Candice Horbacz
The Tax Foundation’s recently published book, Options for Reforming America’s Tax Code 3.0: A Policymaker’s Guide to Tax Reform Trade-Offs, serves as a critical resource for lawmakers grappling with the complexities of federal fiscal policy. This comprehensive analysis meticulously models the economic, distributional, and revenue effects of 86 distinct changes to the nation’s tax code, offering invaluable insights into how different reforms impact the broader economy. A central theme emerging from this extensive research is the nuanced relationship between tax policy and economic expansion: not all tax cuts generate equal amounts of growth, nor do all revenue-raising measures incur the same economic costs. The study underscores that certain tax adjustments exert a more potent influence on economic activity than others, a vital lesson for policymakers aiming to craft a tax system that simultaneously encourages robust growth and ensures sustainable revenue streams.
In the current economic climate, characterized by persistent inflation, growing national debt, and the impending expiration of key provisions from the 2017 Tax Cuts and Jobs Act (TCJA), the urgency for informed tax reform has intensified. Lawmakers face the dual challenge of stimulating long-term prosperity and shoring up federal finances, making evidence-based policy design more critical than ever. The Tax Foundation’s latest report steps into this void, providing a granular look at how specific structural changes, beyond simple rate adjustments, can yield significant dividends for the economy.
The Methodology Behind the Insights: Dynamic Scoring and Economic Modeling
The Tax Foundation employs sophisticated modeling techniques to project the economic, revenue, and distributional impacts of proposed tax changes. Crucially, their analysis utilizes "dynamic scoring," which accounts for how changes in tax policy alter individual and business behavior, subsequently affecting the overall economy, the tax base, and ultimately, federal revenues. This contrasts with "conventional scoring," which often assumes no behavioral response to tax changes, thus underestimating the growth potential of certain reforms or overestimating the revenue loss. The report’s findings highlight that while tax cuts rarely "pay for themselves" in a simplistic sense, careful design of the tax base can deliver an outsized growth impact with minimal, or even positive, long-term revenue effects, particularly when economic growth is factored in.
Among the 86 options examined, five distinct policy changes stand out for their projected impact on long-run Gross Domestic Product (GDP). Notably, three of these top-performing options move from increasing the deficit to reducing it after accounting for the positive feedback loop of economic growth. This finding challenges conventional wisdom and emphasizes the power of strategically designed tax reforms to achieve both economic expansion and fiscal responsibility.
Top-Tier Reforms for Long-Run GDP Growth
1. Full Expensing for All Capital Investment (Option 53): A Catalyst for Productivity
Ranking as the most impactful reform for long-run GDP growth, full expensing for all capital investment addresses a fundamental bias within the existing corporate tax code. Under current law, businesses typically deduct most operational expenses, such as wages and raw materials, in the year they are incurred. However, capital investments – like new machinery, equipment, or buildings – are treated differently. Instead of immediate deduction, their costs must be "depreciated" over many years, following predetermined schedules. For example, a commercial building might be depreciated over 39 years, and residential buildings over 27.5 years.
This system of depreciation, while intended to align deductions with the useful life of an asset, significantly undervalues the deduction in present value terms, especially in an inflationary environment. A $10 million residential building deducted over 27.5 years, for instance, is worth only about $5.5 million in present value. This effectively acts as an implicit tax on long-lived investments, discouraging businesses from making crucial upgrades and expansions.
Full expensing eliminates this distortion by allowing businesses to immediately deduct the full cost of their investments. This policy change directly incentivizes capital formation, making new investments more attractive and profitable. The concept gained significant traction with the 2017 Tax Cuts and Jobs Act (TCJA), which introduced 100% bonus depreciation for certain assets, though with a sunset provision. More recently, the 2025 One Big Beautiful Bill Act (OBBBA) made expensing permanent for equipment and domestic research and development (R&D) and temporary for manufacturing structures, yet it left out foreign R&D (on a 15-year schedule), inventories, and other long-lived assets.
Extending full expensing to all capital investment, as modeled in Option 53, is projected to dramatically increase the long-run capital stock by 5.0 percent, boost GDP by an impressive 2.7 percent, and raise wages by 2.2 percent. This would also translate into the creation of 706,000 full-time equivalent jobs. While the conventional cost over the budget window is estimated at $1.4 trillion, largely due to deductions being shifted forward, the dynamic analysis reveals a different picture. The surge in business investment, higher wages, and increased employment lead to greater income and payroll tax collections, ultimately offsetting the initial loss in business tax revenue. Consequently, the primary deficit is projected to fall by $321.1 billion dynamically. This option delivers the largest GDP boost among all 86 options analyzed, underscoring its potential as a powerful pro-growth reform.
2 and 3. Full Expensing and Neutral Cost Recovery for Structures (Options 54 and 55): Addressing the Burden on Built Capital
Tied for the second and third most impactful reforms, Options 54 and 55 focus specifically on the tax treatment of structures. Nonresidential buildings are currently depreciated over 39 years, and residential buildings over 27.5 years – these are among the longest depreciation schedules in the tax code. Consequently, capital-intensive industries relying on structures like factories, warehouses, and apartment complexes have historically faced disproportionately high tax burdens. Although qualified production property, such as manufacturing structures, currently benefits from temporary full expensing, the broader category of structures remains largely subject to these extended recovery periods.
Option 54 proposes extending full expensing to all structures, allowing immediate deduction of their costs. Option 55, conversely, introduces a neutral cost recovery system for structures. This alternative approach retains the existing depreciation schedules but adjusts each year’s deduction upward to account for inflation and the time value of money. The economic rationale behind both options is similar: they aim to restore the full present value of the deduction, thereby neutralizing the implicit tax on long-lived structural investments.
The economic effects of these two options are nearly identical. Both are projected to increase the capital stock by 2.8 percent, boost GDP by 1.5 percent, raise wages by 1.2 percent, and create 400,000 full-time equivalent jobs. These figures represent about half the GDP effect of Option 53, reflecting their more limited scope to a specific portion of capital investment.
However, the two options differ significantly in their timing and administrative implications. Full expensing (Option 54) front-loads the deductions, leading to a conventional federal revenue reduction of $536.8 billion from 2027 through 2036. A potential drawback is that if a firm’s deductions exceed its taxable income, excess deductions may become net operating loss carryforwards, delaying their full benefit. Neutral cost recovery (Option 55), in contrast, is backloaded, resulting in a modest revenue reduction of $2.2 billion within the initial 10-year window, with nominal revenue losses growing over time as inflation and real rate of return adjustments become more pronounced. Administratively, neutral cost recovery requires lawmakers to establish an accurate discount rate to ensure its equivalence to expensing, which can be a point of debate.
Despite these differences, both options are projected to be revenue positive on a dynamic basis. Expensing (Option 54) is estimated to cut the primary deficit by $433.5 billion, while neutral cost recovery (Option 55) achieves an even larger reduction of $964.6 billion over the budget window, primarily due to the timing differences within the conventional scoring period. These reforms would provide substantial relief to industries that rely heavily on physical infrastructure, fostering investment in manufacturing, real estate development, and other capital-intensive sectors.
4. Replacing the Corporate Income Tax with a Destination-Based Cash Flow Tax (Option 71): A Bold Structural Overhaul
Option 71 proposes a radical overhaul of the corporate tax system by replacing the current corporate income tax and the individual tax on non-corporate business income with a flat 21 percent destination-based cash flow tax (DBCFT). The existing corporate income tax is primarily source-based, meaning it taxes profits where they are produced, irrespective of where the goods and services are consumed. This system creates several distortions: it biases financing towards debt by allowing interest paid to be partially deductible while returns to equity are not, and its reliance on corporate location necessitates complex anti-profit shifting rules that multinational companies often exploit to reduce their tax burden.
A DBCFT fundamentally redefines the tax base. It combines immediate expensing for all investment, repeals the deduction for interest, eliminates general business credits and Section 199A, and crucially, includes a border adjustment. The border adjustment converts the tax base from source to destination, taxing goods and services where they are consumed rather than produced. This mechanism is similar to those found in value-added taxes (VATs) and effectively neutralizes the problem of profit shifting, as the tax applies based on consumption within the country’s borders. It’s important to clarify that a border adjustment is distinct from a tariff; a tariff is a standalone tax on imports, whereas a border adjustment taxes imports and exempts exports. Economic theory suggests this results in an appreciation of the domestic currency (e.g., the U.S. dollar), which, in the long run, leaves the trade balance unchanged.
During the Trump administration, a similar DBCFT proposal was considered but ultimately not adopted, partly due to concerns from importers about potential price increases and transitional complexities. However, proponents argue its benefits, including simplification, neutrality, and the elimination of profit shifting, are substantial.
The Tax Foundation’s modeling projects that a DBCFT would increase capital stock by 2.6 percent, GDP and Gross National Product (GNP) by 1.4 percent, wages by 1.3 percent, and create 463,000 full-time equivalent jobs. While the expensing component drives most of the growth, the repeal of the interest deduction raises the cost of capital for some firms. This option is unique among the top five in that it raises substantial revenue on a conventional basis, before accounting for growth effects, by broadening the tax base. It is projected to cut the primary deficit by $2.3 trillion conventionally and by an even larger $3.3 trillion dynamically, positioning it as a powerful tool for both growth and fiscal consolidation.
5. Lowering Individual Income Tax Rates by 10 Percent Across the Board (Option 2): Boosting Labor Supply
The fifth option among the top performers involves a blanket reduction of all seven marginal individual income tax rates by 10 percent. This would see the top rate fall from 37 percent to 33.3 percent, and the bottom rate from 10 percent to 9 percent. This type of tax cut primarily aims to increase the incentive to work by reducing marginal rates on labor income and also encourages investment by lowering marginal tax rates on pass-through business income (income from sole proprietorships, partnerships, and S corporations that is taxed at individual rates).
This reform is projected to boost GDP by 1.3 percent and the capital stock by 1.6 percent. Notably, it leads to the largest gain in hours worked among the five options listed, adding 1.3 million full-time equivalent jobs. This outcome highlights the option’s primary focus on labor supply incentives rather than direct capital investment. Consequently, wage growth is projected to be more modest at 0.2 percent, as growth is driven more by additional hours worked rather than a deeper capital stock, unlike the investment-focused reforms.
A significant implication of this option is its impact on the federal deficit. Even on a dynamic basis, the tax cut substantially increases the deficit, leading to a "wedge" between the GDP effect (1.3 percent) and the GNP effect (0.9 percent). The higher deficit increases interest payments, including those made to foreign investors, which ultimately reduces American incomes. This is the only option in the top five that is not revenue positive; it is projected to increase the primary deficit by $3.6 trillion conventionally and $2.5 trillion dynamically. While politically appealing due to its direct benefit to individual taxpayers, its substantial deficit impact underscores the trade-offs involved in broad rate cuts versus targeted investment incentives.
Broader Implications for Tax Reform and Policymaking
The Tax Foundation’s analysis offers several critical takeaways for the ongoing debate on tax reform. First, it powerfully demonstrates that the debate should extend beyond mere rate reductions to encompass fundamental changes in how the tax code measures business income. Reforms like full expensing for all capital investments (Option 53) yield roughly twice the GDP effect of a 10 percent individual income tax rate cut (Option 2) and, remarkably, can even reduce the primary deficit dynamically. In contrast, the growth generated by Option 2 offsets only about 31 percent of its substantial revenue cost.
Second, the report clarifies the distinct economic mechanisms at play. Business tax reforms, particularly those that encourage expensing, primarily deepen the capital stock. This leads to increased worker productivity and, consequently, higher wages that rise nearly in step with GDP growth. Conversely, broad individual income tax rate cuts predominantly affect hours worked by altering labor supply incentives, resulting in more jobs but more modest wage gains. The message is clear: removing existing biases against capital investment embedded in the tax code represents some of the "lowest-hanging fruit" for achieving robust, pro-growth tax reform.
Finally, the Tax Foundation stresses that while economic impact is a paramount consideration, lawmakers must also adhere to the foundational principles of sound tax policy: neutrality, simplicity, stability, and transparency. Neutrality ensures that the tax code does not unduly distort economic decisions. Simplicity reduces compliance costs and makes the system easier to understand. Stability provides certainty for businesses and individuals, encouraging long-term planning. Transparency allows taxpayers to understand their obligations and policymakers to be accountable. The options presented in this guide, particularly those focused on expensing and consumption-based taxation, generally align well with these principles by reducing distortions and simplifying compliance for businesses.
As the nation approaches critical deadlines for expiring tax provisions and grapples with an evolving economic landscape, the insights from Options for Reforming America’s Tax Code 3.0 provide a robust, data-driven framework. The report empowers policymakers to move beyond conventional rhetoric and strategically design a tax code that fosters innovation, boosts productivity, and ensures long-term prosperity for all Americans, while also managing fiscal challenges responsibly.
