De Rugy: How to pay for Trump's tax cuts

While the GOP may not speak as loudly about our fiscal situation as it once did, this week's Republican convention offers a good chance to do so — and to offer something positive. The situation is indeed dire. The national debt has reached staggering levels, and the next president will inherit a ticking time bomb of fiscal deadlines that could significantly worsen the burden.

The potential expiration of the previous (and popular) Trump tax cuts is one such fiscal cliff. However, it also represents an opportunity: Pay to extend Trump's cuts by cleaning out the tax code of unfair, costly tax breaks that aren't shared by enough Americans.

Congress passed the Tax Cuts and Jobs Act in Dec. 2017. By the end of 2025, roughly all the individual tax cuts and two important business provisions will expire. While deciding which provisions to extend, legislators must take two things into consideration: the impact on economic growth and on the deficit.

Considering that there seems to be general bipartisan agreement on keeping a majority of the tax cuts and maintaining growth, let's focus on the deficit question. I firmly believe that any new costs or extensions of current policies must be paid for. We simply cannot afford to keep adding to our debt without considering the long-term consequences.

A sensible place to start is by examining the myriad tax expenditures that have turned our tax code into Swiss cheese. According to the Treasury Department, there are 165 tax expenditures (think revenue losses due to tax carveouts), which is up from 53 in 1970.

We should start by eliminating the ones that distort economic decision-making. The goal is a neutral tax system that doesn't favor certain activities or industries over others. That's one reason tax expenditures aimed at social engineering should be on the chopping block. Tax expenditures that add complexity to the tax code should be prime candidates for elimination too. Simpler tax systems reduce compliance costs and are more transparent.

Based on these criteria, one prime candidate for termination is the mortgage interest deduction. It's expensive, favors relatively wealthy people, distorts the housing market, and promotes housing debt more than true homeownership.

Another is the state and local tax deduction, which primarily benefits high-income earners and high-tax states. Tax-free municipal bonds should be terminated once and for all. These also disproportionately benefit high-income individuals and can lead to overinvestment and debt in municipal projects.

We should also end tax exemptions on employee compensation that is not considered wages. Hear me out. In a recent study on extending some of the Trump tax cuts without additional debt, the Cato Institute's Adam Michel explained that "employers often provide compensation in the form of health insurance, meals, parking, transportation benefits, education assistance, and child care. Not taxing these employment benefits as wage income creates an incentive to compensate employees with tax-free fringe benefits, and the tax advantage is primarily used by higher-income workers who tend to have access to more comprehensive employment arrangements."

He adds that "taxing these benefits as wage income would increase income tax revenue by $447 billion a year." The exclusion of employer-provided health insurance is the most expensive and distortive of the tax expenditures, and one of the main reasons why the health care market is such a mess.

Business subsidies are also ripe for cuts. Michel calculated that "tax credits for the energy sector reduce revenue by $119 billion a year." They should be terminated. They distort energy markets and often benefit large corporations more than the environment.

Of course, the other $133 billion in annual business subsidies should be on the chopping block. Michel suggests that "place-based tax incentives for economic development or investment in targeted locations have 40 years of research showing they fail to meaningfully increase employment, raise wages, or advance general economic opportunity." On that note, we should repeal the state and local tax deduction for corporations.

This doesn't mean every tax expenditure should end. The preferential treatment of capital gains is one of them. Since corporate profits are already taxed, taxing capital gains at full rates can be seen as a form of double taxation and a disincentive to invest in corporate investment returns that help spur growth, innovation and hiring.

Addressing these issues won't be politically easy, as each tax expenditure has its defenders. However, the magnitude of our fiscal challenges demands bold action, especially if we are rightfully going to extend most of the Trump tax cuts and engage in further reform.

Veronique de Rugy is the George Gibbs Chair in Political Economy and a senior research fellow at the Mercatus Center at George Mason University.