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Five Ways to Improve the Senate Tax Bill

Nov 29, 2017 | Taxes

The current Senate version of the Tax Cuts and Jobs Act (TCJA) would add too much to the debt, but several improvements could make the bill both more fiscally responsible and pro-growth.

With the tax code in need of reform but debt at its highest point as a share of the economy since just after World War II, Congress should pass a fiscally responsible tax overhaul that grows the economy but does not add to the debt.

To improve the bill, the Senate should replace gimmicks with real savings, enact further base broadening, add a tax expenditure cap, create a revenue trigger, and – after tax reform – turn their focus toward entitlement reform.

1. Replace the Senate Bill's Gimmicks with Real Savings

The Senate bill currently uses several budget gimmicks to try to get around the limits of reconciliation. As a result, the Senate bill increases the debt by $1.4 trillion using conventional scoring but sets up a potential true cost of up to $1.9 trillion, or $2.2 trillion including interest, assuming expiring policies are continued and certain future tax hikes are ignored. The largest gimmick is the arbitrary expiration of the individual tax provisions, hiding roughly $250 billion of potential costs. The bill also allows expensing to expire after five years, imposes several new taxes eight years in the future, and includes other sunsets and sunrises.

Senators should remove these gimmicks and replace them with real savings. As an example, they could make the five-year expensing provision permanent and offset the cost by further limiting the deductibility of business interest costs. Since it is clear many lawmakers intend to make expensing permanent, this swap would serve the dual purpose of eliminating a $100 billon gimmick while also improving investment incentives and therefore better promoting economic growth.

The Senate should also address the other $400 billion of sunsets and sunrises. Expiring policies should be made permanent and be paid for. Offsets delayed to well in the future should either be implemented up front or replaced with more realistic savings that are implemented soon.

2. Enact Further Base Broadening

While the tax code is currently projected to offer over $18 trillion of tax expenditures over the next decade, the current Senate tax bill cuts just $3.7 trillion of tax breaks. Significant more base broadening would improve the bill, both by reducing its costs and making the tax code simpler, fairer, and more economically efficient.

In looking for offsets, the Senate could start by turning to its House companion, which includes over $300 billion of reforms not incorporated in the Senate bill. Additionally, the Senate should look to the Tax Reform Act of 2014 – a comprehensive tax reform bill released by former Ways and Means Chairman Dave Camp (R-MI). Even excluding excise taxes and 'cost-recovery' provisions in that bill (which run counter to expensing), Chairman Camp's bill included an additional $300 billion of potential reforms that are not part of the Senate bill. Previous President's budgets offer additional options.

One other option would be to repeal the deduction for state and local taxes (SALT) paid by businesses. Although taxes are technically a business expense, because the bill repeals the SALT deduction for individuals in full it would be more equitable to also repeal the business SALT. Retaining the business SALT deduction would also encourage tax gaming and arbitrage, weakening the effectiveness of the individual SALT repeal.

Select Base Broadening Options Not Included in the Current Senate Tax Bill

Policy
10-Year Savings
Source
Repeal corporate state and local tax deduction (SALT) $200 billion CRFB
Eliminate exclusion for “private activity bonds”
$40 billion
House Bill
Cap mortgage interest deduction at $500k on primary homes
$20 billion
House Bill
Remove deductions/exclusions for employee awards and gyms
$5 billion
House Bill
Reform and repeal various energy tax breaks
$10 billion
House Bill
Reform higher education tax breaks
Up to $55 billion
House Bill
Phase out exclusion of gains from home sales
$20 billion
House Bill
Repeal rather than scale back structure rehabilitation credit
$5 billion
House Bill
Reform or repeal low-income housing credits
$10 to $40 billion
Chairman Camp's Bill
Freeze existing limits on retirement account contributions
$65 billion
Chairman Camp's Bill
Repeal Blue Cross/Blue Shield deduction
$5 billion
Chairman Camp's Bill
Reform treatment of derivatives
$20 billion
Chairman Camp's Bill
Phase out Child Tax Credit (CTC) beginning at $230k of income, not $1 million
$50 billion
House Bill
Require Social Security number for children to receive non-refundable portion of CTC
$15 billion to $30 billion
House Bill
Repeal like-kind exchanges for real estate (others repealed in bill)
$10 billion
Chairman Camp's Bill
Repeal or reform FICA tip credit
$5 billion to $10 billion
House Bill
Repeal rather than scale back orphan drug credit
$25 billion
House Bill
Repeal medical expense deduction
$40 billion
House Bill
Repeal adoption credit and exclusion for dependent care assistance
$10 billion
House Bill
Tax capital gains/dividends as ordinary income with ~45% deduction
$50 billion
Chairman Camp's Bill
Repeal dependent care credit
$30 billion
Chairman Camp's Bill
Add a 2% floor to charitable deduction & other reforms
Up to $100 billion
Chairman Camp's Bill
Tax carried interest as ordinary income
$20 billion
President Obama's Budget
Close various estate tax loopholes
$10 billion
President Obama's Budget
Treat retirement accounts as distributed five years after death
$5 billion
President Obama's Budget
Eliminate ESOP deduction
$10 billion
President Obama's Budget
Repeal fossil fuel tax breaks (most related to cost recovery)
$20 billion
President Obama's Budget

Sources: CRFB calculations and Joint Committee on Taxation on House Tax Cuts and Jobs Act, Chairman Camp's 2014 Tax Reform Act, and several of President Obama's budgets. Note: all numbers rounded to the nearest $5 billion.

3. Add a Cap on Tax Expenditures

This year's experience with tax reform has reinforced a well-known policy gripe: it is easy to say we need to get rid of tax expenditures, but it is hard to say which ones we ought to get rid of. To reduce the cost of some of the larger (but largely untouched) tax preferences in the code, policymakers should consider a broad tax expenditure cap. Such a cap could limit numerous tax expenditures at once – possibly for high earners only – and could take numerous forms.

One option is to limit the combined value of numerous tax breaks, as proposed by the Feldstein-Feenberg-MacGuineas cap. A second alternative would be to limit the value of each tax break to a certain rate. For example, Chairman Camp's Tax Reform Act allowed most deductions and exclusions only against the 25 percent rate – meaning a taxpayer in the 35 percent bracket would receive a 25 cent tax reduction for every dollar of deduction, rather than 35 cents (those in the 25 percent bracket or below would see no change). This is similar to a proposal from President Obama to limit the value to the 28 percent bracket. Another option would be something similar to an idea floated by Mitt Romney's 2012 campaign to limit the total amount that high-income taxpayers can deduct and exclude from their income.

To raise sufficient revenue, an ideal cap would include all itemized deductions, most above-the-line deductions, the standard deduction, and the tax exclusions for employer-provided health care, municipal bonds, and foreign income. Such a cap could be applied only to higher earners and, depending on the details, could raise $500 billion or so.

4. Incorporate a Revenue "Trigger"

Lawmakers have justified enacting a large tax cut under the argument that faster economic growth will produce at least $1 trillion of new revenue. No credible analysis has found that the Senate tax bill would produce $1 trillion of revenue or the 0.4 percentage points of faster annual growth that advocates have claimed it would. Lawmakers should rely on credible dynamic estimates such as those produced by the Joint Committee on Taxation. Even then – and especially if they rely on higher estimates – a revenue "trigger" could help ensure revenue losses don’t persist of expected growth fails to materialize.

Lawmakers are already discussing such a trigger, but the details matter. Ideally, a trigger would hold back some share of the proposed tax cuts unless sufficient revenue levels have been achieved over a multi-year period. Alternatively, a trigger could snap back some tax cuts – or impose new base broadening – if targets are not met.

Triggers could be designed in any number of ways, but it is important that a trigger be credible and that there be a commitment to allow it to take effect (incremental triggers may better achieve this goal). The trigger should also be large enough to ultimately cover any revenue that does not end up materializing as a result of economic growth or other factors.

While it is important to get the details right, it is also important to set an achievable target. If lawmakers truly believe tax reform will generate enough growth to raise $1 trillion, they should have no problem with a $1 trillion trigger. If they believe growth will be more modest, that’s all the more reason to reduce the cost of the bill.

5. Don't Forget About Future Spending Reforms

Even in the scenario that tax reform is improved enough to reduce the deficit on a dynamic basis, it's important that senators remember that revenue is only one side of the deficit equation. To promote growth and reduce deficits, spending reforms will ultimately be necessary – keeping in mind that spending growth is largely driven by population aging and rising health care costs. With debt at record-high levels and $10 trillion projected to be added to it over the next decade, we should be looking at ways to reduce, not increase, our debt. Doing so will require making Social Security solvent (try your hand at doing so with our Social Security Reformer) and slowing the growth of Medicare and Medicaid while also cutting other lower priority spending.

To achieve Social Security reform, lawmakers should consider embracing a bipartisan commission. With regards to health care and other spending, they could work toward a deal with a mini-bargain to address paying for sequester and disaster relief, reducing mandatory spending, and improving the trajectories of federal health spending.

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These are just a few solutions that, if properly put in place, could improve the tax reform bill and make it both pro-growth and fiscally responsible. Lawmakers should make choices that ultimately put the debt as a share of the economy on a downward sustainable path, not increase it.

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