The Good, Bad, and the Ugly

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Senate Republicans have advanced legislation to extend many provisions of the 2017 TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
Cuts and Jobs Act (TCJA) alongside dozens of new provisions, following broadly similar legislation put forward by House Republicans. Any comprehensive tax legislation is going to have its wrinkles, and the “One, Big, Beautiful Bill” is no different. We have previously published estimates of the budgetary, economic, and distributional effects of the House legislation and the Senate legislation, and this post will dive into the good, the bad, and the ugly of the Senate’s.

The Good

Both the House and Senate bills make some smart tax cuts and revenue increases.

Most of the good tax policy aligns with Tax Foundation’s principle of stability. The Senate bill makes permanent the House bill’s provisions allowing expensing for investment in short-lived assets and domestic research and development. Permanent expensing has the most bang-for-the-buck when it comes to economic growth. In the context of the full Senate bill, the two provisions boost long-run GDP by 0.7 percent, providing taxpayers the certainty they need to boost long-run investment. The Senate retains the House bill’s temporary expensing for qualified structures, a good addition that would need to be made permanent for taxpayer certainty and long-run economic growth.

The Senate bill also makes permanent TCJA’s less restrictive limitation on interest deductions. Both bills provide a permanently higher threshold for expensing certain equipment for smaller businesses (Section 179 expensing).

The House and Senate bills both secure permanent extension of the rates and brackets of the 2017 individual tax cuts, providing certainty for households and stability to the structure of the tax code. The Senate bill also permanently extends a larger standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes.
and a modified alternative minimum tax threshold. These two provisions have greatly simplified the tax code for millions of taxpayers. Furthermore, by retaining the $10,000 cap on the state and local tax (SALT) deduction, the Senate bill would maintain the TCJA’s simplification benefits by keeping the standard deduction preferable for millions of taxpayers. The bills permanently extend some of the TCJA’s limits on some itemized deductions, such as for mortgage interest, and limit each dollar of itemized deductions for top earners. However, the House bill waters down the TCJA’s $10,000 SALT cap, raising it to $40,000 for taxpayers earning less than $500,000.

Regarding the estate and gift taxA gift tax is a tax on the transfer of property by a living individual, without payment or a valuable exchange in return. The donor, not the recipient of the gift, is typically liable for the tax.
, the bills institute a permanent (and inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power.
-adjusted) exemption level of $15 million beginning in 2026.

The bills establish permanent, though different, solutions for the treatment of international business income,  removing the threat of substantially higher taxes at the end of this year for US-based multinational companies. While the House permanently extends a slightly less generous version of current policy for the international regime (GILTI, FDII, and BEAT), the Senate introduces permanent reforms (with new acronyms) that increase tax rates but reduce double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income.
.

The bills also raise revenue relative to current law by reducing some of the tax code’s many tax credits, deductions, and other preferences. The largest area of reform is the Inflation Reduction Act’s (IRA) green energy tax credits; both bills raise about $500 billion over a decade, reducing the cost of the green energy credits by about half. Several IRA credits are repealed—as for electric vehicles (EVs) and residential energy products, which are expensive and ineffective—while most others are restricted or phased out quicker. However, the bills expand and extend the clean fuel production tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income rather than the taxpayer’s tax bill directly.
and introduce additional compliance challenges for many of the credits.

Health insurance premium tax credits, projected to cost about $1 trillion over the next decade, are pared back about 20 percent by tightening eligibility rules and reducing improper payments. The bills also tighten some of the tax-exempt rules, such as for unrelated business income.

The Bad

The bills spend far too much money on political gimmicks and carveouts. For example they introduce tax exemptions for overtime pay and tips, a deduction for auto loan interest, and an additional standard deduction available for some seniors, all of which violate basic tax principles of treating taxpayers equally. Combined, the four provisions cost more than $350 billion over the four years they are in effect, and if eventually extended beyond that date, the cost would more than double over the next decade. Complicated eligibility restrictions reduce the cost somewhat, but it would be better to not introduce bad ideas in the first place. 

Another costly mistake is the route lawmakers have taken on the treatment of non-corporate businesses. In 2017, lawmakers introduced a 20 percent deduction for business income that is taxed on the individual rate schedule and not at the corporate tax rate of 21 percent. Taxes on dividends and capital gains are a second layer of tax on corporate income. The non-corporate businesses (also known as “pass-throughs”) face a few changes in this legislation, but the main change is that the deduction is made permanent at 20 percent in the Senate version and increased to 23 percent by the House. The House version would cost more than $700 billion over the next decade ($800 billion according to the Joint Committee on Taxation). Increasing the pass-through deduction would further decrease the effective tax rates on pass-through income relative to corporate profits, making the tax code less neutral with respect to business form.

Lawmakers could have reduced the cost of their legislation by trillions of dollars through further base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability.
and cleaning up the tax code. For example, lawmakers could have gone further than the TCJA’s limitations on itemized deductions, rolled back tax exclusions for various types of employer-sponsored benefits (including but not limited to the tax exclusion for employer-sponsored health insurance), and repealed several tax expenditures, such as the credit union exemption and the low-income housing tax credit (which instead gets extended in both versions of the legislation).

The Ugly

The bills further complicate the tax code in several ways, sending taxpayers through a maze of new rules and compliance costs that in many cases likely outweigh potential tax benefits. No tax on tips, overtime, and car loans comes with various conditions and guardrails that, if enacted, will likely require hundreds of pages of IRS guidance to interpret. The changes to the IRA credits, while commendable in many ways, keep in place some of the most complicated rules, e.g., bonus credits for meeting prevailing wage and apprenticeship requirements, and add new “foreign entity of concern” restrictions that may make many of the credits cost-prohibitive. The Senate version at least provides some clarity on these new FEOC rules.  

While the bills provide new incentives for saving, the accounts are redundant and the rules complex. The tax code is already littered with a confusing array of special preferences for savers, including tax-preferred accounts for education, health, retirement, and other purposes that go largely unused by low- and middle-income households. Rather than simplifying and liberalizing the rules to allow saving for any purpose without penalty (universal savings accounts), the House bill expands health savings accounts, and both bills expand savings accounts for higher education (529 accounts) and for individuals with disabilities (ABLE accounts), drawing new lines to define eligible expenses and allowing larger contributions under certain conditions.

The bills also introduce  a new savings vehicle called “Trump Accounts,” an entirely new type of incentive that includes a $1,000 government-provided baby bonus for children born in the next four years. The accounts allow taxpayer contributions up to $5,000 a year that can grow tax-free until the beneficiary withdraws the money at age 18 or older, at which point the withdrawal is subject to capital gains taxA capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment.
if used for a few qualified expenses or otherwise ordinary income tax plus a 10 percent penalty. Various other conditions apply. Trump Accounts provide a more limited and restricted tax benefit than existing saving incentives, such as 529 accounts. The bills also allow certain tax-exempt entities to contribute to Trump Accounts, under rules to be established by the Treasury Secretary, which could lead to substantial benefits for some account holders. The major effect is to introduce a new baby bonus entitlement that requires taxpayers to track yet another small dollar account for 18+ years. This is a missed opportunity to simplify saving and improve financial security for all Americans.

The bills establish a new tax credit for donations to scholarship-granting organizations, limited to $5,000 per individual annually through 2029, which may be intended to work in tandem with Trump Accounts. While helpful for some, the tax credit would undoubtedly require a lot of rulemaking and administration by the Treasury Department and IRS, which is already overwhelmed with the task of administering our complicated tax code and multiple benefit programs under current law.

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