As America stands at an important crossroads, numerous elements of the Tax Cuts and Jobs Act from 2017 are nearing their expiration date this year. This scenario presents Congress with two distinct paths: allowing these provisions to lapse, which could result in a significant tax hike detrimental to many Americans, or deciding to make these cuts permanent, a move that risks exacerbating the country’s already troubling debt situation if not balanced by revenue measures.
Instead of choosing either extreme, a more nuanced and responsible fiscal strategy is essential in addressing this issue.
Political discussions often fall into the trap of advocating for tax reductions without considering the larger fiscal picture. We’re currently burdened with $37 trillion of national debt, a figure projected to skyrocket to $59 trillion in the next decade. The annual spending shortfall is staggering, nearing $2 trillion, and we’re also staring down a major entitlement crisis. Not to mention, the interest on the national debt is the fastest-growing component of the federal budget. Given these changing circumstances, the need for fiscal responsibility has never been more pressing.
The initial 2017 tax cuts carried a price tag of $1.5 trillion, and making them permanent could potentially cost $4.6 trillion. Though these projections might slightly underestimate the potential for increased taxable income, investment, and growth, the cost remains substantial.
There’s much to learn from the 2017 tax reform. Crucially, not all tax cuts are equally effective in promoting growth. It’s wise to make only the most economically stimulating cuts permanent, while allowing less effective ones to expire or extend temporarily.
The most significant growth and revenue boosts from the 2017 tax changes were mainly due to the permanent corporate tax rate reduction from 35% to 21%. This certainty encouraged businesses to invest, leading to job creation and wage growth. Permanent cuts provide businesses with the stability needed for expansion, unlike temporary measures that incite short-term boosts but generate uncertainty.
Pairing permanent corporate tax reductions with the full expensing of capital investments, which is soon to expire, drew both domestic and foreign investment. This led to increased economic productivity and job opportunities over time.
A new study from the Hoover Institution highlights how sensitive businesses are to changes in corporate tax rates. Researchers, including Kevin Hassett, the director of the National Economic Council, and economists Jon Hartley and Josh Rauh, found that a one-percentage-point reduction in capital costs could increase investment rates by as much as 2.4%, exceeding previous estimates.
Therefore, Congress should focus on making full capital investment expensing permanent, potentially extending it to structural investments as well.
Similarly, individual tax rate cuts merit permanence. These cuts incentivize work, saving, and investment, particularly among high earners, thus fostering a more robust and adaptable economy. Recent analyses by Rauh and Ryan Shyu on the effect of California’s Proposition 30 illustrate high-income individuals’ higher sensitivity to tax changes than previously acknowledged. The proposition increased marginal rates by up to three percentage points for affluent households, prompting an additional 0.8% of such taxpayers to leave the state and those who remained to reduce their taxable income, undermining anticipated revenue by up to 61% within two years. This underscores the outsized impact of allowing individual tax cuts to expire and the underestimated effect of extending them on the deficit.
While the economics underlying this are straightforward, navigating congressional rules adds complexity. The budget reconciliation process allows for tax, spending, and debt-related legislation to pass with a simple Senate majority, bypassing the traditional filibuster. However, per the Byrd Rule, this process is confined to budgetary items and cannot increase the deficit in the long term without offsets.
Therefore, a key lesson is that legislators should cement the revenue-generating components of the 2017 measure and implement spending cuts.
Prolonging the limitations on the state and local tax (SALT) deduction, mortgage interest deduction, and doing away with the personal exemption could significantly augment revenue, sufficiently offsetting the costs associated with the most beneficial tax cuts. Congress should reevaluate other tax breaks, such as the corporate SALT deduction and certain subsidies and incentives, while also reassessing overall spending to ensure fiscal stability.
Finally, other costly and less growth-oriented provisions, though popular, should be extended only temporarily. This includes the expanded Child Tax Credit, the larger standard deduction, and alternative minimum tax reductions, all of which could be scheduled to sunset in a few years rather than being cemented permanently. Such measures may help manage deficits while providing Congress the opportunity to debate each issue thoroughly.
This approach may also be applicable to President Trump’s proposed new tax breaks for tips, overtime pay, and Social Security benefits, policies that aren’t particularly growth-oriented and could cost $5 trillion over a decade.
With only a single vote Republican majority in the House, the task of extending the tax cuts via reconciliation is daunting. Setting clear priorities and guidelines can help navigate this process effectively. Ultimately, the goal is to stimulate economic growth without further inflating the national deficit or debt.
Veronique de Rugy serves as a senior research fellow at the Mercatus Center, George Mason University.
