Experts concerned about new administration’s tax policy

Tax experts are already ringing warning bells about the effects of tax cuts promised during the election campaign and their effects on future budget deficits. 

“If you cause the bond market to completely freak out by having extraordinarily large deficits right off the start due to an unwise tax bill, you will undo that promise very quickly,” said Douglas Holtz-Eakin, president of the American Action Forum, a think tank that describes itself as having a moderate conservative lean.

The size of the deficit will be directly affected by the uncertain future of the Tax Cuts and Jobs Act which is set to expire at the end of 2025. Both parties agree on extending certain provisions including the individual deduction in tax rates. 

“I think that bond markets will basically be fine if the lower tax rates in the Tax Cut and Jobs Act were extended,” said Wendy Edelberg, director of the Hamilton Project at the Brookings Institution.

“I think that they would just swallow that $4 trillion increase and kind of move on with slightly higher interest rates. But if he (Trump) creates a more unserious conversation, I think he does risk that freak out.”

The comments came from two panel discussions hosted by Brookings on Tuesday. Much of the debate focused on the possibility of achieving “deficit neutral” tax reform, a condition determined by an accounting test to judge whether a tax move increases or decreases the deficit.  

Most experts believe the debate will begin with a decision about the accepted size of the deficit.  The Congressional Budget Office has put the number on extending all the provisions of the TCJA at an addition of about $5 trillion to the deficit.

“I think there are enough House Republicans in particular that getting the $5 trillion number is not possible,” said Michael Graetz, a law professor at Yale Law School. “I’d be shocked if you could get a $5 trillion number. I think it’s likely to be closer to two.”

The Tax Cuts and Jobs Act stands as the centerpiece of the first Trump administration’s domestic legislative accomplishments. 

Major provisions of the TCJA remain unpopular in the muni community as it eliminated the advance refunding of tax-exempt bonds and put a cap on the state and local tax deduction. 

The SALT deduction cap remains an ongoing bone of contention that cuts across party lines. The cap is perceived by many as a strong revenue tool for the federal government while bond issuers believe it infringes on their sovereign ability to levy future taxes. The calls for removing the SALT deduction cap comes from states with high taxes even though many states have developed work-around systems.  

“We’re looking at somewhere between probably 19 and 21 House Republicans from New York, New Jersey and California, and these Republicans have not always been the ones who are really willing to flex their legislative muscle against their party leadership.” said Molly Reynolds, senior fellow in Governance Studies at Brookings.

Reynolds also notes a similar situation exists with states currently benefiting from green energy tax credits created by the Inflation Reduction Act. Cutting those credits is also being considered to raise revenue.  

Public power companies and municipalities are tapping into the credits for the first time this year in the form of a direct pay system that converts credits into cash for non-profit entities. 

The increase to the Internal Revenue Service budget via the IRA is also a favorite target for possible reductions. 

“If there’s one thing they’re going to repeal, the simple wager is that some of the IRS funding is going to get cut,” said Graetz. “Their problem is that doesn’t score as a plus, and CBO last time you scored it as a revenue loser.” 

Boosting the enforcement arm of the IRS raises worries in the muni community about more bond audits.      

The muni market is especially concerned that budget tightening in the next Congress could cause some to focus on the elimination of tax-exempt bonds.