By Andrew Cohen
Berkeley Law Professors Mark Gergen and Alan Auerbach, two of the nation’s leading tax law and policy experts, are giving mixed reviews to the sweeping new bill that President Trump signed recently.
The first major reform of the United States tax code since 1986 has triggered passionate, wide-ranging reactions throughout the country. This new legislation will affect the decisions of millions of Americans, from home ownership and health care to education and divorce.
The bill slashes corporate and many individual income tax rates, eliminates numerous deductions, and creates a new framework for international taxation. It is of the largest tax cuts in U.S. history, estimated at $1.5 trillion over the next decade, and will meaningfully redistribute the nation’s wealth.
Gergen and Auerbach say the reform is a mixed bag—and anticipate eventual corrective action.
“The legislation makes some improvements in the tax code, but overall has a number of significant problems that make it unlikely to be an enduring change,” Auerbach says. “These include the problematic treatment of pass-through entities, substantial increases in the federal deficit, a worsening of the income distribution, and a large number of important expiring provisions.”
Digging in on details
While the corporate tax cut from 35 percent to 21 percent is permanent, individual tax cuts are set to expire in 2025, which complies with Senate rules that limit the impact of legislation on the federal deficit after 10 years.
Gergen believes that increasing the standard deduction and lowering the corporate tax rate “are good as a policy matter,” and that the latter should increase long-term capital investment in the U.S. He said the legislation most benefits people with significant wealth and those who can convert their labor income to taxable capital income.
“The bill also benefits tax lawyers and accountants,” Gergen says. “In the short term, it most hurts individuals whose wealth is mostly in the form of human capital who won’t be able to structure their labor income to be taxed as capital income, and those who live in high-tax states.”
Geared to have fewer people itemize their taxes, the bill nearly doubles the standard deduction—from $6,350 to $12,000 for single filers and from $12,700 to $24,000 for married couples filing jointly.
“This will help make the tax system simpler,” explains Auerbach, co-director of Berkeley Law’s Robert D. Burch Center for Tax Policy and Public Finance. “The limits on various itemized deductions, particularly for state and local taxes, will further increase the number of households opting for the standard deduction.”
An elephant in the room: multiple independent studies project the tax bill to increase our deficit between $500 billion and $2 trillion over the next decade. Given those estimates, Gergen says that “in the long term, the bill hurts whoever ends up bearing the cost of repaying the increase in government debt.”
Another red flag
Both professors are also skeptical about the 20 percent business income deduction benefitting pass-through entities—owners, partners, and shareholders of S-corporations, LLCs, and partnerships who pay their share of the business’s taxes through individual tax returns.
“[T]hese new rules are terribly designed, they will be gamed, and they will be difficult to administer,” says Gergen, Berkeley Law’s associate dean for faculty development and research. “Part of the problem is that these rules were slapped together quickly.”
Auerbach foresees the pass-through provision leading to “considerable tax planning, complexity, and enforcement problems for the IRS.”
In addition to the lowered corporate tax rate and increased standard deduction, Gergen identifies two other key aspects of the tax bill: a shift toward taxing only the domestic income from U.S. corporations and away from taxing their global income, and the expensing of investment.
Predicting a major impact on the deficit and future generations, he notes how tax bills in the Reagan and the Bush II presidencies led to revenue loss that sparked subsequent tax increases.
“We’ve been down this road before,” Gergen says. “I think we can be fairly confident that the tax burden will rise at some point in the future. The experience of the Reagan years gave some of us the notion that the correction could take the form of fundamental tax reform. More recent experience is cause for pessimism about the prospect for such reform.”
The long-range uncertainty surrounding some of the main provisions makes it difficult to project their impact, Auerbach says. Key items set to expire by the end of 2025 include individual tax rates and brackets, personal exemption repeal, pass-through income deduction, business investment write-off, doubling the child tax credit and estate tax exemption, and the $10,000 cap for state and local tax deduction.
Before each of these measures expires, Congress will need to decide whether to extend them. When that time comes, Gergen and Auerbach anticipate some major revisions.