The use of sunset provisions in the tax code
One step forward, two steps back
Main Points:
· The pending 2025 tax debate centers on the renewal of Trump and Biden provisions scheduled to phase out or sunset.
· The sunset of tax provisions can result in large abrupt changes in tax obligations unless Congress and the President act to prevent the sunset from occurring.
· Sporadic tax sunsets creates economic uncertainty and fail to promote growth or tax equity.
· Congress can change any provision of the tax code at any time. A provision with a sunset will change without Congressional action.
· It is hard to understand why Congress sunsets some provisions and makes other part of the code permanent.
o Why did Congress decide to make lower personal income tax rates temporary and lower corporate tax rates permanent under current law?
· It is hard to understand why Congress phases out some tax benefits quickly and some slowly.
o Why did Congress phase out the expanded premium tax credit in 2025 and the tax credit for electric vehicles in 2032?
· The 2025 Congress should earmark additional revenue to the Social Security and Medicare Trust funds to avoid abrupt benefit cuts to these programs.
Summary of Key Aspects on 2025 Tax Debate:
Many tax code provisions routinely sunset or phase out after a certain number of years. These include Trump-era tax cuts enacted in the Tax Cuts and Jobs Act (TCJA) of 2017 and Biden Administration tax provisions, including enhancement of the ACA premium tax credit, and the exemption of student loan discharges from federal tax will expire after 2025.
All aspects of the tax code can be changed at any time by any Congress. A tax provision with a scheduled sunset will change regardless of whether Congress acts.
Some key changes of the tax code that will automatically change in 2025 unless Congress acts include:
· The top individual tax rate currently at 37 percent will revert to 39.6 percent.
· The cap on deductibility of state and local taxes will be eliminated.
· Limits on the deductibility of mortgage interest on home equity loans.
· Miscellaneous itemized deductions over 2.0 percent of income will be restored.
· Child tax credit will be reduced from $2,000 to $1,000 per child. (The child tax credit was temporarily increase to $3,600 under the American Rescue Plan but this Biden-era provision has already phased out.)
· Reinstatement of the personal exemption on federal income tax.
· Reversion to older more stringent Alternative Minimum tax rules.
· Elimination of tax breaks and deduction of qualified business income for pass through businesses.
· Bonus depreciation on qualified property.
· Elimination of the higher wealth exclusion from estate taxes.
· Elimination of the expanded ACA premium tax credit.
· Restoration of federal income taxes on discharged student loan debt.
Comments:
Comment One: The change in the corporate tax rate in the 2017 TCJA from a top rate of 35 percent to a flat rate of 21 percent was a permanent change in the tax code, which will remain in place unless changed in a new tax law. By contrast, several of the highest Democratic priorities, the enhanced ACA premium tax credit, the childcare tax credit, and the exemption of student loan discharges from federal taxes are scheduled to sunset in 2024. The Democrats prioritized tax credits for expensive EVs (expiration 2032) over expanded ACA premium tax credit (expiration end of 2025).
Comment Two: Three aspects of the TCJA -- the SALT cap, the restriction on deductibility of mortgage interest on home equity loans, and the elimination on miscellaneous deductions – appear beneficial and should be made permanent. Moreover, the restoration of deductibility on mortgage interest on home equity loans would likely increase house prices, which are already too high.
Comment Three: The 2025 debates over tax sunsets could lead to higher tax rates without additional funds for Social Security or Medicare, which are slated for automatic benefit cuts.
A decision to sunset the decrease in the marginal tax rate for high income taxpayers should be coupled with a provision earmarking funds from the higher rate to the Social Security and Medicare Trust funds.
Comment Four: The combination of three policies -- higher marginal tax rates for high income taxpayers, the elimination of the deduction of qualified business income for pass-through businesses, and the reversion to old Alternative Minimum Tax rules -- will lead to a large tax increase for people with pass-through businesses. The size of the increased tax burden on this sector of the population should be evaluated and alternative compromises should be considered.
Comment Five: “Progressives” strongly favor expansion of the childcare tax credit and proposals to make the credit refundable. However, other programs and expenditures including permanent expansion of Medicaid benefits, retention and further expansion of the ACA premium tax credit, and permanent liberalization of rules governing SNAP benefits would more effectively reduce poverty than the expansion of the childcare tax credit.
Comment Six: The retention and further expansion of the ACA premium tax credit should be the highest priority for the Democrats. Health care reform is unfinished and modifications to the tax code could substantially reduce disparities in health insurance outcomes, and reduce problems associated with high out-of-pocket health costs including the tendency to substitute savings for health care expenses for saving for retirement.
Comment Seven: Most discharged student debt is treated as taxable income subject to federal income tax. The American Rescue Plan Act of 2021 exempted student loans discharged between 2021 and 2025 from federal income tax. Student loan discharged after 2025 will be subject to federal income tax unless Congress extends this tax exemption.
Most Republicans oppose expansion of student loan discharges through Income Driven Repayment loan programs. The programs often fail to provide timely assistance to people in need as discussed here. A tax on the amount of the loan discharged could help reduce the number of people who increase the amount they borrow without increasing the amount they repay. A strong case could be made for allowing the tax exemption on student loan discharges to sunset while considering other substantive changes to student loan policy.
Comment Eight: The TCJA doubled the amount of income excluded from the estate tax and linked the exemption amount to inflation. The sunset of this provision in 2025 will cut the exemption in half. There is a 40 percent tax on all inherited wealth above the exemption threshold.
Estate taxes will be most burdensome on people with estates who have not prepared for the estate tax and people with estates with land and relatively small amounts of liquidity.
Estates of people who die in 2025 may be subject to the estate tax if they failed to prepare for the estate tax due to the expectation of the higher exemption remaining in place.
Households deserve a stable predictable set of estate tax rules. The rules could provide for a lower tax rate and different exemptions for liquid assets versus property or businesses.
Concluding Remarks: It is hard to understand why Congress lets some features of the tax code and some spending programs quickly lapse, and other tax expenditures and program remain in place for a decade or have no sunset provision at all.
Why, for instance, did Congress insist on a sunset of the expanded ACA premium tax credit after three years and a sunset on the tax credit for electric vehicles after 10 years?
The large number of tax provisions scheduled to sunset in 2025 increases the stakes of the 2024 election and sets the immediate agenda for the new Congress and Administration. The priority will involve preventing large abrupt changes in tax obligation that will adversely impact certain sectors and possibly the entire economy. Congress must consider changes in the tax code beyond the items scheduled to sunset and the possibility of earmarking additional tax revenue towards the pending shortfalls in the Social Security and Medicare Trust funds.