5 Questions on the Midterms with Tax Expert Michael Graetz

October 30, 2018
Michael Graetz

Michael Graetz, Columbia Alumni Professor of Tax Law at the Law School, doesn’t expect much from the next Congress when it comes to taxes. Especially not after last December’s Tax Cuts and Jobs Act, which reduced taxes for most businesses and some individuals.

“We should not overlook its most important shortcoming: its effect on federal deficits and debt,” he writes in a just-published article for the Yale Law Journal. Graetz is deeply concerned about the cost of that legislation, which he estimates could reach $3 trillion over the next 10 years—twice what Republicans estimated when the act was passed. “The sad truth is that the 2017 tax legislation moved us a long distance away from the economically advantageous, fiscally responsible, and simplified tax reform that our nation so badly needs.”

Graetz, who joined Columbia from Yale in 2009, was assistant to the secretary and special counsel for the U.S. Department of the Treasury in 1992 and deputy assistant secretary for tax policy in 1990 and 1991. He is the author of numerous articles and several books, including 100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States.

Q. What’s the impact of 2017 tax legislation?

A. Lowering the corporate tax rate was long overdue. The higher U.S. corporate rate—compared to much of the developed world—was an incentive for companies to take tax deductions here while investing abroad to keep income in low- or zero-tax countries. Many individuals will benefit from an increase in the standard deduction. But limiting the deduction for state and local taxes clearly was intended to hurt states that tend to vote Democratic, places that have a state income tax and relatively high property taxes. Many provisions of the new law may lead to unintended consequences. Some of the politicians who voted for it may find themselves thinking, “I didn’t mean to do that.”

Q. What do you find most troubling about it?

A. It’s very, very complicated. For example, the legislation includes a 20 percent deduction from taxable income for certain businesses, effectively creating an unprecedented lower tax rate for partnerships, Subchapter S corporations and sole proprietorships, regardless of their size. It was labeled as a benefit for small business, but it benefits certain firms with more than $50 million in assets. In another example, employees no longer can deduct business expenses their employer doesn’t cover, but independent contractors can deduct all their expenses. This may encourage more people to become independent contractors, depriving them of employer-provided benefits, such as retirement contributions, and certain rights under state labor laws.

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Q. What’s the bottom line?

A. We have never in modern times faced such a dangerous imbalance between the levels of federal spending and revenues. We need to spend money on infrastructure and education. An aging population will need more for medical expenses. Federal taxes as a percentage of the economy already are lower than at any point since World War II, 16.3 percent of GDP, while we’re spending 21 percent. Half of our debt now is held by investors abroad. Some of those who are our friends today may not be our friends tomorrow.

Q. What happens if Democrats win control of the House?

A. The 2017 legislation was designed to kick a number of hard questions down the road, until after the 2020 elections. Many of the individual provisions, such as limiting the deduction for state income taxes and cuts in individual tax rates, expire in 2025, and a number of business tax provisions expire in the coming decade or are supposed to be tightened. But that’s really just an invitation to the next round. If the Democrats control the House and Republicans control the Senate, in normal times it would be an invitation to bipartisan legislation and cooperation. But these are hardly normal times.

Q. How do we dig ourselves out of the hole?

A. Experts from both political parties would have no trouble finding reasonable solutions on both the tax and spending sides. They would cut some spending, probably raising the age at which Social Security and Medicare kick in. They would certainly look for ways to better control healthcare costs, for example allowing Medicare to negotiate the cost of prescription drugs, which isn’t permitted now. And they would agree that we need a national sales tax, a value-added tax like that in every other developed country. The accumulation of deficits coupled with rising interest rates means that interest payments on the federal debt will become so burdensome that American taxpayers are going to begin taking that debt seriously. At the moment, nothing is politically feasible. But it’s politically inevitable.

—By Georgette Jasen