The Tax Cuts and Jobs Act passed Congress yesterday. As with any major legislation, the new law includes some beneficial changes, some bad tax policy, and especially missed opportunities. It is not the last word on US federal tax policy. After President Reagan’s 1981 tax cuts, he turned around and supported significant deficit reduction and loophole closing tax legislation in 1982 and 1984, and also a revenue-neutral tax reform in 1986.
The bill’s ten-year revenue loss totals $1.5 trillion. The modest positive economic effects from deficit spending and certain tax reductions could alternatively have been achieved with needed government infrastructure spending that would also reduce the costs of doing business in the US. The beneficial tax reductions could have been financed with beneficial tax base broadening.
According to the Congressional Joint Committee on Taxation’s (JCT) revenue estimates, the bill includes provisions with $5.5 trillion of gross tax reductions and $4.0 trillion of gross tax increases. The bill costs $2.5 trillion from reductions in individual (-$1.2T) and corporate (-$1.3T) statutory tax rates.
Some people have asked whether this legislation should be called tax “reform”. My answer is a qualified yes. The move to a “territorial” tax system with recognition that tougher anti-base erosion and profit shifting rules, plus some reduction in the corporate tax rate, were badly needed and are a significant fundamental tax reform. The increase in the standard deduction and tighter limitations on various itemized deductions is along the lines of lower rate, broader base reform.
The legislation, however, is a significant deficit-increasing tax cut, and creates several new tax expenditures (government subsidies provided through the tax system in the form of special lower tax rates or exemptions). The 20% deduction for certain qualified pass-through business income and reduced rate on certain foreign-derived intangible income (e.g. type of “patent box”) are new and complex tax expenditures. The legislation also moves away from a net income tax by adding further limitations on the use of business losses for both active partnerships and corporations.
The table below shows the legislation’s provisions with the largest tax reductions and tax increases.
Besides a tax cut disproportionately benefiting the well-to-do and which will burden our kids and grandkids with higher debt, the legislation missed an opportunity to do significant tax base broadening by reducing the largest tax expenditures. If the legislation had been revenue neutral from additional base broadening, then it would clearly have been tax reform. The legislation did not touch the three largest tax expenditures: exclusion of employer-provided health insurance ($3.0T over ten years), exclusion of pension/IRA contributions and earnings ($2.5T), and lower rate on dividends and capital gains ($1.6T). Meaningful reductions in any of those tax expenditures could have made the legislation revenue neutral and with a fairer distribution.
Tax expenditures in the US are very large, totaling as much as current income tax collections. Lowering corporate and individual tax rates will reduce tax expenditures given in the form of lower rates, exemptions, exclusions and deductions. Overall, I would expect the US tax expenditures on net to decline after the legislation from rate reduction, rather than from base broadening.
The US does a good job of measuring and monitoring income tax expenditures with annual reports by both the Congressional JCT and the US Treasury. I’m pleased to be working with the Switzerland-based Council on Economic Policies (CEP) in an effort to improve tax expenditure reporting globally. A new IMF blog with Agustin Redondo of the CEP presents some preliminary results from a new Global Tax Expenditure Database.
Tax cut vs. tax reform? The new bill is both, but 2017 was a missed opportunity for more significant tax reform. Future federal income tax reform is needed, and perhaps 1982 and1984-style loophole closing deficit reduction legislation will follow this new legislation. Focus on future deficit reduction should not be limited to just direct spending reductions, particularly after this $1.5 trillion tax cut.
Tom Neubig