The Good, the Bad, and the Ugly of the Senate Tax Bill
Senate Finance Committee Chairman Orrin Hatch (R-UT) has released his Chairman's Mark of the Tax Cuts and Jobs Act, a Senate version of the House's Tax Cuts and Jobs Act. The Senate bill is in many ways similar to its House counterpart and the previous unified framework both bills are based on, but it also includes some significant differences.
According to the Joint Committee on Taxation (JCT), the Senate proposal would cost $1.5 trillion over ten years; however, the "true cost" could be higher after accounting for gimmicks (though there are fewer than in the House bill). The table below summarizes in detail how the bill would change major provisions of the tax code.
| Area | House Version | Senate Version |
|---|---|---|
| Individual Tax | ||
| Tax Rates | 12% | 25% | 35% | 39.6% | 10% | 12% | 22.5% | 25% |32.5% | 35% | 38.5% |
| Standard Deduction | $12,000 (single) / $24,000 (married) / $18,000 (head of household) | $12,000 (single) / $24,000 (married) / $18,000 (head of household) |
| Personal Exemptions | Replaced with $300 credit per person through 2022; eliminated without replacement after | Eliminated |
| Child Tax Credit | Increased to $1,600/child – phased out at higher income than current law | Increased to $1,650/child – phased out at higher income than House bill; separate $500 nonrefundable credit for non-child dependents |
| Alternative Minimum Tax | Eliminated | Eliminated |
| Earned Income Tax Credit | Same as current law but with program integrity measures | Same as current law |
| Mortgage Interest Deduction | Limit lowered to $500,000 of debt for new mortgages on primary residences | Mostly retained; $100,000 home equity interest deduction eliminated |
| Charitable Deduction | Mostly similar to current law | Mostly similar to current law |
| Health Exclusion | Same as current law | Same as current law |
| State & Local Tax Deduction | Eliminated for income and sales taxes; limited to $10,000 for property taxes | Eliminated |
| Medical Expense Deduction | Eliminated | Same as current law |
| Municipal Bond Exclusion | Private activity and advance refunding bond exclusion eliminated for new bonds | Advance refunding bond exclusion eliminated for new bonds |
| Capital Gains from Home Sales | Exclusion phased out for high earners | Residence requirement increased |
| 401(k) Retirement Accounts | Same as current law | Catch-up contributions phased out at higher incomes |
| Capital Gains and Dividends | Same as current law | Same as current law |
| Higher Education Tax Benefits | Consolidated to single benefit | Same as current law |
| Indexing of Tax Provisions | Chained CPI used for inflation adjustments | Chained CPI used for inflation adjustments |
| Other Itemized Deductions | Mostly eliminated | More retained than House bill |
| Other Tax Provisions | Several provisions repealed | Preserves more tax provisions than House bill |
| Business Tax | ||
| Corporate Rates | Flat rate of 20% | Flat rate of 20% starting in 2019 |
| Pass-Through Businesses | Top rate limited to ~35% for active owners; 25% for passive owners | Creates a 17.4% deduction for business income capped at 50% of wage income; disallowed for active owners |
| Depreciation Schedule | Full expensing of certain equipment for 5 years; current law afterwards | Full expensing of certain equipment for 5 years; permanently shortens depreciation lives for buildings |
| Small Business Expensing | Increases limit to $5 million and phaseout to $20 million for five years | Increases limit to $1 million and phaseout to $2.5 million permanently |
| Domestic Production Deduction | Eliminated | Eliminated starting in 2019 |
| Interest Deduction | Limit lowered from 50% to 30% of income before interest, taxes, depreciation, and amortization | Limit lowered from 50% to 30% of income before interest and taxes |
| Inventory Accounting | Same as current law | Same as current law |
| R&E Expenses | Amortized starting 2023 | Same as current law |
| Meals and Entertainment Expenses | Deduction eliminated for entertainment expenses; retained for meals | Deduction eliminated for entertainment expenses; retained for meals |
| Executive Compensation | Performance pay exception eliminated | Performance pay exception eliminated |
| International Tax | Territorial w/ base erosion provisions and one-time transition tax | Territorial w/ base erosion provisions and one-time transition tax |
| Fringe Benefit Deductions | Eliminates most deductions for fringe benefits | Eliminates most deductions for fringe benefits |
| Other Tax Provisions | Several provisions repealed | Several provisions repealed; more retained than House bill |
| Other Taxes | ||
| Excise Tax on University Endowments | 1.4% tax on endowments exceeding $250,000 per student | 1.4% tax on endowments exceeding $250,000 per student |
| Estate Tax | Exemption increased to $11.2 million through 2024, then the tax is eliminated | Exemption doubled; tax retained |
Sources: Joint Committee on Taxation, House Ways and Means Committee, Senate Finance Committee.
Overall, we are disappointed to see tax reform add so much to the debt at a time when it is already too high and rising unsustainably. On the other hand, the legislation also includes some smart reforms, and the current Senate version includes fewer gimmicks than the House bill. Here's a rundown of the good, the bad, and the ugly of Chairman Hatch’s Mark of the Tax Cuts and Jobs Act.
The Good
A second detailed tax reform plan. After numerous memos, outlines, blueprints, and frameworks that focused much more on the giveaways, like tax rate reductions, and much less on how they would be paid for, the House and Senate have now both put forward specific details on how they would reform the tax code. Now that two detailed plans exist, policymakers, analysts, and the public can study each plan and provision to understand its impact and weigh trade-offs. Ideally, policymakers will take the best ideas from each plan and build from there.
Significant tax base broadening. Like its House counterpart, the Senate bill includes many significant base broadening measures to help pay for its large tax cuts. It would entirely eliminate the state and local tax (SALT) deduction for individuals, replace the personal and dependent exemption, eliminate the domestic production activities deduction, and repeal numerous smaller provisions. It would also would scale back or reform numerous other tax breaks and deductions, for example by eliminate the deductibility of home equity debt, limiting the business interest deduction, restricting like-kind exchanges, and reforming the tax treatment of fringe benefits. The package includes several smart tax changes that belong in any comprehensive tax reform package.
Improvements on the House bill from additional base broadening and fewer gimmicks. Encouragingly, the Senate bill goes further than its House companion in cutting certain tax breaks – most significantly, it fully repeals the SALT deduction rather than retaining a capped property tax deduction. The Senate plan also avoids several of the House bill’s gimmicks, like the arbitrary expiration of the $300 dependent tax credit and expanded Section 179 expensing for small businesses, the delayed amortization of Research & Experimentation (R&E) expenses (which would start the same year the temporary credits and expensing provisions end, setting up a huge tax cliff), and the phased-in repeal of the estate tax.
The Bad
The largest tax expenditure is untouched. The exclusion for employer-sponsored health insurance (the ESI exclusion) is the largest tax expenditure in the code, estimated by JCT to cost $165 billion in 2017 alone. Not only is it expensive, but experts from across the ideological spectrum agree that it drives up health care spending and costs by encouraging employers to offer more expensive insurance rather than higher wages. Like its counterpart in the House, the Senate bill does not include any policy to directly limit or reform the exclusion. While repealing the ESI exclusion was never really discussed in the lead-up to the bill, we’ve written about numerous options to scale back or reform the exclusion in order to both generate tax revenue and help slow health care cost growth.
Many House base-broadeners ignored. While the Senate bill includes important base-broadening, it also leaves in place many tax breaks cut by the House, including preferences for medical expenses, private activity bonds, employee awards, and bars and restaurants who report tip income. The Senate bill also fails to consolidate and reform higher education tax breaks as the House bill does, and it does not follow the House’s lead in scaling back the mortgage interest deduction for high-cost houses and second homes, a distortionary, regressive, and ineffective subsidy that JCT has estimated will cost $64 billion in 2017 alone.
Gimmick #1: Delay of the corporate rate cut. The Senate bill cuts the corporate tax rate to 20 percent by 2019, instead of 2018 as in the House bill. While there are some legitimate arguments for phasing in the corporate rate cut, the Senate bill’s one-year delay appears to be due to a desire to shave $100 to $150 billion off of the bill's reported costs rather than to set the best tax and economic policy. While the delay would indeed reduce those near-term costs, it does nothing to change the structural deficits caused by the bill. Instead it simply spreads nine years of costs over ten years and paints a misleading picture of the provision's true costs.
The Ugly
Massive new debt. The Senate version of the Tax Cuts and Jobs Act would cost $1.5 trillion over the next decade according to JCT. With debt already higher as a share of Gross Domestic Product (GDP) than at any time other than just after World War II, additional borrowing is likely to slow economic growth and hasten the country's fiscal deterioration. Like the House bill, the Senate bill would likely result in debt reaching the size of the economy by 2028 and exceeding its post-World War II record shortly thereafter.
Gimmick #2: Arbitrary expiration of expensing. In an effort to encourage investment, the Senate bill – like the House bill – proposes allowing businesses to fully deduct (“expense”) 100 percent of the cost of certain investments. However, the provision is set to expire after five years. Not only is this sunset unwarranted, but it is likely to actually undermine the very growth it is trying to create. Because expensing changes the timing of deductions, the $61 billion cost of five years of expensing is likely many much cheaper than the cost of making the provision permanent, which is probably the intention.
*****
While Senate tax writers deserve credit for putting forward new details and real base-broadening measures, as with the House version, significant changes will be necessary to turn the current proposal into a responsible and pro-growth tax plan. The current bill is also not compliant with the budget's reconciliation instructions because it would increase the on-budget deficit by more than $1.5 trillion, and it would have to be revised just to be passed through reconciliation. Rather than removing offsets or adding new gimmicks, policymakers should work together to identify new base-broadening provisions, add additional offsets, or scale back the bill's tax cuts. Tax reform must not be allowed to add another $1.5 trillion (or more) to the national debt.
