Trump’s Next Fiscal Target? An Analysis of Tax Expenditures in the TCJA
An interview with Martin Luby and Michael Granof
It’s been hard to keep track of everything the Trump administration has been up to recently, from tariffs to executive orders. While the possibility of tax law changes hasn’t been the focus of the media frenzy, it’s another policy that would have major implications. With his congressional majority in place, most observers believe President Trump will seek to renew key provisions set to expire from the Tax Cuts and Jobs Act of 2017 (the signature policy achievement from his first term).
However, the budgetary impact of renewing these policies will face headwinds from the substantial government deficit and rising interest rates. I caught up with Martin J. Luby and Michael Granof at the University of Texas at Austin to discuss the important role of tax expenditures in the federal budget and how they are in need of reform. Luby and Granof, along with Matthew Zachary, recently collaborated on “An Essential Component of Any Policy Toolkit to Address Federal Budget Deficits: Tax Expenditure Reform.” Granof is Professor at the McCombs School of Business, and Luby is Associate Professor at the Lyndon B. Johnson School of Public Affairs.
Note: This transcript has been lightly edited for clarity.
Sarah Bromley (SB): I’m sure many people are familiar with the TCJA and looking forward to hearing your thoughts on everything that is happening in the government right now. But to avoid any confusion, maybe you could start by giving a quick breakdown of what exactly tax expenditures are, and why they’re so relevant for today’s political environment?
Martin Luby (ML): Federal tax expenditures are losses in federal tax revenue associated with provisions in the tax code that allow for a special exclusion, exemption, or deduction from gross income, a tax credit, preferential rate of tax, or tax deferral. These provisions reduce the amount of taxes owed by taxpayers, resulting in an overall reduction in federal tax revenues. Many people have identified curtailing tax expenditures as a source of new funds to increase federal spending, shrink the deficit, or reduce other taxes.
Michael Granof (MG): It’s also worth noting that tax expenditures for 2025 are estimated by the U.S. Treasury to total $1.569 trillion (although, owing to taxpayer behavioral changes, if various tax expenditures were to be eliminated, the impact on the deficit would almost certainly be less).
SB: Given the size of tax expenditures, I can see why they might have attracted some scrutiny. But is there any particular reason that tax expenditures are a popular target for reform?
ML: Tax expenditures are often criticized as lacking transparency and proper oversight. They exist in the tax code, which is rarely changed, rather than being budgeted via the appropriations process (which theoretically needs to be reviewed every year). And they lack proper oversight since tax expenditure programs are usually overseen by the IRS rather than federal agencies that have functional experience in the area of tax expenditure. The lack of oversight leads to tax expenditures remaining in the tax code long after they have achieved their stated purpose. Tax expenditures have also been criticized on equity grounds as mainly benefiting higher-income taxpayers.
MG: Tax expenditures are, in economic substance, subsidies. Some of these, especially the larger ones such as employer contributions for medical insurance, can better be provided in the form of tax expenditures rather than direct appropriations. Hence, we most certainly don’t advocate for the elimination of all tax expenditures.
SB: You mentioned something interesting there about tax expenditures being criticized on equity grounds. Why is that the case?
ML: Since many of the largest tax expenditures are in the form of deductions, which reduce a taxpayer's taxable income, higher-income taxpayers who face higher marginal tax rates gain more from the deduction than taxpayers with lower marginal tax rates. Thus, a tax system that includes deductions without or with limited tax deduction caps makes the overall federal income tax system less progressive (i.e., less equitable), as measured by the effective tax rate of various taxpayers.
SB: So it seems like tax expenditures have a place, but they can often be wasteful. Can you give some examples of tax expenditures that didn’t serve their intended purpose, yet persisted?
ML: Tax subsidies for oil and gas exploration and drilling — even as oil and gas shortages have turned into surpluses. In this case, the tax expenditure may have initially served its purpose, but the tax break has persisted longer than necessary to achieve the policy goal. We discuss this in more detail in our paper.
SB: Now we’ve covered some of the basics, I’m wondering where exactly the Tax Cuts and Jobs Act (TCJA) of 2017 comes into this. What impact did the Act have on tax expenditures and the budget as a whole?
ML: The TCJA simplified the tax code in certain ways — for instance, an expansion of the standard deduction reduced the number of taxpayers who itemized their deductions. It eliminated and reduced certain tax expenditures and introduced some new ones, and it slightly changed the number of tax expenditure categories. As a result of TCJA 2017, the amount lost in federal tax revenue (i.e., the size of tax expenditure budget) declined modestly after the passage of the law.
SB: Got it. And if Trump were to renew the TCJA, what impact would you expect it to have on tax expenditures, the federal budget, and the deficit?
ML: Republicans in Congress are scouring the federal budget to find ways to pay for the extension of TCJA 2017. This includes eliminating or reducing special preferences in the tax code as a way to raise revenues. At the same time, the Trump administration has signaled interest in expanding certain tax preferences, like increasing the deduction for state and local taxes (SALT) and instituting new tax preferences, such as no taxes on tip income.
There would be some difficulty eliminating or reducing existing special tax breaks, while it would be politically popular to expand existing measures like SALT and institute new provisions (such as no tax on tips). Given this, one could see momentum towards greater tax expenditures and larger budget deficits once the dust clears. However, Republican deficit-hawks in the House have influence given the thin margins among the Republican majority, which may both rein in attempts at expanding tax expenditures and force efforts to curtail existing tax breaks.
SB: So not all Republicans agree on how to approach tax expenditures. You mentioned in your paper that TEs are a bipartisan issue, and that reforming them would suit the interests of both parties. How feasible do you think it is to achieve bipartisan support for tax expenditure reform currently?
ML: Curtailing tax expenditures can be viewed as both cutting spending — since tax expenditure is simply a form of spending — and increasing taxes, since reducing or eliminating tax expenditures results in a greater tax bill to the taxpayer. This could form the basis for bipartisan support for deficit reduction since both Republicans and Democrats can credibly claim they’re using their preferred means. Republicans would be cutting spending to address the federal budget deficits, while Democrats would be reducing tax breaks for special classes of taxpayers and upper-income households to achieve the same goal.
SB: That makes sense, though I imagine it’s easier said than done. Do you anticipate that it would be difficult to gain political support to eliminate or scale back some of the most popular tax expenditures?
ML: It would be very difficult to scale back many of the largest tax expenditures, such as the mortgage interest deduction, charitable contributions, and child tax credit. Moreover, as we note in the paper, some of this type of spending may be best done via a tax expenditure rather than through direct federal appropriations, like supporting charitable organizations through tax deductions for charitable donations.
SB: I’m definitely getting the picture that this is an issue to be approached delicately. We’ve touched on your recommendations for reforming tax expenditures already, and I know it’s something you discuss in more detail in your paper, but maybe you could summarize your core ideas?
ML: We are simply suggesting to reduce or eliminate the least efficacious ones, as well as creating a formal process that regularly evaluates tax expenditures to ensure they are meeting their goals. Such a regular evaluative process would aim to reduce tax expenditures over time.
MG: At the very least, whenever a tax expenditure is incorporated into the tax code, it should be accompanied by a sunset provision to ensure that it will have to be reviewed and explicitly voted upon again after a specified number of years.
SB: Hopefully the Administration is reading this! You also say in your paper that you believe the federal government should provide subsidies through direct grants rather than special tax provisions. Can you explain why this would be a better approach for the federal budget?
ML: There are three reasons. Firstly, direct grants typically require reappropriation every year, whereas once a tax expenditure is incorporated into the tax code, it remains in the code until explicitly removed — which is often never. Direct grants can also be more readily targeted to specific industries or narrow classes of taxes that satisfy the goals of the subsidy, and they’re typically administered by the federal agency most closely associated with the nature of the grant. Meanwhile, tax expenditures fall under the purview of the IRS, which is less qualified to ensure that those who take advantage of the special tax provisions are truly qualified to do so.
SB: Before we close things off, there’s just one more thing I’m curious about. It’s been a few months since you last revised your paper — is there anything you would want to add-on if you wrote it today, based on recent events with the Trump administration?
MG: One thing to note is that since the presidential election, Congress has begun to scour the tax code and tax expenditures to find "pay fors" for the extension of the TCJA, as well as other policy priorities of the Trump administration. Unfortunately, they are looking to curtail tax expenditures not to address the federal deficit (which was the thrust of our paper), but rather to only partially offset the cost of extending tax cuts. This will have the effect of exacerbating the negative long-term federal budget outlook.
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