The Coming Tax Fight Will Not Be What You're Expecting

Plus, I share my secret “19-20 Solution” to our budget crisis…

One of the most consequential policy fights of the coming year will be over taxes. Most parts of the Tax Cuts and Jobs Act (TCJA or, more commonly, “the Trump tax cuts”), which became law in December 2017, are scheduled to expire this year. Conventional wisdom long held that, if President Trump were back in the White House and Republicans controlled Congress, they would extend the expiring provisions en masse. But that looks increasingly improbable for the simple reason that we cannot afford it.

The year before TCJA’s passage, the federal budget deficit was roughly $600 billion. That’s not nothing, to be sure, but at three percent of GDP it stood near the long-run average dating back to 1980. Interest payments on the national debt cost $240 billion that year, or roughly six percent of total federal spending. In that situation, Republicans seemed quite comfortable with a $1.5 trillion net reduction in tax revenue over the coming ten years, that would add directly to deficits and debt. The Wall Street Journal’s Richard Rubin provided a helpful refresher yesterday on how the negotiations proceeded:

House Republicans initially wanted a deficit-neutral approach but relented after their major revenue-raising proposal fell flat. Then-Sens. Pat Toomey (R., Pa.) and Bob Corker (R., Tenn.) cut the final deal, with Toomey seeking a larger number that banked on tax cuts leading to economic growth and Corker expressing concern about deficits. Their agreement set the limit at $1.5 trillion, and Congress wrote and passed the bill within that constraint.

(As an aside, please never call someone like Pat Toomey or Paul Ryan a “fiscal conservative” when their main legislative achievement was an enormous, unpaid-for tax cut. Instead, use a term like “anti-tax zealot.”)

Fast forward to 2024, the deficit for this year is forecasted to approach $2 trillion, or seven percent of GDP—the highest figure on record for the United States, outside of wars and pandemics and economic recoveries. Interest payments will approach $900 billion, roughly 13% of total federal spending and an amount larger than the defense budget. In short, a “fiscal crisis” is not some future threat to worry about; we are living in it. Forget about tax cuts, both House Budget Committee chairman Jodey Arrington (R-TX) and House Appropriations Committee chairman Tom Cole (R-OK) have gone on record in the past year acknowledging that tackling the budget deficit is going to require raising additional tax revenue.

Historically, Republicans might have pushed ahead with claims that tax cuts would generate enormous economic growth and even “pay for themselves.” But at issue here is a specific set of tax provisions that was already sold once on those grounds, and found sorely wanting. The decline in federal revenue after their adoption is plain for all to see: from 17.1% of GDP in 2017 to 16.3% in 2018 and 2019 and, post-pandemic, still at 16.5% in 2023.

The growth story is even more embarrassing. As I’ve documented at American Compass, former White House Council of Economic Advisers chairman Kevin Hassett was so excited to sell TCJA’s success that he took the stage at the American Economic Association’s 2019 Annual Meeting to present the evidence that it had delivered precisely in line with the economic models. He chose the metrics and the baseline against which he would measure TCJA’s effect. Sure enough, total vindication. “Last year we were saying that you should use these models to think what’s gonna happen next year,” explained Hassett, “and they say this is what the growth effect is going to be and here we are a year later and … it’s exactly what the models say.” To emphasize the point, he continued, “if you say the tax cuts aren’t working then you’re kind of in some kind of denial that you should think about.”

Well, I thought about it. Unfortunately, Hassett had prepared his presentation using preliminary data from the Department of Commerce’s Bureau of Economic Analysis. When the final data came in later in the year, TCJA’s effect vanished. Worse than vanished, really. Put the final data into Hassett’s charts, and TCJA appears to have slowed investment and slashed growth. This repeated the experience of the Bush tax cuts in 2001 and 2003, which, using Hassett’s same measures, had likewise accomplished nothing at best.

On top of the facts that we cannot afford to extend the tax cuts and they didn’t work anyway, the ideological shift underway as conservatives shed 1980s-style market fundamentalism has led to a recognition that what’s good for multinational corporations is not necessary good for America. Vice President–Elect JD Vance and Congressman Chip Roy, policy chair of the House Freedom Caucus, have indicated an appetite for raising taxes on corporations, particularly if they are engaging in massive mergers or moving jobs overseas. Even President Trump’s proposal to lower the corporate tax rate from 21% to 15% was only for “corporations that make their products in America.”

Rather than pursue anything approaching a full extension of TCJA, which would cost nearly $5 trillion over the next ten years, Congressional Republicans are likely to settle on a much, much lower figure and then engage in intensive negotiations over what fits under “The Number,” as Rubin calls it. He cites Ryan Ellis, who spent more than a decade as tax policy director at Grover Norquist’s Americans for Tax Reform, predicting that the figure will be closer to zero than to $4 trillion.

For any fiscal conservative, the number should indeed be zero. That doesn’t mean there are no good provisions of TCJA worth preserving. For instance, the expanded child tax credit, limiting of various deductions, and incentives focused directly on rewarding business investment would all be made permanent in an ideal world. But they need to be paid for with some combination of increases in other taxes and offsetting spending cuts.

Of course, a key factor not previously present in budget negotiations is the possibility of substantial tariff revenue. Trump’s proposal for a 60% tariff on China and a 10% tariff on all other imports could raise hundreds of billions of dollars annually, which would cover most of a TCJA extension’s cost. But the same anti-tax zealots most eager to extend TCJA and perhaps cut taxes even further are the free-trade fundamentalists most opposed to tariffs. How they choose to manage this struggle against themselves will be fun to watch.

THE 19-20 SOLUTION

The unavoidable reality is that the total U.S. tax burden is going to have to rise in the coming years, pursuing some form of what I call the 19-20 solution. What is the 19-20 solution? It’s pretty easy to understand. The only way to bring our budget back to balance is to get taxes and spending each back to between 19 and 20% of GDP.

Read between the lines, you discover there's actually incredibly broad agreement on this: Biden's White House budget, with his wish list of tax increases, gets revenue up to 20% of GDP. The budget from the Center for American Renewal, led by formed Trump budget director Russ Vought, has a very good wish list of spending cuts, which get spending down to 19% of GDP (before assuming higher GDP growth).

How about Paul Ryan’s “Path to Prosperity” from ten years ago? Remember that monument to fiscal discipline? The proposal there was to get revenue and spending in the 2030s to... 19% of GDP. Guess what the federal government was collecting in revenue from 1998–2001, the last time we had a balanced budget, in an era with robust economic growth? 19.4% of GDP.

The Congressional Budget Office forecast for next year expects taxes at 17.0% of GDP and spending at 23.5%. With Republicans unwilling ever to raise taxes, or Democrats ever to cut spending, what will we do? An American Compass survey asked people how they would want to reduce the deficit—what share in tax increases, what share in spending cuts. They could enter whatever numbers they wanted. Did Democrats all choose 100% tax increases, Republicans 100% spending cuts?

No. To the contrary, vanishingly few actual Americans agree with the all-or-nothing position of partisans in Washington. Close to a supermajority expects at least 25% of deficit reduction to come from tax increases and at least 25% to come from spending cuts. The median American wants 40% tax increases and 60% spending cuts. What would happen if we tried to tackle the deficit that way, starting from where we are today? We’d end up with spending and revenue at...

19.6% of GDP.

We're not going to get there next year. We probably can’t even get all the way there in 10 years. Indeed, better not to make that the initial goal. Enough with the magical 10-year budgets that balance in impractical ways. And please, no more blue-ribbon commissions. 

A deal that makes a real, permanent $250 billion in annual spending cuts, and raises a real, permanent $150 billion in annual tax revenue is achievable, everyone on both sides knows off-the-record that it’s necessary, and it would lay the groundwork for further progress. For conservatives, especially, this has to be a priority. There’s simply no evidence that a “starve the beast” strategy of cutting taxes and then waiting for spending to come down has ever worked or could possibly work or would sustain any political support. If you want to cut taxes and cut spending back to 1950s levels without any sort of negotiation, by all means explain how you’re going to do it. Not “make a fancy spreadsheet with those numbers in it.” Explain how you're going to do it. 

The anti-tax zealots who have been allowed to commandeer conservatism have no path to fiscal responsibility or limited government and they don't care. Not their job. They should be treated like the special-interest lobbyists they are, not like serious members of a coalition.