In 2017, Congress passed, and former President Donald Trump signed, the Tax Cuts and Jobs Act into law. The TCJA made several improvements to taxation in the United States. But by no means was it perfect. Most of the individual income tax provisions are scheduled to expire at the end of 2025 and some provisions are not ideal.
Congress should not simply extend the law. They have an opportunity to build on the TCJA and pass fiscally responsible, pro-growth tax reforms.
Prior to the passage of the TCJA, the federal tax code had several problems. The individual income tax had high statutory tax rates that discouraged work and a narrow tax base that favored those who itemized their deductions. At the same time, the individual code was unnecessarily complex, requiring more than 5 million tax filers to calculate their taxes twice: once under the alternative minimum tax and again under the ordinary income tax.
The business tax code was anti-growth and internationally uncompetitive. The corporate income tax rate stood at 35%, the highest in the developed world. In addition, we were one of the last countries to tax the worldwide profits of U.S.-based multinationals.
To simplify the tax code and promote economic growth, the TCJA cut and reformed individual and corporate income taxes. For individuals, the law reduced statutory tax rates while broadening the tax base and simplifying tax filing. It reformed family benefits, limited certain itemized deductions, and scaled back the AMT. The corporate reforms included a significant reduction in the corporate income tax rate to 21%, reforms to the tax treatment of multinational corporations, and 100% bonus depreciation, which allows businesses to immediately deduct the full cost of new investments.
The law made many improvements, but it had several shortcomings. It included a handful of complex and anti-growth provisions. Starting in 2022, it required businesses to amortize research and development costs. The following year, 100% bonus depreciation started to phase out. It also introduced a complex, non-neutral deduction for pass-through businesses called Section 199A.
Furthermore, major portions of the law were set to expire after eight years. In 2017, Republicans held a slim majority in the Senate. As a result, they decided to use the budget reconciliation tool, which allowed them to pass certain legislation in the Senate with a simple majority. The catch, however, was that the bill could not increase the budget deficit after 10 years. To conform to this rule, lawmakers scheduled several business tax increases and made nearly all the individual income tax provisions sunset after 2025.
The scheduled expiration of the individual provisions is now right around the corner. Although it may be the path of least resistance, lawmakers should not simply extend the entire law. Instead, lawmakers should approach 2025 as an opportunity to enact fiscally sustainable, pro-growth tax reform. They should attempt to accomplish three goals.
First, aim for revenue neutrality or a bill that neither increases nor decreases federal revenue. In 2017, federal debt was high, but interest rates were low, and the cost of debt was sustainable. Thus, a $1.5 trillion tax cut was manageable. Today, that is not the case: debt and interest rates are now even higher and interest costs as a share of the economy are at historical levels. It would be irresponsible to add $5 trillion to the debt by extending the TCJA with no changes.
Second, build on the most pro-growth aspects of the TCJA. First, lawmakers should restore 100% bonus depreciation, ideally on a permanent basis. This provision is the single most pro-growth policy in the law. Lawmakers could increase its growth potential by expanding it to apply to more assets.
Further, lawmakers should reverse amortization of research and development expenses. These reforms should be paired with an additional limitation on business interest expenses. Not only would this offset the cost of expensing, but it would also further reduce the tax code’s bias in favor of borrowing.
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Third, further clean up the tax code. Even after the TCJA, the federal government still loses more than $100 billion a year from itemized deductions. Lawmakers could raise nearly as much by repealing the new green energy tax credits introduced in the Inflation Reduction Act. Allowing the deduction for pass-through businesses to expire would reduce the cost of extending the law by more than $600 billion. Lawmakers should also take the opportunity to fully repeal the AMT, which raises less than $10 billion a year after TCJA’s changes.
Reforming the tax code in 2025 will not be easy. Lawmakers will need to make several difficult trade-offs. However, it is worth it. The right reform will grow the economy and improve living standards without adding to the federal government’s fiscal challenges.
Kyle Pomerleau is a senior fellow at the American Enterprise Institute, where he studies federal tax policy.
