President-elect Donald Trump and the Republican majority set to take control of Congress next year will have tough choices to make when it comes to setting promised tax policies without dramatically worsening the federal budget deficit.
This was the conclusion drawn by Robert Bloink and William H. Byrnes, the primary authors behind Tax Facts, during a webcast discussion Wednesday.
The professors, who analyze and debate key tax policies expected to affect wealth managers and their clients, looked closely at various tax policies that are ripe for change — whether to fullfill Trump's campaign promises or to raise revenue to pay for promised tax cuts elsewhere.
One of Trump's top stated priorities will be making permanent the expiring tax cuts under the 2017 tax overhaul. The incoming president has also proposed several additional tax cuts, Bloink and Byrnes explained. The promises may have helped get him elected, but they are also likely going to complicate the debate over how to balance tax cuts and fiscal responsibility.
Altogether, Trump has promised almost $8 trillion in tax cuts and $5 trillion in offsets, potentially adding at least $3 trillion to deficits over 10 years — assuming that no other policy changes are made.
Many wealth managers and clients find themselves in a wait-and-see mode, the professors explained. What is certain at this point is a serious tax-policy debate early in 2025.
Lifting the SALT Cap
While proposing to make most of the 2017 tax changes permanent, Trump has backed eliminating the $10,000 cap on the deduction for state and local taxes — the so-called “SALT cap.”
As the professors noted, the estimated 10-year cost of such an action would be $1.2 trillion, in addition to the $3.2 trillion to make the tax cuts permanent.
“The SALT cap is one of the more controversial aspects of the 2017 tax reform legislation,” Byrnes said. “The cap on state and local tax deductions blatantly favors taxpayers living in low-tax, generally red states, at the expense of taxpayers in higher and moderate tax states.”
Since the tax overhaul was passed, the SALT cap has represented a significantly increasing inequality between taxpayers living in low-tax and high-tax states. Some Republican House incumbents in blue states partly blame the cap for the loss of their seats.
Notably, House Republicans are entering the next Congress with 220 seats, leaving just two votes to spare to still obtain a 218 voting majority to pass a tax bill using budget reconciliation. Potentially, removing the SALT cap would obtain buy-in from the few remaining elected Republicans in generally high-tax blue states. There are, by the professors’ count, nine in California, seven in New York and three in New Jersey.
Bloink warned that removing the SALT cap would significantly reduce the economic gains that Trump projects through proposals to make permanent certain other aspects of the 2017 tax overhaul.
“When it comes to revenue-raising initiatives, we can’t really have it both ways,” he said. “If we want to eliminate the SALT cap entirely, we have to question the viability of maintaining the tax cuts Trump handed to the wealthiest Americans back in 2017.”
Another important consideration, according to Byrnes, is that the SALT deduction includes property taxes that have dramatically increased since Trump’s first term. Home values have surged by 40% on average across the United States. In Austin, Texas, in one red state example, they’re up nearly 90%.
Allowing the full deduction for state and local taxes paid would conceivably limit taxpayers being forced out of their homes because of rising values and related rising property taxes. But it would be costly.
Should the 199A ‘Loophole’ Expire?
With Section 199A of the 2017 tax legislation, a pass-through business entity is entitled to deduct 20% of qualified business income. This generally excludes service business income, although service businesses with income that falls below the annual threshold levels also qualify for the deduction.
As the professors explained, this policy has essentially leveled the playing field between corporations and pass-through entities. That is, when the corporate tax rate was cut to 21%, business owners would have been making the choice between the potential 37% tax rate for pass-throughs and the much lower 21% corporate tax rate.
“The 20% QBI deduction has ended up offering yet another tax loophole for the wealthy,” Bloink said. “Yes, it's beneficial for small-business owners who might otherwise have been forced into the corporate structure, but it's also given wealthy corporations yet another option for reducing their federal income tax liability.”
The rules governing the Section 199A deduction are complicated, Bloink noted, and can easily be manipulated by high-net-worth taxpayers.
