Republicans have their hands full this year, with the individual provisions of the 2017 Tax Cuts and Jobs Act set to expire. If Congress fails to act, 62 percent of taxpayers will see a tax hike. But if Congress simply extends the law, upwards of $3.5 trillion will be added to our already unsustainable deficits.
As in any year where consequential legislation is at the forefront of Congress’s agenda, the D.C. lobbyists will be at work double time. Every group has its tax priority and is willing to sacrifice a stronger code for one that has its industry’s win. Though the 2017 reforms made strides to simplify our tax code, our tax laws are still — kindly put — a mess.
If Republicans want a successful year for tax reform, they must put aside the extensive demands for niche provisions and, instead, approach this debate with a principles-first mindset.
What does a principles-first mindset look like? For something as big and confusing as the U.S. tax code, it can be a daunting question. But it can boil down to Congress’s tax-writers asking themselves three questions: Does this policy grow the economy? Does this policy cost substantial revenue? Does this policy simplify our tax code?
Already, we’ve seen groups come forward to push for specific policies.
There’s the SALT Caucus, which wants to see the $10,000 cap on the state and local tax deduction nixed or dramatically increased. President Trump has advocated eliminating taxes on tips, which has gained traction in Congress. And a debate has begun regarding the nonprofit sector — particularly nonprofits that earn a lot of business-like income or investment income, such as universities.
Competing factions will build their own narratives for how to treat these policies. To cancel out the noise, lawmakers should instead take these provisions through the principles-first machine to test their merit.
- How would these policies change the economy? The SALT cap can affect state tax policy decisions and encourage individuals to move to lower-tax states; removing it would give states more flexibility to levy higher taxes on income, superseding much of the relief these workers may get from a higher SALT cap. Meanwhile, removing tax on income earned from tips would introduce complexities and distort choices about whether a worker is eligible to earn tips or wages. This could drastically change how the service industry is structured. While a higher endowment tax may not be the best tool to change university decisions, the rise in tuition costs has at least leveled off (and fallen, in some cases) in recent years.
- What impact do these have on revenues? Relief from the SALT cap gets expensive quickly — into the hundreds of billions based on most proposals. Not taxing tips has a bit more fiscal uncertainty, but it likely puts more than $100 billion at risk. Though it wouldn’t have a negative fiscal impact, the revenue raised from the endowment tax (or even proposed increases) is simply a drop in the trillion-dollar bucket lawmakers need to fill, likely raising under $50 billion.
- How would changing these simplify our code? SALT cap relief and changing the tax treatment of tips would complicate the tax code. Neither should be part of tax reform. If relief for those in high-tax states and the tip industry is a priority, policymakers would be better served by eliminating itemized deductions and broadening the tax base to support lower tax rates for everyone. The current endowment tax applies narrowly to larger endowments with a per-student endowment size threshold. If the tax is intended to encourage a spend-down of endowment funds, this makes sense, but not if the idea is to place endowment funds on the same playing field as other types of earned income. A better approach may be to broadly apply the tax on endowments, irrespective of size or per-student assets, before raising the rate.
These are just three examples, and the principle-first approach should be exercised toward every expiring provision.
Take something like full expensing, for example, which allows for a business to deduct the cost of capital investments and research and development. If full expensing were made permanent, it would produce enough economic growth to offset nearly half its costs, all while making the tax code more competitive and easier for our businesses to comply with.
On the other hand, the Tax Cuts and Jobs Act limited a litany of itemized deductions that have little impact on the economy, and reinstating them to their pre-act shape (or adding new ones) would cost billions while muddying our tax code.
Republicans took one step forward during the 2017 reforms, and this is their chance to avoid taking two steps back. The only way to achieve this is for Congress to focus on principles, policy, and permanence, not on the industry with the loudest megaphone that day.
Daniel Bunn is president and CEO of the Tax Foundation.