Jorge Barro, “Promote Fiscal Responsibility by Limiting Tax Breaks,” Rice University’s Baker Institute for Public Policy, October 2, 2024, https://doi.org/10.25613/86RB-ZS90.
This brief is part of “Election 2024: Policy Playbook,” a series by Rice University and the Baker Institute that offers critical context, analysis, and recommendations to inform policymaking in the United States and Texas.
Expiration of the TCJA provisions at the end of 2025 brings fiscal policy into focus for both the 2024 election cycle and the new administration. Whoever inherits the Oval Office will face a generational issue in determining the future of U.S. tax policy. Sustaining the base-broadening provisions from the TCJA would maintain the efficiency and fairness of reform while contributing to deficit reduction. These are all features of tax policy that can generate bipartisan support.
While several features of the TCJA have been debated since its passage, one of the most contentious provisions has been the limitation of the state and local tax (SALT) deduction. Prior to 2018, taxpayers could deduct state and local property taxes plus the greater of income or sales taxes. The unfettered SALT deduction disproportionately benefited high-income households and taxpayers in high-tax jurisdictions. The TCJA limited the SALT deduction to $10,000 per taxpayer, reducing it to a small fraction of its previous size and effectively eliminating almost all its economic effects.
After the implementation of the SALT cap, low-tax states experienced a relative increase in domestic migration. Proponents of the SALT cap highlight both the benefits of a broader tax base and lower rates, as well as the regressive nature of the deduction, while opponents focus on issues regarding geographical unfairness and the benefits of state and local government provisions.
Another major sunsetting provision of the TCJA is the reduction of the mortgage interest deduction limit from $1 million to $750,000 of mortgage debt. The mortgage interest deduction was originally introduced to subsidize home ownership, which was seen as a path to financial independence. This regressive tax deduction, however, only contributed to excess house price inflation and may have even reduced the home ownership rate by pricing low-income households out of the market. Before passage of the TCJA, proponents of the mortgage interest deduction often expressed concerns over a housing market collapse if the provision were removed. However, in the years since the deduction was reduced, house prices have risen sharply, and support for maintaining or expanding the deduction has softened.
Although the SALT and mortgage interest deductions were major components of the TCJA, the tax reform also limited the deduction on large out-of-pocket medical expenses and eliminated other deductions, including unreimbursed employee expenses and other miscellaneous items. Finally, what remained of any itemized deductions was effectively nullified for many households by coupling the personal exemption and the standard deduction into a single expanded standard deduction.
While a broader tax base with lower rates enhances efficiency of the tax system, the impact of the TCJA base-broadening measures may have gone much further. In particular, data from the 2019 Survey of Consumer Finances showed the first decline in U.S. wealth inequality in nearly three decades. Evidence from the survey indicates that the decline was largely due to a relative improvement in the valuation of homes owned by poorer households. This shift in valuation can be explained in part by the effects of limiting regressive housing subsidies implicit in the mortgage interest deduction and the property tax component of the SALT deduction. Consequently, reinstating the pre-TCJA SALT and mortgage interest deductions — as would happen in 2026 under current law — could cause wealth inequality to increase once again.
Fiscal issues related to the aging population and rising health care costs are also projected to exacerbate the federal deficit over the next several years. Bipartisan solutions will require compromise through expenditure reductions and revenue increases, whereas base-broadening provisions offer a fair and efficient path to a fiscal resolution.
To maintain a broad, fair, and efficient income tax base, legislators can take the following actions:
With America facing an unsustainable fiscal deficit and scarce opportunities for bipartisan solutions, limiting deductions offers a viable path to tax reform. By extending or enhancing base-broadening provisions of the TCJA, the new administration could prioritize fiscal responsibility while also contributing to a fair and efficient tax system.
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