Making 2017 Tax Reform Permanent: Details & Analysis
Key Findings
- The TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
Cuts and Jobs Act of 2017 (TCJA) overhauled the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S.
code, cutting taxes across income levels on average. The tax law also reduced the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs.
. These changes were temporary, however, and are scheduled to expire after the end of 2025. - The TCJA permanently reduced the corporate tax rate and made other changes to the business tax system that were temporary or scheduled to change, including full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs.
for short-lived business investments, a requirement to amortize research and development (R&D) expenses, limitations on business net interest expense, and an overhaul of the international tax system. - Without congressional action, the individual expirations and the business changes will raise taxes on households and businesses across the income spectrum relative to current policy, reducing incentives to work and invest in the United States.
- Making the expiring individual and estate tax changes permanent would increase GDP by 0.5 percent and employment by 686,000 full-time equivalent jobs. It would decrease federal revenue by $2.6 trillion on a conventional basis and by $2.2 trillion on a dynamic basis. Incorporating added interest costs, the deficit impact would be $3 trillion on a conventional basis and $2.6 trillion on a dynamic basis. Without other offsets, the long-run debt-to-GDP ratio would increase by 20.0 percentage points (conventional) or 16.1 percentage points (dynamic) above its baseline of 231.8 percent.
- Permanently reversing the business tax phaseouts and other changes would increase GDP by 0.7 percent and employment by 143,000 full-time equivalent jobs. It would decrease federal revenue by $1.1 trillion on a conventional basis and by $863 billion on a dynamic basis. Incorporating added interest costs, the deficit impact would be $1.4 trillion on a conventional basis and $1.1 trillion on a dynamic basis. Without other offsets, the long-run debt-to-GDP ratio would increase by 6.3 percentage points (conventional) or 1.9 percentage points (dynamic) above its baseline of 231.8 percent.
- Taken together, full TCJA permanence would boost GDP by 1.2 percent and employment by 829,000 full-time equivalent jobs and reduce revenue by $3.7 trillion on a conventional basis. On a dynamic basis, the cost falls by 16 percent to $3.1 trillion as higher economic output raises some additional tax revenue. Incorporating added interest costs, the deficit impact would be $4.1 trillion on a conventional basis and $3.7 trillion on a dynamic basis. Without other offsets, the long-run debt-to-GDP ratio would increase by 26.6 percentage points (conventional) or 18.4 percentage points (dynamic) above its baseline of 231.8 percent.
- Lawmakers will have to weigh the economic, revenue, and distributional trade-offs of extending or making permanent the various provisions of the TCJA as they decide how to approach the upcoming expirations. A commitment to growth, opportunity, and fiscal responsibility should guide the approach.
Introduction
The 2017 Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth.
overhauled the U.S. tax system. It reduced tax rates for corporations and individuals, provided full expensing for some business investment, limited major deductions, expanded the child tax credit (CTC)The federal child tax credit (CTC) is a partially refundable credit that allows low- and moderate-income families to reduce their tax liability dollar-for-dollar by up to ,000 for each qualifying child. The credit phases out depending on the modified adjusted gross income amounts for single filers or joint filers.
and standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes.
, and established a new set of rules for companies earning income overseas.
But it also created uncertainty over the future of the U.S. tax system with its reliance on temporary policies. While the lower corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.
rate and new international system were made permanent, after 2025, most of the individual income tax changes will expire, the estate tax changes will expire, and the international tax ruleInternational tax rules apply to income companies earn from their overseas operations and sales. Tax treaties between countries determine which country collects tax revenue, and anti-avoidance rules are put in place to limit gaps companies use to minimize their global tax burden.
s will become more restrictive, in addition to several business tax changes and phaseouts, some of which have already begun.
In this paper, we model the economic, revenue, and distributional effects of permanence for the expiring individual income tax, estate tax, and business tax provisions of the Tax Cuts and Jobs Act. An all-out extension would boost GDP by 1.2 percent but worsen the long-run baseline debt-to-GDP ratio of 231.8 percent by 26.6 percentage points on a conventional basis and by 18.4 percentage points on a dynamic basis.
As the expirations draw near, lawmakers should weigh the trade-offs of extension, prioritizing simplifications, improved incentives for work and investment, and fiscal responsibility.
Reviewing TCJA’s Individual, Estate, and Business Tax Changes
Adjustment of Tax BracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat.
s and Tax Rates (Individual)
The TCJA reduced the seven individual income tax rates from 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent, and 39.6 percent to 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. The law also reconfigured the thresholds and widths of several brackets, reducing the size of marriage penalties arising from the tax bracket structure.
Expansion of the Standard Deduction (Individual)
The TCJA increased the standard deduction from $6,350 to $12,700 for singles and from $12,700 to $25,400 for married joint filers in 2018, adjusted annually for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.
. The 2023 standard deductions amounts are $13,850 for single filers and $27,700 for joint filers.
Modification of the Child Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.
and Creation of the Additional $500 Nonrefundable Dependent Credit (Individual)
The TCJA increased the CTC from $1,000 to $2,000, with the maximum refundable portion increased from $1,000 to $1,400 in 2018, adjusted for inflation until it reaches $2,000. The 2023 refundability limit is $1,600.
The phase-in threshold was lowered from $3,000 to $2,500, and the phaseout thresholds were increased from $75,000 to $200,000 for single filers and from $110,000 to $400,000 for married couples filing jointly, over which the credit phases out at a 5 percent rate.
The TCJA also created a nonrefundable $500 credit for certain dependents who do not meet the CTC eligibility guidelines. The new credit is available for filers with children ages 17 to 18, dependents between ages 19 to 24 for those in school at least five months of the year, and some older dependents. It is subject to the same phaseout as the CTC.
Elimination of Personal and Dependent Exemptions (Individual)
The TCJA suspended the personal exemption, which had previously allowed households to reduce their taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income.
by $4,050 for each filer and dependent, adjusted annually for inflation.
Modification of Itemized DeductionItemized deductions allow individuals to subtract designated expenses from their taxable income and can be claimed in lieu of the standard deduction. Itemized deductions include those for state and local taxes, charitable contributions, and mortgage interest. An estimated 13.7 percent of filers itemized in 2019, most being high-income taxpayers.
s (Individual)
Prior to the TCJA, individuals who itemized their deductions could deduct the amount they paid in state and local taxes (SALT) against their federal taxable income (unless they were subject to the alternative minimum tax, or AMT). The taxes individuals could deduct included state and local individual income taxes (or sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding.
es), real estate taxes, and personal property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services.
es. The amount individuals could deduct was unlimited outside of interactions with the AMT or the Pease limitation. The TCJA introduced a cap on state and local tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state/local taxes paid, mortgage interest, and charitable contributions.
s of $10,000 per household.
Prior to the TCJA, the home mortgage interest deductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act reduced the amount of principal and limited the types of loans that qualify for the deduction.
was limited to interest paid on $1 million of home acquisition debt and $100,000 of home equity debt. The TCJA limited the mortgage interest deduction to interest paid on $750,000 of home acquisition debt and made interest on home equity debt no longer deductible.
The TCJA suspended miscellaneous itemized deductions, such as job-related expenses or casualty and theft losses, which were previously deductible if they exceeded 2 percent of AGI. The TCJA retained the itemized deduction for charitable giving and allowed taxpayers to deduct a larger share of their charitable giving by increasing the 50 percent of AGI limit to 60 percent.
The TCJA repealed the Pease limitation on itemized deductions. The provision reduced the value of a taxpayer’s itemized deductions by 3 percent for every dollar of taxable income above a certain threshold (in 2017, the thresholds were $261,500 for single filers and $313,800 for joint filers). The reduction continued until the Pease limitation had phased out 80 percent of the value of itemized deductions. Most taxpayers never reached the limitation, so in effect, Pease operated like a surtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services.
on higher-income households.
Increase in AMT Exemption Amount and Phaseout Threshold (Individual)
The alternative minimum tax requires some upper-income households to calculate their taxes under two sets of rules and pay whichever amount is higher to prevent households from receiving excessive benefits from tax preferences.
The TCJA increased the AMT exemption amount from $54,300 for singles in 2017 to $70,300 for singles in 2018, and from $84,500 for married couples filing jointly to $109,400. In 2023, the AMT exemption is $81,300 for single filers and $126,500 for joint filers.
It also increased the exemption phaseout thresholds from $120,700 in alternative minimum tax income (AMTI) to $500,000 for single filers and from $160,900 to $1 million for married taxpayers filing jointly. For 2023, the exemption phaseout thresholds are $578,150 for single filers and $1.16 million for joint filers.
Introduction of Section 199a 20 Percent Deduction for Pass-Through BusinessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates.
Income (Individual)
The TCJA established a temporary 20 percent deduction (section 199A) for households that receive income from pass-through businesses, such as LLCs, that face individual income taxes instead of the corporate tax. The deduction effectively reduces pass-through business tax rates by 20 percent. For instance, instead of facing a top rate of 37 percent like wages and salaries, pass-through businesses generally face a top rate of 29.6 percent after deducting 20 percent of their income. That said, the deduction is subject to several complex limitations that restrict the benefit of the provision for high-income households.
Introduction of $250,000/$500,000 Excess Business Loss Limitation (Individual)
The TCJA introduced a limitation on excess business loss deductions for noncorporate businesses. It disallows losses that exceed income by more than $250,000 for single filers and $500,000 for joint filers. The thresholds adjust for inflation each year.
The limitation was scheduled to be in effect from 2018 through 2025 but it was postponed to tax years beginning after 2020 during the COVID-19 pandemic by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The American Rescue Plan Act (ARPA) then extended the limitation through 2026 and the Inflation Reduction Act (IRA) extended the limitation through 2028.
Increase in the Estate Tax Exclusion (Estate)
The TCJA doubled the estate tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the IRS, preventing them from having to pay income tax.
from $5.6 million in 2017 to $11.2 million in 2018. The exemption increases with inflation and is set at $12.9 million for 2023.
Reduce the Corporate Tax Rate and Overhaul International Tax Rules (Business)
The TCJA permanently reduced the corporate tax rate to 21 percent, from a previous top rate of 35 percent. The TCJA also enacted reforms that moved towards a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation.
by exempting foreign profits from domestic taxation. At the same time, it enacted anti-base erosion provisions targeted at high-return foreign profits, intangible income, and income stripped out of the United States. The four main components of the new international tax system are the participation exemption, GILTI, FDII, and BEAT.
Require Amortization of R&D Expenses (Business)
Before the TCJA, when a company spent money on research and development, it could deduct the full cost of the expense immediately. But under the TCJA, beginning in tax years after December 31, 2021, companies that invest in R&D generally must deduct their domestic investment costs over five years.
Limit Business Net Interest Deduction Based on EBITDA and Then on EBIT (Business)
The TCJA created a limit on the deduction for net business interest paid, intended to reduce the tax code’s preference for debt over equity. Prior to the TCJA, businesses could generally deduct their total amount of interest paid, subject to a few minor limitations.
Starting in 2018, companies faced a limit on deducting net interest equal to 30 percent of their “adjusted taxable income,” defined as earnings before interest, taxes, depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment.
, and amortization (EBITDA). After 2021, the limitation became significantly tighter by switching from EBITDA to earnings before interest and taxes (EBIT).
Temporarily Allow Full Expensing for Short-Lived Business Investments (Business)
The TCJA temporarily enacted full expensing for most short-lived business investments, such as equipment and machinery, substantially lowering the cost of investing in the United States. The provision began phasing out by 20 percentage points each year after the end of 2022 and will fully expire after the end of 2026.
Tighten International Provisions: FDII, GILTI, and BEAT (Business)
All three provisions of the TCJA’s international tax system overhaul are scheduled to become more restrictive after December 31, 2025. Effective rates under global intangible low-taxed income (GILTI)Global Intangible Low-Taxed Income (GILTI) is a special way to calculate a U.S. multinational company’s foreign earnings to ensure it pays a minimum level of tax. GILTI was adopted as part of the 2017 Tax Cuts and Jobs Act (TCJA) and can lead to high tax burdens on foreign profits, putting U.S. companies that operate abroad at a disadvantage.
are scheduled to rise from 10.5 percent to 13.125 percent, the foreign-derived intangible income (FDII)Foreign Derived Intangible Income (FDII) is a special category of earnings that come from the sale of products related to intellectual property (IP). If a U.S. company holds IP in the U.S., such as patents or trademarks, and has sales to foreign customers based on that IP, the profits from those sales face a lower tax rate.
deduction from 13.125 percent to 16.406 percent, and the base erosion and anti-abuse tax (BEAT)The Base Erosion and Anti-Abuse Tax (BEAT) was adopted as part of the 2017 tax reform bill and is a tax meant to prevent foreign and domestic corporations operating in the United States from avoiding domestic tax liability by shifting profits out of the United States.
from 10 percent to 12.5 percent.
Economic, Revenue, and Distributional Effects of Individual and Estate Tax Permanence
Making the individual and estate tax provisions of the TCJA permanent would increase GDP by 0.5 percent, decrease wages by 0.2 percent, and increase employment by 686,000 full-time equivalent jobs.
The main driver of the increase in output and work is the reduction in ordinary income tax rates and the widening of tax brackets, which reduces marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax.
s on work and investment across income levels. The base broadeners have a partially offsetting effect by bringing more income into the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.
and increasing marginal tax rates. Two base broadeners in particular, the limitations on itemized deductions for state and local taxes and for mortgage interest, raise the tax burden on housing capital, which has a negative impact on the capital stock.
Two factors drive a wedge between the effects on American output (measured by GDP) and on American incomes (measured by GNP).
First, lowering the tax burden on saving leads to an increase in domestic saving. As American ownership of assets increases, American incomes increase because returns on investment flowing to Americans increase. Second, deficit financing requires the federal government to make interest payments on the debt, and we assume that the marginal buyers of U.S. debt are foreigners. As a result, as deficits increase, so do foreign claims on U.S. assets and payments to foreigners in the form of interest, leading to a reduction in American incomes. Increased interest costs from deficit financing the tax cuts reduce American incomes by 0.8 percent.
On a conventional basis, making the TCJA individual and estate tax provisions permanent would reduce revenue by $2.6 trillion over the 10-year budget window, with the costs beginning in 2026. The lower rates and wider brackets reduce revenue by the largest amount, $2.1 trillion, while the larger standard deduction costs $927 billion, the AMT modifications cost $924 billion, and the child tax credit expansion costs $708 billion. The Section 199A pass-through deduction and the increase in the estate tax exemption reduce revenue by $608 billion and $159 billion, respectively.
In all, the tax reductions amount to $5.6 trillion before counting the revenue raisers, which offset $3 trillion of the reductions. The repeal of deductions for personal exemptions is the largest offset, amounting to nearly $1.8 trillion, while the $10,000 cap on the SALT deduction raises $899 billion, limitations on other itemized deductions raise another $200 billion, and the limitation on excess business losses for noncorporate businesses raises $144 billion.
On a dynamic basis, higher economic output increases tax revenues, offsetting about $350 billion of the cost of TCJA individual and estate tax permanence so that it reduces federal revenue by $2.2 trillion.
Incorporating added interest costs from deficit financing, the change in the budget deficit rises to nearly $3 trillion on a conventional basis and to $2.6 trillion on a dynamic basis.
Making the provisions permanent does not have an effect until 2026 when the TCJA changes would otherwise expire, and as such they have no impact on after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize after-tax income.
s in the first year of the budget window.
On a conventional basis, after-tax incomes would increase for all taxpayers by 2.1 percent in 2033. In 2033, taxpayers in the top 1 percent would see an increase of 3.5 percent, while taxpayers in the bottom quintile would see an increase of 1.2 percent. Higher economic output further increases incomes, leading to a dynamic increase of 2.4 percent in after-tax incomes on average.
Economic, Revenue, and Distributional Effects of Business Tax Permanence
We interpret TCJA business permanence to mean full expensing for short-lived assets, cancellation of R&D amortization, cancellation of the switch to EBIT for purposes of the limitation on business interest expense, and cancellation of the international provision tightening.
Permanence for the TCJA business provisions would increase economic output by 0.7 percent, the capital stock by 1.4 percent, wages by 0.6 percent, and employment by 143,000 full-time equivalent jobs. Full expensing for short-lived assets drives the results, increasing GDP by 0.4 percent and employment by 73,000 full-time equivalent jobs. Increased interest costs from deficit financing the tax cuts reduce American incomes by 0.2 percent.
On a conventional basis, federal revenue would fall by $1.1 trillion over the 10-year budget window from 2024 through 2033 due to TCJA business tax permanence. Full expensing for short-lived assets and R&D account for more than half the 10-year cost, and both provisions are front-loaded. By the end of the budget window, the cost of the two provisions falls significantly to $26 billion for full expensing and $6 billion for R&D.
Higher economic output increases other tax revenues, offsetting $255 billion of the cost of TCJA business permanence so that it reduces federal revenue by $863 billion on a dynamic basis.
Incorporating added interest costs from deficit financing, the change in the budget deficit rises to nearly $1.4 trillion on a conventional basis and nearly $1.1 trillion on a dynamic basis.
On a conventional basis, after-tax incomes would increase for all taxpayers by 0.5 percent in 2024. Taxpayers in the top 1 percent would see an increase of 1.2 percent while taxpayers in the bottom quintile would see an increase of 0.4 percent. In 2033, the overall change in after-tax incomes remains at 0.5 percent, but the pattern across the income distribution has changed.
The top 1 percent see an increase of 0.7 percent and the bottom quintile an increase of 0.5 percent. On a dynamic basis, factoring in economic growth, all households would see larger increases in after-tax incomes, with a 1.0 percent increase on average.
Economic, Revenue, and Distributional Effects of Complete TCJA Permanence
Making all the individual, estate, and business tax changes of the TCJA permanent would increase economic output by 1.2 percent. The capital stock would expand by 1.3 percent, wages by 0.5 percent, and employment by 829,000 full-time equivalent jobs. Deficit financing of TCJA permanence reduces American incomes by 1.0 percent, driving a wedge between the change in output (+1.2 percent) and the change in income (+0.4 percent).
Making all the TCJA provisions permanent would reduce federal revenue by $3.7 trillion, excluding additional interest costs. The $3.7 trillion cost is comprised of $2.6 trillion of individual and estate tax reductions, $1.1 trillion of business tax reductions, and $78 billion of miscellaneous tax reductions scored by the Congressional Budget Office.
On a dynamic basis, increased economic output raises other tax revenues by $604 billion, resulting in a $3.1 trillion revenue loss on a dynamic basis. Increased tax revenues from higher economic output offset about 16 percent of the conventional cost.
Incorporating added interest costs from deficit financing, we estimate the deficit impact of full TCJA permanence would be a $4.1 trillion increase on a conventional basis and $3.7 trillion on a dynamic basis.
On a conventional basis, after-tax incomes would increase for all taxpayers by 0.5 percent in 2024. Taxpayers in the top 1 percent would see an increase of 1.2 percent while taxpayers in the bottom quintile would see an increase of 0.4 percent. The 2024 combined results are equal to the business-only results because the individual and estate tax provisions do not take effect until later in the budget window. In 2033, when permanence for all the TCJA provisions is in effect, after-tax incomes rise by 2.5 percent on average. The top 1 percent see a 2.7 rise compared to 1.7 percent for the bottom quintile.
On a dynamic basis, higher economic output further increases after-tax incomes, resulting in an average increase of 3.4 percent. The top 1 percent sees a 3.4 percent increase, while the bottom quintile sees a 2.6 percent increase.
Permanence for TCJA provisions would increase the deficit on a conventional and dynamic basis. In the baseline, the ratio of debt-to-GDP will reach 231.8 percent in the long run. Permanence for the TCJA provisions would increase the ratio, though different provisions would worsen the ratio by different magnitudes because they have different impacts on economic growth and revenue.
On a conventional basis, the debt-to-GDP ratio would increase from its baseline estimate of 231.8 percent to 251.8 percent under individual and estate tax permanence (a 20.0 percentage point increase), to 238.1 percent under business tax permanence (a 6.3 percentage point increase), and to 258.4 percent under combined permanence (a 26.6 percentage point increase).
On a dynamic basis, the rise in debt-to-GDP is smaller because the tax changes also increase output and raise some offsetting revenue. Business tax permanence especially stands out, with a rise in debt-to-GDP of 1.9 percentage points above baseline on a dynamic basis. Individual and estate permanence increases the ratio by 16.1 percentage points and the combined changes by 18.4 percentage points on a dynamic basis.
Conclusion
The federal income tax system’s future is highly uncertain as major reforms to individual, estate, and business taxes made by the 2017 Tax Cuts and Jobs Act are scheduled to expire after 2025. Allowing the tax changes to expire would result in significant tax increases on people across the income spectrum, reducing incentives to work and invest in the U.S. economy.
Making all the changes permanent would prevent sudden tax increases and would grow the economy. However, it would also substantially increase the deficit at a time when deficits are already too high and forecast to grow higher still.
Lawmakers should approach the TCJA expirations with thoughtfulness, weighing which provisions deserve permanence and determining how to offset the cost of that permanence. Prioritizing the changes that simplify the tax system and increase incentives to work and invest, while committing to fiscal responsibility, will help boost growth and opportunity without further deteriorating fiscal health.
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Modeling Notes
We use the Tax Foundation General Equilibrium Tax Model to estimate the impact of tax policies, including recent updates allowing detailed modeling of U.S. multinational enterprises. The model produces conventional and dynamic revenue and distributional estimates of tax policy.
Conventional estimates hold the size of the economy constant and attempt to estimate potential behavioral effects of tax policy. Dynamic revenue estimates consider both behavioral and macroeconomic effects of tax policy on revenue. Our conventional and dynamic revenue estimates are equal to the impact of the tax changes on the federal budget deficit before changes in interest costs. The model also produces estimates of how policies impact measures of economic performance such as GDP, GNP, wages, employment (by hours worked), capital stock, investment, consumption, saving, and the trade deficit.
Our modeling of the alternative minimum tax does not capture compliance costs, the elaborate planning some households undertake to avoid the AMT altogether, nor the base effects associated with the AMT. Scaling back the AMT would reduce federal revenue, but counterintuitively, increases the marginal tax rate on some households even as it reduces average tax rateThe average tax rate is the total tax paid divided by taxable income. While marginal tax rates show the amount of tax paid on the next dollar earned, average tax rates show the overall share of income paid in taxes.
s, resulting in a small reduction in GDP.
To calculate the impact of financing the cost of TCJA permanence, we use the Congressional Budget Office’s forecast for the 10-year Treasury bond interest rate over the next 30 years. The rate ranges from 3.8 percent in 2024 to 4.5 percent by 2054. We assume the additional interest costs accrued each year are also financed. Our estimates are a conservative estimate of the impact of deficit financing, as interest rates may increase above CBO’s forecast when TCJA permanence is deficit financed. The estimates omit any impact on the effective interest rate on U.S. debt from the term structure of U.S. Treasury bond financing.
We use Congressional Budget Office revenue estimates for TCJA provisions we did not score, converted from fiscal years into calendar years for consistency with our estimates.
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