Editorial written by Bloomberg Opinion Editorial Board.
For the new Congress, deciding the fate of the 2017 Tax Cuts and Jobs Act will present an immediate dilemma. Allowing the law’s provisions to expire as scheduled at the end of the year would effectively raise taxes on tens of millions of Americans. Yet fully extending them would add almost $5 trillion to an already dire 10-year budget deficit. What to do?
As a start, lawmakers need to accept budgetary reality: With debt expected to reach nearly 120% of gross domestic product by 2035, comprehensive tax reform and spending cuts — across a range of entitlements and other programs — will be unavoidable. A bipartisan commission should be empaneled to lay out realistic options for such an overhaul, with a goal of stabilizing the debt ratio at its current level of about 100% of GDP.
With that in mind, both parties should also agree that any extension of the law will be revenue-neutral over the next decade. The law cut individual tax rates, increased the standard deduction that taxpayers can choose instead of taking itemized deductions for mortgage interest and assorted other outlays, trimmed the value of some of those deductions, increased the child tax credit, and cut estate and gift taxes. It reduced the corporate rate from 35% to 21% (this change doesn’t expire automatically), raised depreciation allowances and cut taxes for so-called pass-through businesses (which pass their earnings directly to owners and investors and aren’t taxed separately in their own right).
Under normal conditions, many of these reforms might’ve been sensible. They simplified the tax code and most likely helped investment. But the overall effect on growth wasn’t nearly enough to boost revenue and curb borrowing. Combined with the new spending necessitated by the pandemic, the law helped push public debt onto an unsustainable trajectory. The next big economic setback would cause it to rise even further — and investors’ willingness to keep lending might run out at the worst possible moment.
The best strategy for a revenue-neutral extension would be to combine the law’s main structural features with more judiciously chosen tax rates and further base broadening. To illustrate, as compared with a full extension, dial back the standard deduction by 5%; set most individual rates higher than in the Tax Cuts and Jobs Act but lower than before 2017; restore the top rate of 39.6% and apply it to incomes above $400,000 (not $600,000); phase out the child tax credit at $200,000 (not $400,000); maintain the $10,000 cap on the deduction for state and local taxes, phase the deduction out altogether for incomes of more than $400,000, and apply the cap to businesses as well as individuals; limit the mortgage-interest deduction to loans of less than $500,000 (not $750,000); restore the estate tax to its pre-tax-cuts level; end step-up basis for capital gains at death; tighten the concessions to pass-through enterprises; and raise the corporate rate to 25% (as compared to 35% before the tax cuts).
Many variations are possible. But some such combination could deliver revenue neutrality (or better, if the mix were tilted more forcefully in favor of fiscal prudence) with the further benefit of making the code more progressive. To repeat, even this wouldn’t come close to curing the country’s budgetary sickness: That will require some combination of yet higher taxes and painful spending cuts. But it would at least avoid making the problem worse. As a first step, that shouldn’t be too much to ask.
