Progressive Principles for the 2025 Tax Debate: Having No Deal Is Better Than Having a Bad Deal

Next year, Congress and President-elect Donald Trump will face stark choices about extending expiring portions of the Tax Cuts and Jobs Act. The 2017 tax law permanently cut the corporate tax rate by 40 percent, but a host of other provisions—including increases to the standard deduction and the child tax credit, as well across-the-board reductions in tax rates—will expire at the end of 2025.¹

The original, Republican-passed law was a mistake: It added hundreds of billions of dollars to the annual deficit, delivered disproportionate benefits to the top 10 percent of Americans, and largely ignored low-income families. It also relied on a budget gimmick: Key Republican senators would only support legislation with a 10-year price tag of $1.5 trillion or less, but many wanted larger tax cuts than that headline figure would allow.² Instead of paring back the tax cuts to keep them within the constraint, Trump and congressional Republican leaders decided to sunset them after eight years.³ But now, they are preparing to extend them again.⁴

Policymakers should evaluate any tax package next year according to the following principles:

1. A tax package should not increase income inequality, including through how it is financed.
2. A tax package’s extensions of the 2017 law and any new tax cuts should be fully offset with tax increases on high-income households.
3. A tax package should not reduce the tax code’s horizontal equality.
4. A tax package should not erode investments in future American economic competitiveness.

A heuristic for determining whether a tax package meets the principles laid out above would consider whether it reduces the after-tax incomes of the bottom 60 percent of Americans after taking into account how those tax cuts are financed. Typical analyses of the Trump tax cuts show that they increased the incomes of every income group.⁵ However, these analyses mostly reflect the income gains from the federal government borrowing more money and ignore the fact that policymakers will eventually have to address the increased deficits.

Even relatively generous assumptions about how the Trump tax cuts may be financed in the long run suggest the cuts would reduce the incomes of the bottom 60 percent of Americans while raising those of the top 10 percent. Given these realities, letting the tax cuts expire is a far better alternative than extending a bill that entrenches income inequality.

Policymakers can avoid this outcome by offsetting any extension of the 2017 law with tax increases on affluent households while strengthening provisions for low-income households by, for example, expanding the refundability of the child tax credit. This will require breaking with congressional Republican leadership’s likely approach of extending tax cuts tilted to the wealthy financed by taxes on imported goods, cuts to vital spending programs, and/or increases to the deficit.

The U.S. economy has achieved staggering growth over the past several decades, with the gross domestic product (GDP) per capita growing 115 percent from 1979 to 2024.⁶ The post-pandemic period has been no exception, with inflation-adjusted U.S. GDP exceeding pre-COVID-19 projections.⁷

Unfortunately, that growth has been far from equally shared, with inequality growing across income, wealth, and wages. For example, the share of after-tax income for the top 10 percent of earners grew from 27 percent to 34 percent from 1979 to 2019.⁸ This group’s share of wealth similarly grew from 1989 to 2019 from 61 percent to 70 percent.⁹ COVID-19 pandemic relief and the tight post-recession labor market have fueled a remarkable decline in wage and wealth inequality, but both are still well above their 1980s levels.¹⁰

Major tax cuts have contributed to that inequality by giving high-income Americans larger tax cuts as a share of income than low- and middle-income Americans. For example, the 80 percent of the Bush tax cuts that were made permanent gave a bigger tax cut to the top 10 percent than to any other income group, even though the provision that cut the top tax rate from 39.6 percent to 35 percent was not extended.¹¹

The Trump tax cuts similarly contributed to income inequality by cutting taxes for the top 10 percent of Americans by more than for any other group. They permanently cut the corporate tax rate while raising taxes across the board by slowing the growth rate at which tax provisions are adjusted for inflation.¹² This permanent part of the law was especially tilted to high-income households, but even the expiring provisions—including the so-called middle-class provisions such as increasing the child tax credit and cuts to lower tax brackets—provide larger tax cuts to high-income households. Nevertheless, they should all be considered as part of a single regressive package that would add to the growth of income inequality that has taken place over the past several decades.

But the main way in which extending the tax cuts could add to inequality is through the incoming Trump administration’s plans to finance them.

President-elect Trump’s team has floated offsetting the cost of these cuts with 10 percent to 20 percent taxes on imported goods, which would cost the typical U.S. household thousands of dollars per year.¹³ A tax of that magnitude would entirely offset the benefits low- and middle-income families would receive by extending the expiring tax cuts, and it would only cover a fraction of the cost of extending them.¹⁴ It is unclear whether these import taxes would be included in tax legislation or whether the incoming Trump administration would use executive authority to enact them. Regardless, they should be considered as part of the distribution of a tax package, since congressional Republicans will likely claim them as a way to offset the cost of the tax cuts.¹⁵

In addition, Tesla CEO Elon Musk has suggested cutting $2 trillion annually in government spending.¹⁶ Any such cuts should also be considered as part of the tax package’s effects on inequality. Taken literally, such a reduction in government spending would cut every program in the budget by an average of roughly one-third, including Medicare and Social Security and funding for food safety inspection, cancer and stroke research, and nutrition for newborns.¹⁷ It would potentially throw millions of Americans into poverty. And if Medicare and Social Security were protected in such cuts, it would make the math more difficult for the rest of the budget, cutting all other government functions by more than half.

Importantly, even far smaller cuts than the ones proposed by Musk but consistent with what congressional Republican leaders and Trump advisors have floated, such as cuts to nutrition assistance and Medicaid or freezing nondefense discretionary (NDD) funding, could increase poverty and cripple vital governmental functions.¹⁸

Nevertheless, a tax on imported goods and spending cuts are unlikely to completely offset the cost of the tax cuts, which means that the administration may rely on higher deficits to finance the cuts.¹⁹ Deficit-financed tax cuts break down the logic of the standard tax distributional tables produced by the Joint Committee on Taxation or the Tax Policy Center.²⁰ This is because many of the gains for different income groups the tables show are attributable to increased borrowing, which will be eventually paid for through offsetting tax increases or spending cuts that are not included in the tables. Taken to their logical extreme, distributional tables would show that abolishing all federal taxes would boost everyone’s incomes with zero costs, but that is far from how such a scenario would play out in practice.

One way to address this shortcoming is to include an assumption in the analysis about how tax cuts are ultimately financed. In 2018, the Tax Policy Center provided an analysis of the 2017 tax law showing that the legislation would make most Americans worse off under an “equal-dollars-per-household financing” assumption, which assumes that tax cuts will be paid for with either equal-sized per-household tax increases, spending cuts, or some combination of the two.²¹ If the financing indeed comes disproportionately from spending cuts, as many have suggested, this is a generous assumption because more than 70 percent of noninterest federal spending is aid for individuals, and that spending is tilted toward low-income households, so spending cuts are likely to be larger for low-income than for high-income families in raw dollar terms.²²

A single basic goal of tax legislation is that it should not increase income inequality. But an equal-dollar financing assumption makes clear that extending the 2017 tax law would do just that by reducing the after-tax incomes of the bottom 60 percent of Americans while increasing those of the top 10 percent.

Tax legislation in 2025 should not lose revenue relative to the current revenue projections by the Congressional Budget Office (CBO), which do not assume the 2017 tax cuts will be extended. And any extensions should be paid for by the high-income households who have benefited the most from repeated rounds of deficit-financed tax cuts over the past 40 years.

In order to fund the current government structure, additional revenue will be needed. As the U.S. population ages and health care costs outstrip inflation, it will simply cost more to provide the current level of services in the future. Keeping revenue at its historical average will be insufficient to continue to provide the current level of Social Security and Medicare benefits for retirees in the future.²⁹

The U.S. tax code is designed so that revenues grow as a percentage of GDP over time as people get richer. In fact, until the Bush and Trump tax cuts were enacted, overall revenue was on track to keep pace with the growing costs of providing for retirees. Instead, the U.S. debt-to-GDP ratio has grown, with most of that increase coming from those unpaid-for tax cuts.³⁰

Extending the 2017 tax law without offsets will exacerbate this fiscal imbalance. The 30-year fiscal gap—the average amount of primary deficit reduction required to stabilize the debt-to-GDP ratio—is equal to 2.1 percent of GDP, which is the equivalent of $7.6 trillion over 10 years under current law. Extending the 2017 tax cuts without offsets would raise that to 3.3 percent of GDP, pushing debt above 200 percent of GDP within 30 years.³¹

These higher deficits will increase political pressure for cuts to programs Americans rely on such as Medicaid, nutrition assistance, or eventually even Medicare and Social Security. Congress has repeatedly enacted large, deficit-financed tax cuts tilted to the wealthy and then, citing debt and deficits, demanded and succeeded in achieving large cuts to critical programs. This happened following the enactment of the Reagan tax cuts, the Bush tax cuts, and the Trump tax cuts. The pattern was apparent last year when House Republicans cited rising debt as a reason to threaten defaulting on the nation’s debt if their demands to cut discretionary spending were not met.³²

Higher deficits and debt can also increase interest rates, which makes it less affordable to buy a home or a car, carry student loan debt, or start a business.³³ Elevated interest rates—which many consider part of the cost of living—over the past few years have been strongly unpopular among the public.³⁴ The effects of higher government debt on interest rates are both uncertain and modest, but the sheer scale of higher debt projections resulting from permanently extending the tax cuts means that the impact could be sizable.³⁵ Policymakers should not ask middle-income Americans trying to buy their first home to shoulder the burden of financing tax cuts tilted to the wealthy.

Higher interest rates resulting from higher deficits will also undermine critical national goals:

• Housing. Lower housing construction is one of the most widely recognized channels by which higher interest rates reduce economic growth. In fact, in 2018, the CBO projected that the initial Trump tax cuts would increase business investment but would separately reduce residential investment since their provisions are not favorable toward housing, and “[r]esidential investment is reduced throughout the entire period by crowding out.”³⁶ It is notable that inflation-adjusted residential investment today is actually lower than it was when the Trump tax cuts passed at the end of 2017 and far lower than its pre-2018 trend.³⁷
• Climate and energy. Similarly, elevated interest rates are a widely reported impediment to the capital investment needed for the energy system required to meet U.S. climate goals.³⁸ Renewable energy and energy efficiency provide strong returns on investment and save households and businesses money, but project costs are front-loaded and savings are accumulated over time; higher interest rates further drive up the initial costs of projects and undermine the ability of businesses and households to invest in them.³⁹
• Manufacturing. A higher fiscal deficit and interest rates are a well-established channel for increasing the trade deficit as they will put upward pressure on the dollar, reducing the competitiveness of American producers. The CBO similarly projected in 2018 that the initial Trump tax cuts would increase the trade deficit.⁴⁰

To be clear, not all increases in the deficit and debt are counterproductive. The modest and uncertain harms of deficits are dwarfed by the definite harms of cutting critical support to struggling households, which is why policymakers should consider the tax bill through a distributional analysis that includes assumptions about both the direct benefits of tax cuts and how they are financed (see above). Efforts to offset the tax cuts should be focused on higher-income—not lower-income—families to avoid increasing income inequality. The need to reduce the deficit is also not as urgent as other investments, such as addressing climate change or investing in children from low-income households. When unemployment is high and interest rates are low, countercyclical fiscal policy, such as the American Rescue Plan Act of 2021, is absolutely necessary to return the economy to full employment.⁴¹

But weighing the benefits of permanent across-the-board tax cuts tilted toward wealthy people against the costs of increasing the long-run fiscal imbalance by 50 percent strongly suggests that a deficit-financed extension of the 2017 tax law is not worth it.⁴²

In addition to income equality, it is important to evaluate whether a tax package undermines another type of equality: “horizontal equality,” where households with the same income pay the same tax, even if their income sources are different. For example, if an employee at a car dealership, a part owner of that dealership, and someone who sells their interest in that dealership all earn $200,000, they should each pay the same tax rate regardless of the source of their income.

Horizontal equality in the tax code has important values beyond simple fairness. First, it enhances efficiency because taxpayers do not engage in wasteful tax planning to capture tax benefits. For example, a tax break for business owners encourages employees to start their own business even when it makes more economic sense for them to remain employees. Second, it has an important connection to income equality (also known as vertical equality), since many of the tax breaks that reduce horizontal equality disproportionately benefit wealthy households. For example, the lower tax rate on capital gains and dividend income primarily benefits households in the top 1 percent.⁴⁷ Eliminating them can both reduce income inequality and raise revenue.

Some provisions of the 2017 tax law that are up for renewal undermine horizontal equality, and Congress should not extend them. In particular, the 20 percent deduction for pass-through income ensured that owners of closely held businesses paid a lower tax rate than wage and salary employees essentially doing the same work. For example, the deduction means that a car dealership employee making $200,000 in wages pays $9,600 more in taxes than a car dealership partial owner making $200,000 in profits who also works for the business.⁴⁸

During his campaign, President-elect Trump proposed several additional tax breaks that would further erode horizontal equality. One of the most prominent was exempting tipped income from taxes, which would provide a tax break for tipped employees such as waiters and hairdressers that is unavailable for nontipped employees such as janitors and security guards. If constructed along similar lines to Sen. Ted Cruz’s (R-TX) version of the bill, it would benefit the fewer than 5 percent of low- and moderate-wage workers who are tipped employees that earn enough to pay income taxes.⁴⁹ It would also encourage gaming in the tax code because nontipped employees would face a strong incentive to recharacterize nontipped income as tipped income. One analysis found that this recharacterization could cause the cost of the provision to increase sixfold.⁵⁰ And a bill similar to Sen. Cruz’s that lacks guardrails could even result in hedge fund managers and corporate lawyers shifting to tax-free tipped income compensation.⁵¹

One of the primary justifications for extending the tax cuts is that they will help the economy grow—an argument that is especially weak given the modest effect that the first round of cuts had on growth despite being more oriented toward investment than the expiring provisions are.⁵² It would be especially foolhardy to finance these large tax cuts with cuts to programs that enhance the competitiveness of the U.S. economy.

In particular, a tax package should not cut clean energy and manufacturing tax incentives, which are onshoring the production and labor needed for clean energy and technology deployment. Since the passage of the IRA—from the third quarter of 2022 to the third quarter of 2024—approximately $535 billion has been invested in clean energy deployment and manufacturing in the United States , including a record-high $71 billion in the third quarter of 2024 alone.⁵³ Investments in the electric vehicle supply chain—which includes critical minerals, batteries, and charging equipment—contributed to 92 percent of clean manufacturing investment in the third quarter of 2024.

These investments are critical to ensuring the continued competitiveness of American high-tech industries in the 21st century. Rolling back energy and manufacturing tax incentives would leave American firms ill-equipped to compete in the global market and would likely contribute to their decline domestically and abroad, with one report estimating that repeal would cut more than $50 billion in annual exports.⁵⁴ The incentives ensure the long-term economic strength of America’s manufacturing industry in the face of rapidly intensifying global competition, especially from China.

A potential tax package also should not cut the semiconductor manufacturing investments of the bipartisan CHIPS and Science Act. The semiconductor shortage of 2021 displayed the centrality of those components to the U.S. economy, cutting an estimated percentage point off of GDP growth that year.⁵⁵ Critically, the United States has gone from manufacturing 40 percent of global semiconductors in 1990 to just 12 percent today and does not produce any of the higher-end chips.⁵⁶ The $53 billion investment in domestic semiconductor manufacturing will help the United States regain its edge in this area of advanced manufacturing and boost the economy’s resilience to supply chain disruptions from overseas.⁵⁷ The investments are already paying dividends, with the Arizona facility of the Taiwan Semiconductor Manufacturing Co. achieving productivity on par with facilities in Taiwan.⁵⁸

Finally, a tax package should not rely on cuts to nondefense discretionary spending—whether formally included as part of the package or more informally cited as an offset for the tax package while being included as part of separate legislation. The NDD portion of the budget includes more than $80 billion in research and development spending that funds cutting-edge research to promote American competitiveness globally.⁵⁹ This includes cancer, stroke, and other biomedical research through the National Institutes of Health, as well as work through the National Science Foundation, NASA, and other research agencies and departments. NDD funding, excluding Veterans Affairs medical care, is at an almost 40-year low as a share of the economy.⁶⁰

The 2017 tax law was fundamentally flawed, increasing income inequality while putting upward pressure on the debt for little payoff. Congress will have a chance to address these problems when many of the law’s provisions expire at the end of next year.

Policymakers should focus on a package that does not increase income inequality and does not lose revenue while preserving horizontal equity in the tax code and protecting investments in American competitiveness.