Joel L. Naroff: Managing the sunsetting 2017 tax cuts could be the biggest test of the next Congress and president

With the presidential candidates hitting the road for the final eight weeks of campaigning, the economy, hopefully, will take center stage. For good reason, high consumer prices will continue to be a major focus of attention. However, it should not be the only or even the main economic issue discussed.

While some prices have come back to earth and others are falling, most prices are sticky downward. It would probably require a significant recession before businesses cut consumer prices to anywhere near pre-COVID levels. No one wants the economy to tank. As for inflation, it is already at a reasonable level, and the Federal Reserve could start cutting rates soon to reflect the reduced inflation risks.

While politicians focus on something they have little control over, flying under the radar is a brewing tax storm. Former President Donald Trump’s signature economic piece of legislation, the 2017 Tax Cuts and Jobs Act (TCJA), contained a ticking tax time bomb.

When structuring the bill, so many tax cuts were included that it broke the budget bank. Something had to be done. The solution Congress chose was a favorite budgetary gimmick — sunsetting — a clever way of claiming tax reductions would end even though that was never expected to occur.

Guess what? At the end of 2025, many of the TCJA tax cuts are slated to end.

Getting anything done in Congress is difficult even when a simple majority is required. In the Senate, a bill would need 60 votes to just be voted on if it is being filibustered.

So, how did the Republicans manage to pass a tax law that every Democrat opposed? Through a process called “reconciliation.” Reconciliation allows a strictly budget-related bill to be passed in the Senate with a simple majority. The caveat is that it cannot increase the budget deficit after a 10-year period.

But that wasn’t enough for the Republicans. They pledged not to raise the budget deficit by more than $1.5 trillion (as scored or calculated by the Congressional Budget Office) during the first 10 years after the bill’s passage. Yes, Republicans accepted that the tax cuts would not pay for themselves and the budget deficit would soar — but by “only” $1.5 trillion.

Unfortunately, the Republican majority ran into one big problem: When the CBO scored their bill’s impact on the deficit, it came in way over $1.5 trillion. Estimates by private-sector organizations and economists also found that budget deficits would increase significantly more than the Republican self-imposed limit.

When faced with a problem that appears unsolvable, what do politicians do? They fake it. That is where sunsetting comes in.

The way the Republicans avoided the TCJA exceeding the $1.5 trillion deficit-increase cap was to mandate that some of the tax cuts would sunset, or return to their pre-TCJA levels, after eight years (at the end of 2025). That way, all the losses in revenue in years 2026 and 2027 would magically disappear, and the CBO score would come in under the cap — which it did.

The assumption behind the sunsetting was that when the tax breaks were set to end, Congress would make them permanent. But to be sure that happened, the most voter-friendly ones were sunsetted while the less popular corporate tax cuts were not.

Fast forward to now. The political risks of doing nothing next year are great. Lower personal tax rates, different brackets, increased personal deductions such as the doubling of the child tax credit, large increases in the standard deduction, the estate and gift tax limit increases, as well as a variety of other tax modifications will revert back to pre-TCJA levels. These are just a few of the changes, and they will not make many taxpayers happy. (The unpopular — in high-tax states — $10,000 limitation on the State and Local Tax (SALT) deduction will also disappear, pleasing some taxpayers.)

Put simply, unless Congress acts, a whole range of popular individual tax changes will expire at end of 2025.

The dilemma of how to deal with voter-friendly tax changes sunsetting is highlighted by the impact renewing those breaks would have on the federal budget deficit.

The CBO, as well as most private-sector organizations and economists, estimate the budget deficit would balloon over the next 10 years by between $3 trillion and $4.5 trillion if all the tax reductions are made permanent.

Because saving most of the popular tax changes is both a political necessity and a budget disaster, some of the tax losses will have to be recouped through revenue-raising actions.

Unquestionably, the Democrats will want to reverse some of the massive changes in corporate tax rates, which reduced the top tax rate from 35% to 21%. And undoubtedly, Republicans will fight that.

But the need to save some of the personal income tax changes provides leverage to those who felt the cut in corporate taxes went way too far. A common view at the time was that a 28% rate made the U.S. competitive globally.

A second source of revenue is raising taxes on higher-income earners. Analysts noted that the TCJA’s tax savings were skewed heavily toward the highest-income households — in excess of 80%. Democrats will likely want to claw some of that back while Republicans are likely to disagree.

Because doing nothing is a nonstarter, both the personal and corporate tax changes in the TCJA should be on the table if Congress is to prevent the budget deficit from exploding further.

In 2017, what started out as an attempt to reform and reduce taxes turned into a race to see who could cut taxes for businesses and individuals the most, regardless of the impact on the economy, which has shown to be minimal, or the budget deficit, which has been significant. To hide the full cost of the tax cuts, the sunset charade was implemented.

A massive political battle over personal taxes vs. corporate taxes, and high-income earners taxes vs. lower- and middle-income household taxes is coming in 2025. The outcome will significantly affect federal revenues, the budget deficit, and the ability to pay for government programs and services going forward.

Who will determine which groups win and which lose? The soon-to-be elected members of Congress and next president.

That raises the stakes of the 2024 election significantly.