Economic Analysis of NOL Carryback Relief

Special Studies, August 18, 2009
By Robert D. Dietz, Ph.D.
NAHB Economics and Housing Policy Group
Report available to the public as a courtesy of

Expansion of the Net Operating Loss (NOL) carryback period is a critical stimulus measure for the U.S. economy. Allowing businesses to carryback deductions that would be claimed in the future for an immediate tax refund provides an infusion of monetary resources for firms struggling to retain workers and undertake economic activity. This is particularly true in today's environment in which a destructive credit crunch has hurt the ability of small and large businesses to access capital.


This paper reviews the tax policy background, the link to the economic status of the home building industry, the federal budget considerations, and the economic impact of an expanded NOL carryback period. The analysis in this paper indicates that NOL relief would help generate more than 53,000 jobs in the construction sector and help the survival prospects of nearly 8,000 construction-related businesses.


Policy Background
Under present law, businesses with losses may, in general, carry back deductions for operating losses for up to two prior tax years. [1] The carryback option allows businesses to offset prior taxes paid, thereby generating tax refunds to finance ongoing expenses, including wages for workers and paying debts to financial institutions. If businesses are unable to claim a loss deduction in the permitted carryback window, then these businesses must carry forward the loss deduction to a future tax year, with the tax code limiting the carryforward period to 20 years. Expanding the carryback from two to five years is especially important for the home building sector, which has been mired in an economic downturn since late 2005. Thus, the present-law two-year carryback window offers relatively smaller amounts of taxable income to offset, thereby forcing NOL deductions to be pushed into the carryforward situation, which, among other impacts, creates accounting and time-value-of-money challenges.

Economic theory demonstrates that a suitably long carryback period for NOL deductions helps to smooth out income - and taxes paid - over a business cycle, thereby allowing businesses to make efficient decisions regarding financing and investment. A recent report by the Congressional Research Service notes that the average business cycle since World War II has lasted 6 years. [2] The report suggested that expanding the carryback period to this length (or paying interest on losses carried forward) would increase income-smoothing and reduce business risk.

Providing immediate cash refunds for tax loss deductions is also, in the economists' jargon, an automatic stabilizer in terms of fiscal policy. That is, it provides financial resources when the economy needs fiscal stimulus in times of recession. The Congressional Budget Office has estimated that every one dollar of NOL carryback proceeds provides up to 40 cents of increase in gross domestic product (GDP) due to increased business activity. [3]

Finally, the tax policy justification for an expanded NOL carryback period is that a 12-month period may not properly measure a firm's net income for tax accounting purposes. For example, if a business receives most of its income early in a multiyear contract and then has costs spread over future years, then the tax treatment of the first year (all revenue, no costs) will result in an effective tax rate that is far in excess of the statutory tax rate. This inefficient outcome is particularly harmful for industries with long business cycles, such as home building and affiliated businesses in the residential construction sector. However, suitable carryback periods for losses or deductions are in place if they align the effective business tax rate with the statutory rate.

To see this, consider the following stylized example. Suppose a regional home builder, during the boom period, sold 100% of a 200 home community with an average sale price of $300,000 per home. Further suppose for simplicity that 50% of the sales are cash payments upfront, and the remaining 50% are based on a 15% downpayment and final payment upon completion of construction. Consistent with previous NAHB research, assume 10% of the sale price is profit for the builder, land and development costs are 78% (with 40% of that amount expended in year 2 and 60% in year 3), and the final 12% allocable to overhead, financing and other business expense (evenly expended in years 1 through 3). [4] Assume a tax rate on net income of 35%.

As can be seen in Table 1, under this example, with no NOL carryback and a business cycle that significantly exceeds a 12-month tax year, there arises an effective tax rate of 187% on the actual $6 of net income for the project (until an NOL can be claimed in the future), which exceeds the statutory rate of 35%. (Table 1)

Table 1: Regional HomeBuilder, Inc.
No NOL Carryback
Year 1 2 3 Total  
Revenue $34.50 $0.00 $25.50 $60.00
Costs $2.40 $21.12 $30.48 $54.00
Net Income $32.10 -$21.12 -$4.98 $6.00 Effective Tax Rate
Taxes $11.24 $0.00 $0.00 $11.24 187%

With a one-year NOL carryback, the effective tax rate falls to 64%, as reported in Table 2. And with a two-year carryback, in this example, the effective rate falls to statutory rate of 35% in Table 3. This stylized example illustrates the problem with both longer projects, as found in construction, as well as interactions of the business cycle and how an effective NOL carryback period can help smooth out net income to appropriately measure economic profit for tax purposes. (Tables 2 and 3)

Table 2: Regional HomeBuilder, Inc.
One-year NOL Carryback
Year 1 2 3 Total  
Revenue $34.50 $0.00 $25.50 $60.00
Costs $2.40 $21.12 $30.48 $54.00
Net Income $32.10 -$21.12 -$4.98 $6.00
NOL-adjusted Net Income $10.98 $0.00 -$4.98 $6.00 Effective Tax Rate
Taxes $3.84 $0.00 $0.00 $3.84 64%


Table 3: Regional HomeBuilder, Inc.
Two-year NOL Carryback
Year 1 2 3 Total  
Revenue $34.50 $0.00 $25.50 $60.00
Costs $2.40 $21.12 $30.48 $54.00
Net Income $32.10 -$21.12 -$4.98 $6.00
NOL-adjusted Net Income $6.00 $0.00 $0.00 $6.00 Effective Tax Rate
Taxes $2.10 $0.00 $0.00 $2.10 35%

For these economic and policy reasons, in 2002 Congress enacted a temporary modification to the tax code. Section 102 of the Job Creation and Worker Assistance Act of 2002 established a five-year carryback period for NOLs arising in tax years 2001 and 2002, thereby helping industries suffering as a result of the 2001 recession. It is worth noting that at this time, the home building sector was helping to make the 2001 recession quite mild in historical terms.

Similar proposals have been considered during the current economic downturn. However, in 2009 Congress ultimately passed a more limited version of the 2002 expansion. The American Recovery and Reinvestment Act of 2009 (ARRA) established a five-year carryback for tax losses arising in 2008 but only for qualified small businesses, which were defined as business with average gross receipts over the prior three years (including the year of the NOL) of no more than $15 million. This restriction prevented many home builders from benefiting from the provision. It is also the case that the gross receipts test creates an unfair bias against high volume, low profit sectors such as construction.

Adding further weight for Congress to consider an expanded NOL provision, the president's 2010 budget proposal contained a five-year NOL carryback period for more businesses for tax losses arising in tax years 2008 and 2009. Recent legislative proposals in Congress also involve a suspension of the 90% Alternative Minimum Taxable Income limitation for NOL carryback for business taxpayers who paid AMT in the year of the carryback. [5] This change is important for sectors, such as home building and construction, that include many businesses organized as pass-thru entities, such as S Corporations and Limited Liability Corporations.

The Economic Status of the Home Building Sector
Without a doubt, businesses in the home building sector, including related companies in construction supply, home furnishings and other elements of the construction sector, are experiencing the most painful economic downturn since the Great Depression.  A review of industry statistics demonstrates the historic and dramatic nature of the ongoing recession.

  • Total housing starts were down 80% from 2.273 million in 2006 to 454,00 as of April 2009
  • Single-family starts were down 80.4% from 1.823 million in 2006 to 357,000 as of February 2009
  • Multifamily starts were down 80% from 450,000 in 2006 to 90,000 in April 2009
  • New home sales were down 76.3% from 1.389 million in 2005 to 329,000 in January 2009
  • 1.04 million jobs have been lost in the home building sector since February 2006 (30.2%)
  • As a share of the economy, residential fixed investment (home building) has fallen from 6.2% in 2006 to 2.4% in the second quarter of 2009
  • This decline in housing’s share of the economy has in the last two years routinely subtracted a point or more of GDP growth or added a point to GDP decline

Despite recent signs that these declines are slowing and some evidence of stabilization in home building, access to capital remains restricted.  Without access to credit, home builders will struggle to survive when the economy rebounds.  In this regard, an expanded NOL carryback rule is key to the survival of many home building businesses.  Without access to refunds of prior overpayment of taxes, these businesses will be forced to continue layoffs and shutdown businesses, many of which are multi-generational family-owned small businesses.


Federal Budget Consequences of an Expanded NOL Carryback Period
As with other elements of fiscal policy, the discussion of the pros and cons of an expanded NOL carryback involve the projected impacts on the Federal budget. The Department of the Treasury Office of Tax Analysis has estimated that the five-year NOL carryback proposal would result in a revenue loss to the Treasury of $63.5 billion in fiscal years 2009 and 2010 (the expected amount of the anticipated accelerated deductions that otherwise would be claimed as carryforwards). [6] On the opposite side of the ledger, the proposal scores a $45 billion revenue gain for fiscal years 2011 through 2019 due to the "loss" of the future deductions as forecasted to be used under the present law baseline but which are in fact not claimed in those years because they are used as a carryback.

However, because the federal government generally uses a 10-year budget window, NOL deductions expected to be claimed in fiscal years 2020 through 2029 but which are, under the proposed policy, claimed as a carryback are not scored as revenue gains. These scoring conventions give rise to a 10-year revenue estimate from the Treasury Department of a loss of $18.5 billion. [7] 

For a similar proposal, the Congressional Joint Committee on Taxation (JCT) estimates a revenue loss of nearly $60 billion for fiscal year 2010 and a 10-year score of $17.5 billion. These are the numbers that will be used in any future Congressional debate of the proposal. It is worth noting that if the government used a 20-year scoring window, the revenue estimates for an expanded NOL carryback window would be close to zero. There would be some small revenue loss for the claim of NOL deductions by businesses that would otherwise lose their carryforwards under the baseline due to restructuring or bankruptcy.

As with other tax issues, these revenue scores are estimated under static (or microdynamic) scoring conventions that assume the proposal will have no impact on GDP. As noted above, the CBO has estimated that the proposal - by channeling resources to businesses in need of economic stimulus - would have a positive impact on GDP, thus generating a dynamic (or macroeconomic) impact.

Previous research by the JCT has indicated that a corporate rate cut with no fiscal offset would result in a dynamic, positive feedback for tax receipts of 13 to 21 percent depending on Federal Reserve action. [8] A neutral Federal Reserve, as is reflected in today's monetary policy, is associated with the higher range of these estimates. [9]
This set of previous research indicates that the feedback effect from the $60 billion NOL relief for fiscal year 2010 could total $10 billion. Taken together with the artificial static 10-year revenue estimate, these estimates indicate that over a 20-year period, NOL relief would, at the worst, result in no revenue loss for the government and could produce revenue gains due to the economic stimulus it would provide.

Economic Impact of an Expanded NOL Carryback Period
As noted above, a central benefit of NOL tax relief is the provision of funds to struggling businesses.  These funds can be used to pay wages, retain workers, or undertake business activity that increases national income. Using Bureau of Economic Analysis and Internal Revenue Service Statistics data, this paper presents estimates of the impacts of NOL relief, as detailed above, on employment and business survival of firms in the construction sector. [10] 
The analysis indicates that NOL relief would generate 53,121 jobs in the construction sector during the 12 months after enactment of an expanded NOL carryback period.  Further, the business tax relief would prevent the failure of more than 7,900 businesses, mostly small businesses, in the sector.  The analysis also indicates that the NOL relief would create or save more than 230,000 jobs in sectors outside of construction, as the proposals benefit all businesses with losses - not just home builders or construction businesses.

Estimation Methodology
These estimates were generated through two regression analyses. In each, data from 1999 to 2006 were used, which corresponds roughly to the last business cycle with 2006 being the most recent IRS data available. For the first statistical analysis, total private sector employment was regressed on corporate net income, GDP and the aggregate value of the costs-of-goods-sold. The resulting coefficient for corporate net income was used to predict the impact of adding the NOL tax relief to the balance sheets of businesses. As can be seen below, the correlation between net income and employment is strong, indicating the predictive value of the model. (Figure 1)

Figure 1. Private Sector Income and Employment

For the second analysis, the number of corporate construction firms was regressed on construction sector net income and GDP. [11] Again, the estimated coefficient for net income was used to predict the impact on the number of firms in the sector.

Finally, to determine the benefit of the proposal on the construction sector specifically, a weighted average of the construction sector's share of the private economy in terms of gross domestic product (5.4% in 2006) and the share of employment losses since the beginning of 2006 (23% of all private sector job losses) was used. For the purposes of this paper, the model used the JCT estimate of the $60 billion fiscal year 2010 refund impact. The resulting allocation to the construction sector is estimated to be $11 billion. This value was used to forecast the impact of NOL relief for the sector.

For the jobs estimate, the estimated impacts were transformed from Bureau of Labor Statistics (BLS) style numbers into a measure of Full-Time Equivalents (a smaller number) by using a conversion factor calculated by comparing the 2006 BLS total employment by sector data and comparable Bureau of Economic Analysis Full-Time Equivalent numbers.

For more information about this item, please contact: Robert Dietz at 800-368-5242 x8285  (

[1] Internal Revenue Code Section 172.
[2] Congressional Research Service. Net Operating Losses: Proposed Extension of the Carryback Period. May 27, 2009.
[3] U.S. Congress, House Committee on the Budget. The State of the Economy and Issues in Developing an Effective Policy Response. The Economic Outlook and Budget Challenges, 111th Cong., January 27, 2009.
[4] Census data reveal that as of April 2009, the median time period between completion of construction and final sale had risen to 10.9 months (  Further, Census data indicate that the average length of time between the start and completion of construction as of 2008 was 7.7 months
[5] S. 823 (the Snowe-Baucus bill) and H.R. 2452 (the Neal-Tiberi bill).
[6] General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals. Department of the Treasury. May 2010.
[7] The Treasury estimate actually reports a 10-year score of raising $9.3 billion on the table.  While some may interpret this as a form of dynamic or macroeconomic analysis scoring, it is an artifact that the 10-year score does not include fiscal year 2009 the year in which more than half the NOL relief is claimed, thus undercounting the impact of the proposal.
[8] Macroeconomic Analysis of Various Proposals to Provide $500 Billion in Tax Relief. Joint Committee on Taxation. March 1, 2005.
[9] A "neutral" policy in this context means that the Federal Reserve does not increase interest rates to offset or dilute the fiscal policy of tax relief. Given the Federal Reserve's aggressive monetary policy in 2009, we can classify this stance as non-offsetting (and in fact complementary) to on-going expansionary fiscal policy efforts.
[10] This analysis uses the broader construction sector because not all of the data are available at the more narrow residential construction sector level.
[11] Cost-of-goods-sold was not included due to multicollinearity issues in part to more limited variation in the number of firms relative to changes in employment over the data period.

For more information about this item, please contact Robert Dietz at 800-368-5242 x8285 or via email at

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