Note, Sep. 2024: I want to point something out: I’ve given few references here besides a couple of Google search results I happen to like. This page gives my current understanding. I’m still researching it, and you should research it yourself, don’t take my word as gospel truth. But this is how I understand it right now.
Googling section 174 layoffs will point you to a lot of information.
Update, Dec. 2024: I’m going to add some links at the bottom to interesting references to the issue, as I come accross them. —Mike
Sep. 4, 2024
Ok, this needs to be fleshed out. But I find myself repeating this to a lot of people lately, so I’m going to stick a summary here, until I can flesh it out into a full essay.
I talk up the 2017-2022 changes to the US tax code’s Section 174 pretty frequently online because I really think it’s the root cause of the white collar job crash that started at the beginning of 2023, and most people who followed up and read up on it have come back and agreed with me, but it’s incredible how many people don’t know anything about it.
It has to do with the tax changes passed in 2017. A procedural rule called “Budget Reconciliation”, originally passed in 1974, allows Congress to put through tax cuts without the possibility of a filibuster by including tax revenue increaseas to balance the cuts, scheduled to take effect later on down the road. In 2017, the tax cuts were large, and the shortfall had to be made up for, at least on paper, in the original plan, to get it passed without worrying about it getting filibustered in the Senate. So correspondingly large balancing changes were included and scheduled to take effect in 2022.
Congress has used the Budget Reconciliation rules to pass filibuster-proof packages many times before, but in the past, before the later draconian increases were due to take effect, they re-legislated it and fixed the measures before they could begin and do any damage. This time, however, Congress — and this isn’t a slight against either party, it’s a reflection on both — they all just sat on their hands for five years and did nothing. Right through Dec 2022, everybody assumed that Congress would pass a law preventing the changes from taking affect…
…And they didn’t.
So, this is just my pet theory, but I believe it’s politically radioactive for either party to talk about the fact that it happened, it makes them both look bad, because nobody did anything for five years, and now so many people are suffering.
How Section 174 actually changed: The capsule summary of the actual new tax law that took effect in 2022 is this: they made it impossible to deduct tech R&D expenses the same year that they were paid, and those expenses now had to be amortized out over the following five years.
In other words, if you spent a significant part of your tech company’s gross profit for the year paying your software developers, until 2021, you only had to have enough cash on hand to pay the taxes after deducting the cost of paying your developers. In 2022, suddenly, you still had to pay taxes up front on money you’d spent to pay the salaries of the employees writing your software, even though you didn’t have that money, because, you’d used it to pay them. You only got to deduct the expense of your developers’ salaries later, slowly, over the five following years, 20% a year (“amortization”). This didn’t just affect software companies: many, many businesses have in-house developers building the software they need. All of them suddenly needed a lot more cash on hand because they lost a major same-year deduction and now needed to amortize the cost.
Big companies with a lot of cash resources had an easier time taking the up-front tax hit, but according to some sources (such as this fairly comprehensive overview by The Pragmatic Engineer) this wreaked havoc with the finances of any company who didn’t have enough cash on hand to suddenly pay a tax bill several times higher than they had spent the whole year expecting it to be.
So, to make ends meet for the foreseeable future, companies laid off their in-house software engineers. In-house recruiting staff is considered a major expense and often an early thing to go in cost-cutting, so they went next (and, according to some recruiters I’ve spoken to, mostly were replaced by managers who didn’t really know much about hiring, making the entire hiring process slower and harder, keeping more people out of work for longer.) And the dominoes fell.
Apparently, within the tech startup industry this is all well-known (you are going to google like I suggested, right?) but most media and politicians just won’t seem to go near it. It really bothers me that it’s not being discussed.
I wouldn’t be surprised if, after the election, someone with national visibility suddenly “discovers” that section 174 is a problem and something needs to be done about it. We’ll see what happens.
Most recently, in August of 2024, the House overwhelmingly approved a bill (about 350-70) to undo the Section 174 changes, retroactive to tax year 2022. The Senate voted, almost entirely along party lines, not to even allow the bill to come to a vote. (See https://abgi-usa.com/section174/latest-and-greatest.)
References:
Pragmatic Engineer — The Pulse: Will US companies hire fewer engineers due to Section 174? – the “Pragmatic Engineer” blog, a decent overview and history. This was one of the first pages I saw about the Section 174 changes.
ABGI — Section 174: Latest News & Updates – a pretty good reference keeping a timeline of developments around Section 174.
