What a congressional spending clash this fall could mean for a year-end tax bill

Legislation to fund the federal government for fiscal year 2024, which begins in just a few short weeks, is likely to dominate the congressional agenda as lawmakers make their way back to Washington following their extended summer recess. But for tax professionals, the appropriations process deserves even closer scrutiny than usual, as the resolution of that debate could well set the tone for discussions over a potential tax package later this year.

Countdown to a shutdown?

On paper, at least, the Fiscal Responsibility Act (P.L. 118-5)—the debt ceiling agreement hammered out between President Biden and House Speaker Kevin McCarthy, R-Calif., and signed into law on June 3—provides a ready template for funding government operations for the upcoming fiscal year. That measure, which suspended the federal debt limit through January 1, 2025, also made certain fiscal policy changes, including provisions to keep discretionary spending flat for FY 2024 and limit annual growth to 1 percent for FY 2025 through 2029. For the coming fiscal year, that means an overall domestic and defense spending cap of $1.59 trillion, or $1.65 trillion after factoring in roughly $60 billion in additional spending authority—such as a clawback of some of the mandatory funding that was allocated to the Internal Revenue Service under last year’s Inflation Reduction Act (P.L. 117-169) and a reallocation of those rescinded funds to domestic discretionary accounts—that was included in various “side agreements” reached between the president and the House speaker during their negotiations.

In reality, however, the pathway to a funding agreement is far more complicated. A bloc of Republicans in the House Freedom Caucus, who maintain that McCarthy made too many concessions to the White House in the debt ceiling agreement, have demanded that Congress ignore the negotiated spending caps in that legislation and instead hold nondefense discretionary spending for the coming fiscal year at the levels in place for FY 2022. Freedom Caucus members argue the Fiscal Responsibility Act imposed a ceiling on spending but not a floor, and they intend to see Congress adopt even lower topline numbers than those laid out in that legislation. They underscored their point back in June by staging a protest over spending policy that essentially stymied action on unrelated measures on the House floor for several days. (For prior coverage, see Tax News & Views, Vol. 24, No. 25, June 23, 2023.)

Given that level of resistance from the Freedom Caucus, Speaker McCarthy is likely to bring to the floor—and the House will likely attempt to pass along party lines—spending bills that comport with the FY 2022 topline cap of $1.47 trillion. In the Senate, where the appropriations debate has largely been bipartisan, lawmakers are expected to approve spending bills in line with the $1.65 trillion cap provided for in the Fiscal Responsibility Act.

Fiscal year 2024 begins on October 1 and neither chamber has yet made significant progress in moving its respective versions of the 12 spending bills needed to fully fund government operations. The House has cleared only one measure and the Senate has not yet approved any, although leaders in the upper chamber have indicated that they expect to package several spending bills into a “minibus” that could come to the floor as soon as the week of September 11. Moreover, the legislative calendar for September is relatively tight: the Senate, which returned to Capitol Hill on September 5 is scheduled to be in session for 17 days this month and the House, which resumes work on September 12, will be in for only 11. If the two chambers cannot reconcile the roughly $180 billion discrepancy in their respective funding targets and agree on a unified set of spending bills by the October 1 deadline—or, alternatively, if they cannot agree on a short-term continuing resolution to keep the government’s doors open while they work on a more durable spending agreement—then we would be looking at a shutdown of those federal departments and agencies that don’t have an FY 2024 appropriations bill signed into law.

If there is a shutdown, how might it end?

There are many possible ways to resolve a government funding dispute in the event of a shutdown, but at present there is no obvious path forward.

Speaker McCarthy could draw from his debt ceiling playbook and deputize negotiators to cut a deal with Democrats while engaging with various GOP constituencies throughout the process. It is unclear, though, if Democrats will be as willing to help Republicans resolve the funding dilemma as they were during the debt ceiling debate. One thing that may bolster Democrats’ resolve to stay out of the fray this time around is the fact that Senate Republicans, unlike many of their counterparts in the House, generally favor a spending package that adheres to the parameters laid out in the Fiscal Responsibility Act. (It’s worth noting that although no spending bills have yet been taken up on the Senate floor, all 12 of that chamber’s government funding measures cleared the Appropriations Committee by unanimous or near-unanimous margins.) In contrast, House and Senate Republicans were more closely aligned during discussions over how to address the debt ceiling.

If Democrats do decide to engage in the funding debate, here are two of many possible outcomes:

• Democrats could eventually relent and agree to spending caps that are lower than those contemplated in the Fiscal Responsibility Act but compensate for that reduction with supplemental funding for priorities such as aid to Ukraine and relief for victims of recent US natural disasters. (At this point, such an outcome appears unlikely, however.)
• Alternatively, Republicans might agree to allow spending at levels closer to those provided for in the debt ceiling pact in exchange for concessions on other policy goals, though it is unclear exactly what set of policy “wins” would be both sufficiently meaningful for members of the House Freedom Caucus and acceptable to Senate Democrats and the White House.

The longer a shutdown lasts, the odds begin to rise that House Democrats and a small group of moderate Republicans will unite to force a vote on a short-term spending bill at something near the levels provided for in the debt ceiling legislation—particularly if such a measure has already been agreed to by the Senate.

Implications for a tax bill

Normally, tax legislation and spending legislation take distinct paths through Congress, though those trails have often converged in a big “end-of-year” package. The likelihood of such an outcome this year is particularly fraught given the uncertainty we face today on the spending side, however.

The Fiscal Responsibility Act gives Congress a strong incentive to pass all 12 appropriations bills by imposing an automatic, across-the-board 1 percent cut to discretionary spending if a continuing resolution for any discretionary budget account remains in place beyond January 1 of next year. (The resulting sequester would not be triggered until May of 2024 if all 12 bills are not enacted by the end of April.) In the current environment, though, there is no guarantee that the threat of a sequester would be sufficient to compel action on a year-long spending package. Indeed, Freedom Caucus Republicans might even prefer forced spending reductions over a deal that has buy-in from congressional Democrats and President Biden. Moreover, any continuing resolution that Congress might put in place at the end of the year likely would be a bare bones patch that keeps the government open at current funding levels and not a forward-looking measure that would be expected to carry substantive extraneous policy provisions.

But even if Congress is able to agree on appropriations legislation by the end of the year, there is a risk that the months-long clash over spending levels could limit the size and scope of any tax package that lawmakers may try to attach to it.

Republicans on the House Ways and Means Committee laid down their marker on a tax package in June as they approved a trio of largely business-focused tax-relief measures—the Tax Cuts for Working Families Act, the Small Business Jobs Act, and the Build it in America Act—that Chairman Jason Smith, R-Mo., argues are intended to promote economic growth. The three committee-approved measures are expected to be consolidated into a single package, dubbed the American Families and Jobs Act.

Blowback over tax bill deficit increases: Overall, the Ways and Means package is intended to mitigate the adverse impact of some business-related tax code changes that were enacted in the Tax Cuts and Jobs Act (P.L. 115-197) and other recent legislation, spur small-business manufacturing and investment, pare back clean energy tax incentives that became law as part of last year’s Inflation Reduction Act, help US-based businesses remain competitive internationally, and offer individuals some relief from the effects of inflation by temporarily increasing the standard deduction. (For additional details on the legislation as approved by the committee, see Tax News & Views, Vol. 24, No. 24, June 16, 2023.)

Based on estimates from the Joint Committee on Taxation (JCT) staff, the three Ways and Means bills, taken together, include a total of $237 billion in tax cuts and $216 billion in revenue increases for a net revenue loss of $21 billion over the 10-year budget window covering 2023-2033. The JCT also has released a separate “dynamic” revenue score indicating that the Build it in America Act—the component of the Ways and Means tax package that includes the most significant business-focused tax relief as well as provisions to repeal certain of the Inflation Reduction Act’s clean energy incentives—would produce only minimal economic growth outside the budget window. (For prior coverage, see Tax News & Views, Vol. 24, No. 26, July 14, 2023.)

Although Chairman Smith had hoped that there would be a House floor vote on the consolidated measure ahead of the August recess, the path forward for the legislation remains uncertain as Republicans argue behind closed doors about whether or not to include provisions to repeal or relax the current-law cap on the federal deduction for state and local taxes (SALT).

Off-putting offsets: Even if the SALT issue is resolved, however, the legislation still may be subject to challenges in certain GOP circles because of its deficit impact. Republican policy has long been that extensions of current law—for example, restoration of taxpayer-favorable treatment of research expenditures, bonus depreciation, and business interest expense as proposed in the Ways and Means package—should not require revenue offsets. In the current environment, however, the most fiscally conservative Republicans in the House may well balk at any legislation that drives up the deficit.

Moreover, Republicans likely would view most of the potential tax increases that would raise revenue to cover the cost of new tax relief as nonstarters, and those tax increases that likely would be acceptable—including the rollbacks of various Inflation Reduction Act clean energy credits proposed in the Ways and Means legislation—would be nonstarters for the White House and congressional Democrats.

What about the Senate?: Arguably, the hardline stance among the most conservative House Republicans may not matter in the long run. Any tax bill that passes in the Democratic-controlled Senate is almost sure to include provisions to enhance the current-law child tax credit and most likely would be approved in that chamber on a strong bipartisan vote. That outcome might give Speaker McCarthy enough wiggle room to bypass the deficit-focused objections raised by his more conservative members and work out a deal with the Senate that can pass in his chamber with the support of Democrats and moderate Republicans.

The Senate Finance Committee thus far has not announced plans to mark up a tax package of its own, but Chairman Ron Wyden, D-Ore., has expressed his strong desire to negotiate an end-of-year deal with Ways and Means Committee Republicans.

‘Drivers’ in short supply: The relative scarcity of urgent issues that might drive momentum for a tax bill conceivably could prove to be an impediment a year-end deal, however. One issue that had been regarded as a significant potential driver for tax legislation in 2023—namely, concerns expressed by retirement plan sponsors about their ability to comply with provisions in last year’s SECURE 2.0 Act (Division T of the Consolidated Appropriations Act, 2023 (P.L. 11 7-328)) that require catch-up contributions made by certain higher‑income participants in 401(k) and similar retirement plans to be designated as after-tax Roth contributions effective for taxable years beginning after December 31, 2023—was taken off the table last month when the IRS announced in Notice 2023-62 that it will provide a two-year administrative transition period to implement the new requirement. The notice also addressed concerns by plan sponsors and participants over perceived ambiguity in the statutory language of the SECURE Act by clarifying that eligible plan participants can continue to make catch‑up contributions after 2023, regardless of income.

Even without the urgency of a SECURE Act fix, though, lawmakers may feel compelled to take legislative action to address the pending expiration, at the end of this year, of administrative relief that delayed enforcement of the stricter information reporting threshold for third-party payment processors that was enacted in the American Rescue Plan Act of 2021 (P.L. 117-2). The reduced reporting threshold—$600 in aggregate payments, regardless of the number of transactions—applied to reporting for returns for calendar years after 2021; however, the IRS announced late last year in Notice 2023-10 that calendar year 2022 would be a transition period for implementing the provision.

Mood matters

Regardless of substantive policy differences between the two parties, the mood set by the spending standoff in the next few weeks—and the way in which congressional leaders and the White House are able to resolve any resulting government shutdown—could shape the negotiations necessary for a deal on taxes and, in a worst-case scenario, even prevent a deal from emerging. Moreover, as end-of-year tax bills often are carried on broader omnibus spending bills, the outlook for any bipartisan tax deal is clouded by uncertainty over the annual appropriations process.

Back to top