BackA New Approach to Taxes That Pays Its Own Way
Two decades of unpaid-for tax cuts have eroded the federal government’s revenue base.
PremiumMost of the tax cuts passed in 2017 are set to expire in 2025. Altogether, these cuts cost the federal government about $350 billion a year, or 1% of gross domestic product. Their expiration marks a milestone in American tax policy.
The tax system of the 1990s could have financed the government we have today. But two decades of successive unpaid-for tax cuts eroded our nation’s revenue base. Without those tax cuts, federal debt as a share of the economy wouldn’t be projected to rise significantly over the coming decade.
Americans can’t afford for politicians to keep having the same stale debates about tax policy. Unpaid-for tax cuts make it harder for the federal government to finance its obligations. It’s time for a new approach to taxes.
First, don’t extend tax cuts for the best-off Americans. The last generation of tax policy disproportionately benefits the highest-income Americans. As a result of the 2017 tax cuts, the top 5% of taxpayers received a tax cut roughly three times as large as the bottom 60% of taxpayers got, measured as a share of income.
Second, any extension of tax cuts should be fully paid for by other reforms to the tax system. While this idea sounds simple, it would be a stark departure from the habits of both parties. Republicans made enactment of large, regressive and temporary tax cuts the centerpiece of their domestic agenda during the last two GOP presidencies. Democrats mostly opposed these tax cuts. But when it came to those from the 2000s, they agreed to a bipartisan deal that made over 80% permanent—and without offsetting costs.
The good news is that there are tax reforms that would raise significant revenue, strengthen the tax base and promote economic growth. For starters, corporate tax reform can raise hundreds of billions over the coming decade while encouraging investment and innovation. The 2017 corporate rate cut was particularly ineffective at sparking investment. It handed out windfalls to old investment instead of targeting new investment, and the law allowed too much unproductive offshore profit-shifting to continue. Americans can do better by focusing on incentives for new investment and by raising the tax rate on foreign profits in line with the global minimum tax agreement.
In addition, the U.S. can address how those at the very top entirely escape income taxes by holding on to appreciated property and passing it down to their heirs. The wealthiest Americans should be required to pay a minimum share of their income in taxes. The current cap on deductibility of state and local taxes is controversial, but its continuation would raise revenue—principally from high-income taxpayers. Continuing to invest in the Internal Revenue Service’s capacity to collect taxes already owed would also strengthen the system.
Many policy makers will object to these proposals. But the “pay as you go" principle for tax reform is about trade-offs. If you don’t like raising corporate rates, instituting a minimum tax for billionaires or capping state and local deductions, you should identify what other taxes you would raise—or which tax cuts you would let expire. Any tax plan that can’t answer this basic test should be considered reckless.
Third, any new tax benefits should go to lower-income families and workers. Many lower-income Americans got nothing from the 2017 reform and could face tax increases over time. To address this, Congress should make the child tax credit fully refundable so that all eligible low-income families receive this tax cut. Doing so would lift more than 1.5 million children out of poverty, according to the Center on Budget and Policy Priorities. Congress should also expand the earned-income tax credit for childless workers, as was done in 2021, which would keep more than five million low-income workers from being taxed into poverty—or deeper into it. Together, these tax credits cost around $30 billion annually—a small price tag relative to the tax bill as a whole and the great help it provides to our most vulnerable. Further expansion of the child tax credit is also a good idea. All new tax benefits should be focused on the bottom half of tax filers and fully paid for.
Given the magnitude of our fiscal challenges, we ultimately will need to raise revenue beyond paying for tax-cut extensions in 2025 and address other salient fiscal challenges, such as continuing to slow the growth rate of healthcare costs. But the greatest near-term fiscal risk the country faces is the possibility that policy makers won’t only extend the 2017 reform, but double down on these unpaid-for, regressive tax cuts. Doing so would deal a huge blow to market confidence and the economy. Tax cuts now would likely come at the expense of long-term growth and American pocketbooks.
Showing a commitment to pay for any tax-cut extension in 2025 is smart policy. It would also be a significant step toward instilling confidence in America’s commitment to meeting its long-term fiscal challenges.
Mr. Deese served as director of the National Economic Council, 2021-23. Mr. Kamin was the council’s deputy director, 2021-22.
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