paid in the past and/or to reduce future tax obligations. The process of using an NOL to refund previously paid taxes is known as an NOL carryback, whereas the process of using an NOL to reduce future taxes is known as a carryforward. Under current law, there is a 2-year carryback period and a 20-year carryforward period for most business taxpayers. The intent of the NOL carryback/carryforward provision is to give taxpayers the ability to smooth out changes in business income, and therefore taxes, over the business cycle.

The 2-year carryback period was temporarily extended for up to up to 5 years during 2008 and 2009 to provide assistance to businesses hurt by the economic downturn. Extending the carryback period likely enhanced the ability of firms to smooth income by allowing losses to be offset against a longer period of past profits rather than having them carried forward. The extension, however, decreased revenue accruing to the federal government.

Economic theory suggests that, under certain conditions, extending the carryback period indefinitely could minimize the distorting effects taxation has on investment decisions and, in turn, increase economic efficiency. This result stems from the observation that the majority of the tax burden falls on risky investments. The government, by allowing NOL carrybacks, effectively enters into a partnership with taxpayers when losses are allowed to be carried back, sharing both the return to investment (tax revenue) and the risk of investment (revenue loss). Extending the carryback period indefinitely would reduce the tax burden by reducing the private risk associated with investing. Further gains in economic efficiency are possible if the government can spread risk better than can be done in private markets. Those gains, however, come at the expense of lost federal revenue.

This report explains the current law and recent modifications made during the economic downturn. In addition, this report highlights a number of policy considerations relating to the extension of the NOL carryback period.



Date of Report: September 8, 2010
Number of Pages: 12
Order Number: RL34535
Price: $29.95

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Trends in Discretionary Spending


D. Andrew Austin
Analyst in Economic Policy

Mindy R. Levit
Analyst in Public Finance


Discretionary spending is provided and controlled through appropriations acts, which fund many of the activities commonly associated with such federal government functions as running executive branch agencies, congressional offices and agencies, and international operations of the government. Essentially all spending on federal wages and salaries is discretionary.

Federal spending in 2010 is estimated at just under a quarter (24.5%) of the U.S. economy, as measured by gross domestic product (GDP). Federal spending since 1962 has averaged about a fifth of GDP. (Years denote federal fiscal years unless noted otherwise.) Discretionary spending accounted for 37.8% of total outlays in 2010, as extraordinary federal responses to financial turmoil sharply increased mandatory spending (56.15% of outlays in 2010), reducing discretionary spending’s share of total spending. Net interest accounted for 6.1% of federal outlays in 2010.

In 1962, discretionary spending accounted for 47.2% of total outlays and was the largest component of federal spending until the mid-1970s. Since then, discretionary spending as a share of federal outlays and as a percentage of GDP has fallen. The long-term fall in discretionary spending as a share of total federal spending is largely due to rapid growth of entitlement outlays and slower growth in defense spending relative to other federal spending in past decades.

Discretionary spending is often divided into defense, domestic discretionary, and international outlays. Trends in those categories may indicate broad national priorities as reflected in federal spending decisions. Defense and domestic discretionary spending compose nearly all of discretionary spending. In 1962, discretionary spending equaled 12.3% of GDP, with defense spending making up 9.0% of GDP. In 2010, total discretionary spending is estimated to fall to 9.3% of GDP with defense spending totaling 4.7% of GDP. Military spending has increased sharply over the last decade. On average, from 2000 to 2010, defense outlays grew 6.8% per year in real terms, whereas non-defense discretionary outlays grew 5.6% per year in real terms.

The G. W. Bush and Obama Administrations each created their own division of security and nonsecurity spending. Dividing spending into security and non-security components, however, presents many conceptual and practical difficulties. Some federal activities, such as Coast Guard patrols, advance non-security and security interests. Furthermore, federal programs tasked with non-security aims in normal times may respond to specific homeland security challenges. Nondefense security discretionary budget authority increased sharply after Hurricane Katrina, although changes in outlays were less dramatic. Non-defense non-security outlays, which have ranged between 3% and 3.5% of GDP since the mid-1980s, are estimated to reach about 4% of GDP in 2010, largely due to economic stimulus measures and other recession-related spending.

The Obama Administration in its recent budget submission called for a three-year freeze on nonsecurity discretionary spending. Weak economic conditions have depressed federal revenues and may continue to increase government social safety-net expenditures. Some contend that additional stimulus measures are needed to reduce high unemployment levels, while others have called for imposing greater budgetary stringency. Over the long term, projected future growth in entitlement program outlays may put severe pressure on discretionary spending unless policy changes are enacted or federal revenues are increased.



Date of Report: September 10, 2010
Number of Pages: 26
Order Number: RL34424
Price: $29.95

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New Markets Tax Credit: An Introduction


Donald J. Marples
Specialist in Public Finance

The New Markets Tax Credit (NMTC) is a non-refundable tax credit intended to encourage private capital investment in eligible, impoverished, low-income communities. NMTCs are allocated by the Community Development Financial Institutions Fund (CDFI), a bureau within the United States Department of the Treasury, under a competitive application process. Investors who make qualified equity investments reduce their federal income tax liability by claiming the credit. The NMTC program, enacted in 2000, is currently authorized to allocate $26 billion through the end of 2009. To date, the CDFI has made 396 awards totaling $26 billion in NMTC’s allocation authority.

In the 111
th Congress, legislation is being considered to modify the NMTC program authorization. The American Recovery and Reinvestment Tax Act of 2009, P.L. 111-5, increased the NMTC allocation for 2008 and 2009, to $5 billion from $3.5 billion. Similarly, legislation in the 110th Congress focused primarily on extending the NMTC program authorization. This attention came to fruition with the enactment of P.L. 110-343, which extended the NMTC program authorization one year, through the end of 2009. Other legislation in the 111th Congress, H.R. 2628 and S. 1583, proposes to extend the NMTC for multi-year periods; H.R. 473 proposes to extend the NMTC to the insular areas; H.R. 4849 proposes to allow for the new markets tax credit to offset alternative minimum tax liability; and both the House- and Senate-passed versions of H.R. 4213 and the Baucus Job Creation and Tax Cuts Act would extend the NMTC for one year (through 2010) and $5 billion.


Date of Report: September 17, 2010
Number of Pages: 10
Order Number: RL34402
Price: $29.95

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Running Deficits: Positives and Pitfalls


D. Andrew Austin
Analyst in Economic Policy

Governments run deficits for several reasons. By running short-run deficits, governments can avoid raising taxes during economic downturns, which helps households smooth consumption over time. Running deficits can stimulate aggregate demand in the economy, thus giving policymakers a valuable fiscal policy tool to help support macroeconomic stability. In particular, short-run deficits may help boost economic activity when monetary policy loses its potency. When interest rates fall during an economic downturn, banks can become reluctant to lend when perceived lending risks outweigh anticipated gains, while fewer firms and consumers demand new loans. In such a situation, known as a liquidity trap, a monetary authority such as the Federal Reserve can do little to expand the money supply. Thus, while the monetary authority can cut short-term interest rates to nearly zero—or even to zero—lower interest rates or other monetary policy initiatives may spur little new consumer spending or business investment. Non-traditional monetary policy, however, can play a key role in economic management. During a liquidity trap situation, fiscal policy tools such as increased government spending or tax cuts that increase deficits may be an important complement to monetary policy. So-called “fresh-water” economists have questioned the logic of these fiscal policies. So-called “salt-water” economists, who have sought to put Keynesian fiscal theories on a more modern foundation, contend that government interventions can mitigate economic downturns. Most professional economic forecasters find that deficits can stimulate economic activity when the economy runs below its potential.

In better economic times, deficits may crowd out private investment or worsen trade deficits. But long-run deficits may transfer economic resources from younger to older generations, allowing older generations to enjoy anticipated benefits of future economic growth—long-run deficits may also impose large burdens on future generations. Some have argued this allows politicians to act opportunistically by providing benefits to current constituents while leaving future generations, an unrepresented constituency, with substantial fiscal burdens.

Between 2007 and 2009, federal tax revenues fell by 18.0% and corporate tax revenues fell 62.7%. Government outlays rose during the recession due to “automatic stabilizer” programs such as unemployment insurance and income support programs; federal support provided to Fannie Mae, Freddie Mac, AIG, and other companies; and economic stimulus legislation such as the American Recovery and Reinvestment Act of 2009 (ARRA; H.R. 1, P.L. 111-5).

Anticipation of changes in partisan control of government can motivate deficits, as current policy makers may wish to restrict their successors’ options. Research on state and foreign governments suggests that balanced-budget rules force governments to adjust spending and taxes sharply during economic downturns. Budget enforcement legislation, such as the 1990 Budget Enforcement Act (P.L. 101-508), may have helped preserve budgetary compromises between parties, which may have contributed to a reduction in federal deficits.

Deficits can seriously harm national economies. In the short run, fiscal overstimulation leads to inflation. In the long term, deficits either reduce capital investment, which retards economic growth, or increase foreign borrowing, which swells the share of national income going abroad. Governments can spend more than they collect in revenues by printing money, which causes inflation, or by borrowing. In the long run, governments risk default and bankruptcy if they fail to repay borrowers, at least to the extent of stabilizing the ratio of government debt to gross domestic product.



Date of Report: September 14, 2010
Number of Pages: 22
Order Number: RL33657
Price: $29.95

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Social Security Reform: Current Issues and Legislation


Dawn Nuschler
Specialist in Income Security

Social Security reform has been an issue of political debate in recent years. Currently, there is renewed congressional interest in reform in part due to the National Commission on Fiscal Responsibility and Reform established by President Obama in February 2010, which has been tasked with making recommendations on ways to improve the long-term fiscal outlook recommendations that could include changes to the Social Security program. The commission is required to make its recommendations no later than December 1, 2010.

The spectrum of ideas for reform ranges from relatively minor changes to the pay-as-you-go social insurance system enacted in the 1930s to a redesigned, “modernized” program based on personal savings and investments modeled after IRAs and 401(k)s. Proponents of the fundamentally different approaches to reform cite varying policy objectives that go beyond simply restoring long-term financial stability to the Social Security system. They cite objectives that focus on improving the adequacy and equity of benefits, as well as those that reflect different philosophical views about the role of the Social Security program and the federal government in providing retirement income. However, the system’s projected long-range financial outlook provides a backdrop for much of the Social Security reform debate in terms of the timing and degree of recommended program changes.

The Social Security Board of Trustees projects that the trust fund will be exhausted in 2037 and that an estimated 78% of scheduled annual benefits will be payable with incoming receipts at that time (under the intermediate projections). The primary reason is demographics. Between 2010 and 2030, the number of people aged 65 and older is projected to increase by 76%, while the number of workers supporting the system is projected to increase by 8%. In addition, the trustees project that the system will run cash flow deficits in 2010 and 2011, and again in 2015 and each year thereafter through the end of the 75-year projection period. When current Social Security tax revenues are insufficient to pay benefits and administrative costs, federal securities held by the trust fund are redeemed and Treasury makes up the difference with other receipts. When there are no surplus governmental receipts, policymakers have three options: raise taxes or other income, reduce other spending, or borrow from the public (or a combination of these options).

Public opinion polls show that less than 50% of respondents are confident that Social Security can meet its long-term commitments. There is also a public perception that Social Security may not be as good a value for future retirees. These concerns, and a belief that the nation must increase national savings, have led to proposals to redesign the system. At the same time, others suggest that the system’s financial outlook is not a “crisis” in need of immediate action. Supporters of the current program structure point out that the trust fund is projected to have a positive balance until 2037 and that the program continues to have public support and could be affected adversely by the risk associated with some of the reform ideas. They contend that only modest changes are needed to restore long-range solvency to the Social Security system.

During the 110
th Congress, six Social Security reform measures were introduced, five of which would have established individual accounts. None of the measures received congressional action. During the 111th Congress, four Social Security reform measures have been introduced.


Date of Report: September 14, 2010
Number of Pages: 34
Order Number: RL33544
Price: $29.95

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