'Repeal and Replace' the Trump Tax Cuts

January 25, 2018

Everyone who debated last year's tax law can agree that it won't be the last word. The legislation addressed almost none of the "tax extenders," temporary tax breaks that Congress typically reauthorizes every year. Some of the law's key provisions expire after 2022 or 2025.

More important, the tax cuts put the country on an unsustainable fiscal trajectory, with next year's deficit set to hit 5 percent of gross domestic product, a record outside of major wars and recessions or their aftermath. Finally, anything widely known as the "Trump tax cuts" is politically unstable given that Democrats will eventually take back power.

The question is how Democrats should proceed once they do. After the George W. Bush tax cuts, they focused on repealing the provisions that benefited only high-income households. That approach will not work this time. Although the Trump tax cuts are tilted toward the rich, few provisions benefit them alone.

Another problem is that repealing the law's parts in isolation could be counterproductive. Democrats are rightfully upset about the new $10,000 cap on the deduction for state and local taxes, but eliminating it would cost more than $600 billion over 10 years, with half that going to households earning more than $1 million annually.

Democrats should instead aim for something more radical: "repeal and replace" of the Trump tax law—or, Republicans could join the process and call it comprehensive tax reform. It should have four goals: stability, efficiency, simplicity and help for American families.

Stability doesn't mean simply that the tax code shouldn't be changed on a whim. It also means Congress should raise sufficient revenue to finance the spending it has committed to. Under the current trajectory the deficit is set to hit $1 trillion starting in 2019. If the Trump tax cuts are extended or made permanent, the situation will get even worse. The government will raise about 17 percent of GDP in taxes over the next decade. A sustainable trajectory will require something closer to the 21 percent of GDP proposed in 2010 by the Simpson-Bowles Commission. Even then, the U.S. would still be in the bottom quarter of the 35 countries in the Organization for Economic Cooperation and Development.

On the corporate side, raising revenues can be done while increasing the tax system's efficiency. What would that look like? A higher corporate tax rate, say 25 percent or 28 percent, combined with permanent expensing, no interest deductibility, stronger protections against shifting income abroad, and more favorable treatment of research and development.

Repealing the Trump tax bill's complicated new loophole for pass-throughs would raise revenue while simplifying and reducing distortions. So would ending the so-called Gingrich-Edwards loophole, which allows some pass-through owners to avoid paying their full payroll taxes.

Raising individual capital-gains taxes a bit would help recoup some of the cost of the corporate tax cuts. One of the most efficient ways to do this would be to reduce the incentives to lock in asset allocations. That would include repealing "step-up in basis" at death, meaning the owner's estate would have to pay capital-gains taxes that today are not levied.

Broadening the tax base would be beneficial, too. One way would be to reduce the tax break for very generous health insurance, either by building on the Affordable Care Act's "Cadillac tax" or replacing it. Creating a value-added tax is another option. Many other countries have used VATs to cut corporate tax rates without blowing up their budget deficits. Finally, a carbon tax could be an efficient revenue raiser, especially if combined with a reduction in carbon-related environmental regulations.

On simplification, the Trump tax law was mixed. An estimated 25 million households will stop itemizing and take the standard deduction, a modest step in the right direction. But many millions of small businesses and contractors will struggle with the complicated new rules describing the varying tax rates on differently labeled business income.

The next tax bill should set a much more ambitious goal: to end tax filing entirely. Countries ranging from the United Kingdom to Kenya have already done this by giving people the option to have the government do their taxes. That means there's no need to file a return and, ideally, exact withholding from the worker's paycheck. With this approach April 15 would become just another day.

The next bill should also make the tax code more pro-work, pro-family and pro-middle-class. Expanding the earned-income tax credit for workers without qualifying children is a bipartisan idea that was inexplicably omitted from the Trump law. Taxing spouses separately rather than jointly would both encourage work and make it easier to end mandatory tax filing. Replacing the child tax credit's complicated rules with a flat $2,000 allowance per child, fully refundable regardless of income, would help millions of families while truly simplifying taxes.

Last year's tax law, which passed the Senate with a single vote to spare, shows how difficult tax reform is even when it loses revenue. The political hurdles facing a tax bill that raises revenue will be even higher. The key is not merely to coalesce around repealing or extending individual parts of the Trump tax law but to set higher-level goals for what could be the first fundamental tax reform and simplification since 1986.

Follow @jasonfurman on Twitter.