Candice Horbacz
The Tax Foundation’s newly released book, Options for Reforming America’s Tax Code 3.0, offers a comprehensive analysis of 86 potential modifications to the U.S. tax framework, modeling their profound economic, distributional, and revenue implications. A central and illuminating insight emerging from this extensive research is the varied efficacy of tax policy adjustments: not all tax cuts yield equivalent economic growth, nor do all revenue-generating measures impose identical costs. The report underscores a critical lesson for policymakers: certain tax reforms possess a significantly more potent impact on economic activity than others. This understanding is paramount for crafting a tax code designed to foster robust growth and secure sustainable revenue streams in the long term.
The Imperative for Tax Reform: Context and Challenges
The United States economy consistently faces calls for tax reform, driven by a complex interplay of factors including global competitiveness, domestic investment needs, and the ongoing challenge of federal budget deficits. The Tax Foundation, a non-partisan research organization, provides valuable data and analysis to inform these debates, focusing on the principles of neutrality, simplicity, stability, and transparency. Their latest publication arrives at a time when inflationary pressures, supply chain disruptions, and a dynamic global economic landscape compel a renewed focus on policies that can enhance productivity and long-run prosperity. Historically, major tax overhauls, such as the Tax Reform Act of 1986 and the Tax Cuts and Jobs Act (TCJA) of 2017, have sought to address perceived inefficiencies and spur economic activity, often leading to contentious debates over their design and effects. The current economic environment, marked by significant federal debt and a desire to bolster domestic manufacturing and innovation, makes the findings of Options for Reforming America’s Tax Code 3.0 particularly pertinent.
The report’s methodology involves rigorous modeling to project how changes to the tax code would influence key economic indicators like Gross Domestic Product (GDP), wages, capital stock, and employment. This approach allows for a granular comparison of different policy levers, revealing that the manner in which business income is measured and taxed holds more sway over long-term growth than conventional wisdom often suggests. While many tax reform discussions tend to gravitate towards adjustments in individual income tax rates, the Tax Foundation’s analysis points to structural changes in business taxation as having a disproportionately larger impact on the economy’s productive capacity.
Top Performers: Reforms Driving Long-Run GDP Growth
Among the 86 options evaluated, five reforms distinguish themselves by their significant positive impact on long-run GDP. Strikingly, three of these top five options transition from initially increasing the deficit to ultimately reducing it after accounting for dynamic economic growth. This is not to suggest that tax cuts universally "pay for themselves" – a notion the report explicitly debunks, stating they rarely do. Rather, it highlights the power of meticulously designed adjustments to the tax base that can deliver substantial growth with minimal, or even net positive, revenue outcomes. The key lies in understanding which specific changes unlock the greatest economic potential.
1. Full Expensing for All Capital Investment (Option 53): Unleashing Business Investment
The top-ranked option for boosting long-run GDP is the implementation of full expensing for all capital investment. This reform directly addresses a longstanding bias within the U.S. corporate tax system. Under current law, while most business expenses like wages are immediately deductible, capital investments – such as machinery, technology, or new buildings – are treated differently. Instead of immediate deduction, businesses are often required to spread these deductions over many years through depreciation schedules. These schedules rarely account for inflation or the time value of money, meaning the real value of future deductions diminishes significantly. For instance, deducting a $10 million residential building over 27.5 years results in a present value of approximately $5.5 million in deductions, effectively acting as an implicit tax on long-lived assets.
Full expensing, in contrast, allows businesses to deduct the entire cost of an investment in the year it is made. This eliminates the implicit tax on investment, ensuring that only true economic profit is taxed. The economic rationale is straightforward: by reducing the after-tax cost of investment, full expensing incentivizes companies to allocate more capital towards productivity-enhancing assets. This leads to a deeper capital stock, which, in turn, boosts worker productivity, increases wages, and creates more jobs.
The concept of full expensing is not entirely new to U.S. tax policy. The 2017 Tax Cuts and Jobs Act (TCJA) expanded expensing to certain qualified property, though it was designed to phase out over time. More recently, the 2025 One Big Beautiful Bill Act (OBBBA) made expensing permanent for equipment and domestic research and development (R&D) and temporarily for manufacturing structures. However, critical gaps remain, particularly for foreign R&D (still on a 15-year schedule), inventories, and other long-lived assets.
Extending full expensing to all capital investment, as proposed in Option 53, is projected to have a transformative impact. The Tax Foundation’s model indicates that this policy would increase the long-run capital stock by 5.0 percent, boost GDP by 2.7 percent, raise wages by 2.2 percent, and generate an additional 706,000 full-time equivalent jobs. While the conventional cost over the budget window is estimated at $1.4 trillion, much of this is a timing effect, as deductions are accelerated. Crucially, on a dynamic basis, the surge in business investment, higher wages, and increased employment would lead to greater income and payroll tax collections, ultimately offsetting the initial revenue loss and reducing the primary deficit by an impressive $321.1 billion. This makes full expensing for all capital investment the single most impactful option for GDP growth among the 86 alternatives analyzed.
2 & 3. Full Expensing and Neutral Cost Recovery for Structures (Options 54 and 55): Addressing Long-Lived Assets
Tying for second and third place in terms of GDP impact are two options specifically targeting the tax treatment of structures: full expensing for all structures (Option 54) and adopting a neutral cost recovery system for all structures (Option 55). Nonresidential buildings are currently depreciated over 39 years, and residential buildings over 27.5 years – the longest schedules in the U.S. tax code. This protracted recovery period has historically imposed a disproportionately high tax burden on long-lived assets like factories, warehouses, and apartment complexes, despite temporary full expensing provisions for qualified production property such as manufacturing structures.
Option 54 extends the principle of full expensing to all structures, allowing businesses to immediately deduct the full cost of these substantial investments. Option 55, while different in mechanism, achieves a similar economic outcome. It maintains existing depreciation schedules but adjusts each year’s deduction upwards to account for both inflation and the time value of money. Both approaches effectively restore the full present value of the deduction, thus making their economic effects nearly identical: a projected 2.8 percent increase in capital stock, a 1.5 percent boost in GDP, a 1.2 percent rise in wages, and the creation of approximately 400,000 full-time equivalent jobs.
The primary differences between these two options lie in their timing and administrative complexities. Full expensing (Option 54) front-loads deductions, conventionally reducing federal tax revenue by $536.8 billion between 2027 and 2036. However, if a firm’s deductions exceed its taxable income, the benefits of immediate expensing might be delayed as excess deductions become net operating loss carryforwards. Neutral cost recovery (Option 55), conversely, is more backloaded, with a smaller conventional revenue reduction of $2.2 billion within the 10-year window, but its nominal revenue loss grows over time due to inflation and real rate of return adjustments. Administratively, neutral cost recovery demands policymakers accurately set a discount rate to truly achieve equivalence with expensing.
Crucially, both options become revenue-positive on a dynamic basis. Full expensing for structures is projected to cut the primary deficit by $433.5 billion, while neutral cost recovery for structures reduces it by an even larger $964.6 billion over the budget window. This revenue differential is primarily attributed to the timing differences within the budget window. These options demonstrate about half the GDP effect of comprehensive full expensing (Option 53), as they focus on a more limited, albeit significant, segment of capital investment.
4. Replacing the Corporate Income Tax with a Destination-Based Cash Flow Tax (Option 71): A Fundamental Shift
A more radical structural reform, ranking fourth in terms of GDP impact, involves replacing the current corporate income tax with a flat 21 percent destination-based cash flow tax (DBCFT). The existing U.S. corporate income tax is largely source-based, meaning it taxes profits where they are produced. This system is riddled with complexities, including a bias towards debt financing (interest is partially deductible, returns to equity are not) and the necessity for intricate anti-profit shifting rules due to its reliance on corporate location.
Option 71 proposes a comprehensive overhaul that combines several key elements: immediate expensing for all investment, repeal of the deduction for interest, elimination of general business credits and Section 199A (which provides a deduction for qualified business income from pass-through entities), and crucially, the implementation of a border adjustment.
The border adjustment mechanism, a common feature in value-added taxes, fundamentally shifts the tax base from a source basis to a destination basis. This means the tax applies where goods and services are consumed rather than where they are produced. Under a border-adjusted system, imports would be taxed, and exports would be exempt. A critical clarification is that a border adjustment is distinct from a tariff; tariffs are standalone taxes on imports, whereas a border adjustment is part of a broader tax system designed to be revenue-neutral to trade in the long run through exchange rate appreciation. By taxing consumption within the U.S. borders, a DBCFT would effectively neutralize the incentive for multinational corporations to engage in profit shifting, thereby eliminating a major international tax avoidance problem.
This transformative option is projected to increase capital stock by 2.6 percent, boost both GDP and Gross National Product (GNP) by 1.4 percent, raise wages by 1.3 percent, and add 463,000 full-time equivalent jobs. The growth effect is primarily driven by the immediate expensing component, while the repeal of the interest deduction would raise the cost of capital for debt-financed investments. Uniquely among the top five, this is the only option that raises revenue on a conventional basis before accounting for dynamic growth effects, primarily because it significantly broadens the tax base to offset its costs. Dynamically, it is projected to cut the primary deficit by an impressive $3.3 trillion, building on a conventional reduction of $2.3 trillion. The DBCFT represents a significant departure from current tax policy, requiring substantial political will and international coordination, but its potential economic benefits are considerable.
5. Lowering Individual Income Tax Rates by 10 Percent Across the Board (Option 2): Boosting Labor Supply
The fifth most impactful option for long-run GDP growth involves a straightforward reduction of all seven marginal individual income tax rates by 10 percent. This would, for example, shift the top rate from 37 percent to 33.3 percent and the lowest rate from 10 percent to 9 percent. This type of tax cut is primarily designed to enhance incentives for labor supply and investment. By lowering marginal rates on labor income, individuals face a reduced tax burden on additional earnings, encouraging more work. Similarly, by reducing marginal rates on pass-through business income (income from sole proprietorships, partnerships, and S corporations), it incentivizes investment in these entities, which constitute a large segment of the U.S. economy.
The Tax Foundation’s model projects that this option would increase 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 top five options, adding 1.3 million full-time equivalent jobs. This is because the policy is primarily targeted at boosting labor supply incentives rather than directly incentivizing capital investment. Consequently, wages are projected to rise by a more modest 0.2 percent, as growth stems predominantly from increased labor hours rather than a deeper capital stock, unlike the investment-focused reforms.
A critical distinction for this option is its significant impact on the federal deficit. Even on a dynamic basis, it substantially increases the deficit. This widening deficit creates a "wedge" between the GDP effect (1.3 percent) and the GNP effect (0.9 percent). The higher deficit leads to increased interest payments, including those made to foreign creditors, which ultimately reduces American incomes. This option is also the only one among 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. This highlights a fundamental trade-off: broad-based rate cuts can stimulate labor supply but often come with a substantial revenue cost that is not fully offset by dynamic growth.
The Big Picture: Reforming Business Income for Sustainable Growth
The findings of Options for Reforming America’s Tax Code 3.0 deliver a powerful message: the most potent drivers of economic growth are not always the most obvious. While debates around tax reform frequently center on adjustments to individual income tax rates, the report unequivocally demonstrates that structural changes in how the tax code measures business income yield the strongest growth effects. Full expensing for all capital investments (Option 53), for instance, is projected to generate twice the GDP effect of a 10 percent across-the-board individual income tax rate cut (Option 2), while also reducing the primary deficit. In contrast, the growth spurred by Option 2 offsets only about 31 percent of its substantial revenue cost.
Another crucial distinction lies in the composition of growth. The business tax reforms, particularly those related to capital expensing, foster a deeper capital stock, leading to significant wage increases that largely keep pace with GDP growth. This suggests a more robust and broadly shared prosperity. Conversely, the individual income tax rate cut primarily influences hours worked, resulting in more modest wage gains because the underlying capital stock does not deepen as significantly.
The report’s overarching conclusion is that removing the remaining biases against capital investment embedded in the U.S. tax code represents some of the most readily achievable and impactful strategies for pro-growth tax reform. These reforms incentivize businesses to invest more in productivity-enhancing assets, which is a cornerstone of long-term economic expansion.
Beyond economic impact, the Tax Foundation consistently advocates for sound tax policy principles: neutrality (minimizing distortion of economic decisions), simplicity (ease of understanding and compliance), stability (predictability for planning), and transparency (clarity in how taxes are levied and used). While the options discussed here primarily focus on growth, policymakers must consider how these reforms align with these broader principles and their potential distributional effects across different income groups. The journey toward a more efficient and growth-oriented tax system requires not just identifying potent policy levers but also navigating the complex interplay of economic theory, political feasibility, and societal objectives. The Tax Foundation’s latest analysis provides a critical roadmap for policymakers seeking to achieve these ambitious goals.
