Marc Goldwein & Tyler Evilsizer: Moving from a debt-busting tax cut to pro-growth tax reform

Marc Goldwein is the senior vice president and senior policy director at the Committee for a Responsible Federal Budget. Tyler Evilsizer is the deputy policy director. They recently wrote a blog post for the American Enterprise Institute's #TCJAWhatNow series. Read below:

In 2016, House Republicans released a “Better Way” tax reform framework, which called for dramatically lowering tax rates, eliminating the alternative minimum tax (AMT), repealing or reforming the vast majority of tax breaks, ending the estate tax, and replacing the corporate income tax with a business consumption tax. The framework aimed to substantially accelerate economic growth and improve simplicity through permanent, distributionally neutral, and deficit-neutral reforms to the tax code.

Sadly, the Tax Cuts and Jobs Act (TCJA) lived up to few of these principles. Rates may have gone down, but only one tax expenditure was actually repealed and few were reformed; the AMT and estate tax were retained in a smaller form; and the corporate tax was shrunk rather than shifted to a business consumption tax. Meanwhile, TCJA’s effects on economic growth was modest, it increased complexity in nearly as many ways as it reduced it, and it was neither permanent, distributionally neutral, nor deficit neutral. Although much of the bill will expire at the end of 2025, it still added nearly $2 trillion to the national debt — mostly by cutting taxes for the wealthiest Americans.

It’s no wonder then that so many of the experts writing in this series have expressed concerns over TCJA’s impact: It fell far short of what was envisioned. Regardless if one supports or opposes the TCJA, we should all agree that it could have done better.

Fortunately, it isn’t too late to fix what’s broken. It is neither advisable nor politically possible to revert entirely to the old tax code. We should build on the law’s improvements, repeal the expensive giveaways and gimmicks, and turn the TCJA from debt-busting tax cuts into true pro-growth tax reform. Here’s how.

Build on what’s working

We strongly opposed the TCJA — especially because of how much it added to the debt —but that doesn’t mean there’s nothing to like. The legislation got many things right, and policymakers should build upon them.

That starts with the law’s limits on itemized deductions. In 2017, 31 percent of taxpayers itemized; last year, only about 11 percent were expected to. Thanks in part to the $10,000 limit on the state and local tax (SALT) deduction and a smaller mortgage interest deduction, several regressive and distorting tax breaks are much smaller than they used to be. Policymakers should build on this success, strengthening the SALT cap by applying it to businesses rather than just individuals and by reducing it in half for single taxpayers to remove the marriage penalty. And now that itemized deductions are even more skewed toward a small number of wealthy taxpayers, further reductions to the mortgage interest deduction are also no-brainers.

In addition, policymakers should build on the temporary full expensing in the bill, which allows businesses to immediately deduct many of their capital purchases and was coupled with new limits on interest deductibility. Under current law, expensing begins to phaseout in 2023. The ideal policy might be to make all investments deductible and end the interest deduction, transforming the corporate income tax into a type of consumption tax. A good start would be extending and expanding existing expensing provisions while adopting further limits to the interest deduction.

Finally, enlarging the child tax credit in place of the dependent exemption was a great concept: simplifying two provisions into one and changing a regressively designed deduction into a more universal credit. However, low-income families did not get the full expanded child tax credit because it was made refundable up to only $1,400 per child. Making the credit fully refundable would help the provision’s progressivity and help families bear the cost of raising children. The cost of this change could be paid for in part by undoing the expansion of the child credit to high-income families.

Repeal what isn’t working

Other parts of the TCJA added needless complexity, encouraged tax avoidance techniques, provided a windfall tax cut on past investment decisions, and provided a poorly timed tax cut to the wealthy. Some of the worst decisions were made solely to shoehorn twice as many deficit-financed tax cuts into a bill without increasing its cost on paper.

One of the TCJA’s most troubling provisions, reviled by tax experts on the left and right, is the 20 percent deduction for pass-through income. While it was intended to give small businesses a parallel rate cut to corporations, this deduction offers huge windfalls for the rich, creates complexity, and encourages needless tax gaming. It also costs over $50 billion per year. Policymakers should repeal this deduction if they can, or at least make it less prone to abuse.

Many provisions were added to the TCJA for the sole purpose of including more tax cuts in the price tag that Congress allowed itself. One of the most senseless gimmick required the amortization of research and experimentation starting in 2022. While spreading out the deductibility of research costs to better match their benefits is not unreasonable in isolation, it makes no sense in the context of a bill that did the opposite for equipment, ending multiyear depreciation. Policymakers should be honest and ditch this provision rather than making businesses keep a new set of books to prepare for it.

 Finish what TCJA started, but do so responsibly

While the Better Way plan called for repealing the overly complex AMT and oft-gamed estate tax, the TCJA did neither. Instead, it retained both in much smaller forms. That decision had most of the fiscal cost of full repeal, without the benefit of ending these complex taxes. Policymakers should finish what they started, but with replacements to ensure the debt is reduced rather than increased further.

A full repeal of the AMT could be replaced with a broad limit on tax deductions and exclusions that prevents higher earners from benefiting from these provisions any more than the middle class. That limitation could raise far more than repealing the AMT would lose, and it would achieve the AMT’s goal — to stop high earners from not paying their fair share — without forcing people to calculate their taxes two different ways.

Meanwhile, the estate tax could be replaced by eliminating the current loophole that allows taxpayers to avoid capital gains taxes by holding them until death and by establishing an inheritance tax for large bequests. Again, these changes would raise far more revenue than the estate tax does and in a more fair and efficient way.

Extend only what we can afford

It makes no sense that “once-in-a-generation” tax reform expires after eight years. Not only do expirations make the tax cuts seem artificially cheaper but they also introduce uncertainty and undermine economic growth. Yet extending the bill without reform would double down on its costs, enshrine the law’s worst parts, and add as much as $300 billion per year to the deficit.

Instead, the expirations should be viewed as an opportunity to revisit the law and decide which elements are important. Extensions should be enacted sooner rather than later but should be done in a way that reduces rather than adds to the debt.

As a starting point, we suggest extending the structural reforms to the tax code — the limits to itemized deductions and replacement of the personal and dependent exemptions with a larger standard deduction and child tax credit. This trade would raise revenue, particularly with the proposed tighter limits on itemized deductions.

Some of the lower individual rates could also be extended, but only to the extent they are offset. Extending them all would thus require further reductions to tax breaks, changes to corporate taxes, new sources of revenue, or spending cuts.

Bringing it all together

We believe our above suggestions would improve the tax code relative to current law or pre-2017 law. And while the revenue effect would depend on details beyond what we have described, it’s easy to imagine covering the $1 trillion remaining direct cost of the TCJA over the next decade. Fiscally responsible extensions should ideally raise more on top.

Illustrative Framework to Improve the TCJA
Policy     Potential Revenue, 2020-2029
Expand SALT cap to businesses, reduce cap in half for single taxpayers, and further scale back mortgage deduction*      $500 billion
Make expensing permanent while tightening the interest deduction cap  -$50 billion
Make the child tax credit fully refundable and phase it out at higher incomes*  -$50 billion
Repeal or reform the pass-through deduction and limits on losses*     $200 billion
Repeal scheduled amortization of research & experimentation     -$100 billion
Permanently repeal the alternative minimum tax (AMT) and estate tax   -$500 billion
Limit the value of deductions (including standard deduction) and exclusions for higher earners $500 billion
Eliminate step-up basis of capital gains and establish an inheritance tax $500 billion
Extend structural reforms and other provisions in a fiscally responsible manner     $0 to $500 billion
Total Potential Revenue Gain  $1 trillion to $1.5 trillion
Increase in deficit from the TCJA (2020-2029)`      ~$1 trillion

Revenue estimates extremely rough. *Changes to non-business SALT cap, mortgage deduction, child tax credit, and pass-through deduction assumed only through 2025 expirations; other provisions are assumed permanent

`Figure based on CBO, excludes debt service but include macroeconomic feedback to revenue and interest costs.

The tax code’s purpose is to raise enough revenue to finance the costs of government; it is not doing that. Currently, more than one in five dollars that the government spends are deficit-financed, and the deficit is higher than it has ever been at this point in the economic cycle. Those high deficits will burden long-term economic growth, weighing down what should have been positive gains from tax reform. A tax code that raises sufficient revenue is a better tax code and more pro-growth at that.

* * *

TCJA did not live up to the Better Way principles — it was expensive, regressive, only modestly pro-growth, and introduced new complexity into the code — but it did include a number of important reforms. The country would have been better off without a $2 trillion tax cut but would be better served improving the TCJA than endlessly relitigating it. Lawmakers should build on what works, remove what doesn’t, finish what TCJA started, enact responsible extensions, and help tax reform live up to its potential. 

Read the piece on AEI's site here.

"My Views" are works published by members or staff of the Committee for a Responsible Federal Budget, but they do not necessarily reflect the views of all members or staff of the Committee.