US Tax Policy: The Coming Storm in 2025

The Tax Cuts and Jobs Act of 2017 may seem like past history, but as William Faulkner has one of his characters say in Requiem for a Nun, “The past is never dead. It’s not even past.”

For economists, the 2017 tax law is especially interesting because it’s the most sweeping change in the US tax code since the Tax Reform Act of 1986, so it offers a chance to study and revisit many topics with new evidence. But for policymakers, perhaps the key point is that many provisions of the 2017 tax law were passed with an expiration date at the end of 2025. Thus, under current law, unless Congress revisits US tax law next year, large parts of the tax code will snap back to the 2016 rules at the end of next year.

This situation may seem strange, but here’s the background: When the Tax Cuts and Jobs Act of 2017 was passed into law, its Republican proponents in Congress had a majority in both the Senate and the House, but they did not have the 60-vote majority in the Senate needed to override a filibuster. They could pass their desired tax bill by simple majority vote, under what is known as a “budget reconciliation” procedure. However, under a long-standing precedent going back to the 1980s, laws passed in this way cannot increase the budget deficit outside a 10-year budget window. (This rule leaves Congress the flexibility to act in response to short-term events–like a pandemic or a recession–while still placing some restraint on actions with longer-term budgetary consequences.) Thus, many of the sweeping changes in the Tax Cuts and Jobs Act of 2017 were passed with an expiration date at the end of 2025.

The hope of supporters of the bill was that when 2025 finally arrived, the tax changes would be sufficiently entrenched that they could be extended at that time. But under the looming threat of a snapback to the 2016 tax law, it seems likely that all aspects of the US tax code will be up for political discussion in 2025. It’s worth remembering that even Democrats who were deeply unenthused about the 2017 tax law have made no meaningful efforts to change it during President Biden’s term of office.

The just-released Summer 2024 issue of the Journal of Economic Perspectives thus includes a set of five articles on aspects of the 2017 Tax Cuts and Jobs Act:

• “Sweeping Changes and an Uncertain Legacy: The Tax Cuts and Jobs Act of 2017, ” by William G. Gale, Jeffrey L. Hoopes, and Kyle Pomerleau

• “The US Individual Income Tax: Recent Evolution and Evidence,” by Jon Bakija

• “Lessons from the Biggest Business Tax Cut in US History,” by Gabriel Chodorow-Reich, Owen Zidar, and Eric Zwick

• “US International Corporate Taxation after the Tax Cuts and Jobs Act,” by  Kimberly A. Clausing

• “Are Opportunity Zones an Effective Place-Based Policy?” by Kevin Corinth and Naomi Feldman

I won’t even pretend to try to summarize the articles here, but here are a few nuggets to give you a sense of what will be at stake in US tax policy in 2025.

The provisions of the Tax Cuts and Jobs Act of 2017, taken together, involve lower revenue. Estimating exactly how much lower is hard, given the need to disentangle the budgetary effects of the pandemic from the effects of the tax law. But Gale, Hoopes, and Pomerleau point out, one mainstream estimate from the Congressional Budget Office suggests that if the 2017 tax law was just extended as is in 2025, it would reduce federal tax revenues by about 1.1% of GDP by 2033. In the aftermath of the very high US government budget deficits that occurred as part of the response to the pandemic, which followed a little more than a decade after some very high US government budget deficits that occurred as part of the response to the Great Recession of 2007-08, the need to reduce the red ink from future budget deficits is greater now than back in 2017. Thus, parts of the 2017 law that reduce revenues are likely to come under especially close scrutiny.

Gale, Hoopes, and Pomerleau also point out that the conventional way of thinking about the distributional effects of tax cuts is to look directly at how big the tax cuts are across levels of income. But when tax cuts are part of what is feeding long-term higher budget deficits, then the question changes. If the higher deficits resulting from tax cuts are addressed by, say, cutting spending programs that mainly benefit those with lower incomes, then the distributional effect of the tax cuts, via a need to reduce budget deficits, will weigh more heavily on those with lower incomes. If a future plan to address budget deficits relies more heavily of taxing those with incomes, then the distributional effect of addressing the revenue losses from the tax cut would look different. Either way, the distributional effects of tax law changes made in 2025 will need to be considered against a background of how to address sustained high budget deficits.

In the individual income tax, one of the major changes of the 2017 tax law was a dramatic rise in the standard deduction. In the US income tax, all taxpayers compare the size of the standard deduction to a list of possible deductions for mortgage interest, charitable contributions, state and local taxes, and others. If the standard deduction is bigger, you apply that deduction to taxable income before calculating your tax bill. If the list of other deductions is bigger, you instead “itemize” these individual deductions.

But when the standard deduction got much larger, many fewer people found it worthwhile to itemize. As Bakija notes, the share of taxpayers itemizing deductions fell from 31 percent in 2017 to just 9 percent in 2021. As a result, many higher-middle-income people no longer faced marginal tax incentives to, say, give to charity, or take out a larger mortgage.

Should we go back to much smaller standard deductions? Should we provide alternative methods of providing incentives in the tax code for, say, charitable giving? Many people in higher-tax states, who used to be able to deduct their state and local taxes from their federal income subject to tax, would like to be able to do so again. These questions will be wide-open in 2025.

On the business taxation side, there are multiple issues. One challenge with business taxation is to avoid injuring incentives for investment, which helps to build long-term productivity growth, while still collecting revenue on profits. One tradeoff that arises here, discussed in the paper Chodorow-Reich, Zidar, and Zwick, is that lowering the corporate tax rate is, in effect, a reward for past investment that led to present profits. But one can imagine a combination of a somewhat higher corporate tax rate combined with generous reductions in taxes for current investment: that is, tax the firms that are not investing more than those firms that are investing.

At the international level, a dramatic change is that almost all US trading partners have been working for more than a decade now on a Base Erosion and Profit Shifting (BEPS) project, which seeks to make it more difficult for multinational companies to use accounting methods to shift their profits to lower-tax jurisdictions. As Clausing discusses, Pillar 2 of this agreement “includes a country-by-country minimum tax of 15 percent on multinational company income, regardless of where it is reported.”

This agreement, which the European Union and many other countries have signed late in 2022, includes what is called the Undertaxed Profits Rule. If a company from a country that has not signed on to the Pillar 2 rule, like the United States, is doing business in a country that has signed on to the rule (say, the EU, Japan, and others), then that other country can impose a “top-up tax” to collect higher corporate taxes from the US corporation. The US tax code as it applies to multinationals is not currently in compliance with Pillar 2.

The US tax code is also replete with highly targeted tax breaks for highly targeted social goals. The 2017 tax law included a tax break for certain kinds of “Opportunity Zones,” as discussed by Corinth and Feldman, with the goal of boosting investment in areas with lower income levels. Of course, a challenge for such tax breaks is that some investment in those areas would have happened without the tax break, so these investors are rewarded for what they would have done anyway. Other investment is not going to happen in that area, with or without the tax break. So the challenge is to figure out what marginal share of investment in the area increased because of the tax incentive. The authors find that in this case, most of the increased investment was in property, not in businesses that led to jobs for local residents.

If the 2017 tax provisions just expire at the end of 2025, and the tax code rebounds back to its 2016 version, the reaction to the changes will provide a fertile field for economic researchers. But from a public policy point of view, it seems a peculiar way to run a tax system.