Legislative round-up: Speaker drama, deficits and tax gap

The inability of Republicans to coalesce around a House speaker last week continued to threaten the outlook for a year-end tax package and spending agreement. New information on deficits and the tax gap could also affect tax and spending negotiations.

Republicans remain without a House speaker after former Speaker Kevin McCarthy, R-Calif., was deposed by a handful of Republican members unhappy with the 45-day extension of government funding he brokered. House Majority Leader Steve Scalise, R-La., won the first internal Republican ballot to become speaker but dropped out after failing to get enough support in a floor vote. Freedom Caucus Founder Jim Jordan, R-Ohio, won the nominee next, but failed in three attempts at winning a floor vote and has since dropped out. The House remains without a permanent speaker.

For a moment last week, Republicans appeared to be coalescing around a plan to give more power to temporary Speaker Rep. Patrick McHenry, R-N.C. The plan quickly collapsed under opposition from some hardline conservatives. As many as nine Republicans now say there are running. The eventual resolution of the drama could have a major impact on the prospects for a spending deal and tax legislation.

Lawmakers have just a few weeks before government funding is again scheduled to expire on Nov. 17. Any vote to expand McHenry’s power would likely require Democratic support, and Democrats could extract promises such as an extension of government funding into next year. Such a maneuver could rob tax writers of one of the few remaining legislative vehicles that could carry a tax deal. There are a handful of other priorities that must be addressed before year-end, such as reauthorization of the Federal Aviation Administration, but these are smaller items that appear less likely to carry major tax provisions. Tax writers could also reach agreement on a deal to attach to a spending extension before Nov. 17, but discussions don’t appear to be progressing quickly.

Lawmakers have made little progress in over a year discussing a deal to trade child tax credit enhancements for restoring research expensing under Section 174, reinstating 100% bonus depreciation, and providing relief for the Section 163(j) limit on interest deductions were largely subsumed by the spending negotiations and Republican in-fighting. 

IRS releases new ‘tax gap’ estimate

The IRS released new data last week estimating that the “tax gap”—the difference between the amount of taxes actually owed and the amount paid to the government before enforcement—will reach $688 billion in 2021.

This represents a 20% increase in the nominal amount from the last estimate, but the jump was attributed mostly to a larger economy. The voluntary compliance rate was estimated at 84.9%, virtually unchanged from the previous rate of 85.1%.

In the past, tax gap estimates have spurred new legislation expanding information reporting and have been used by the IRS to direct audit resources. Reporting of third-party settlement networks on Form 1099-K is expanding for payments made in 2023 and new broker reporting for digital assets is also scheduled to come online in 2025 and 2026. Nearly $400 billion of the tax gap comes from underreporting of individual income tax, which includes tax on pass-through income. Corporate underreporting represents $40 billion.

The IRS is stepping up enforcement action with $60 billion in new funding and is hoping to hire 3,700 new revenue agents.

CBO blames ERC credit for larger than expected deficit

The Congressional Budget Office (CBO) has estimated a $1.7 trillion deficit for the government fiscal year that ended on Sept. 30, 2023, which was larger than expected thanks to a 9% decline in revenue from the prior year. The CBO blamed the $455 billion drop in revenue on fewer capital gains and higher-than-anticipated employee retention credit (ERC) claims.

The IRS has made the ERC a major focus of enforcement efforts and just released a program allowing taxpayers to voluntarily withdraw unpaid claims. A settlement initiative is likely to follow for taxpayers who received refunds.

The CBO’s numbers could also affect ongoing negotiations over government funding, as some hardline conservatives push for deep cuts in spending.