Candice Horbacz
The urgency of the fiscal situation cannot be overstated. The United States national debt has surpassed $34 trillion, a figure that continues to climb, driven by persistent annual deficits. The Congressional Budget Office (CBO) has repeatedly warned about the unsustainable path of federal spending and revenue under current law, projecting that debt held by the public could reach 116 percent of GDP by 2034, a level unprecedented in U.S. history. This trajectory poses significant risks, including higher interest rates, reduced national saving and investment, and increased likelihood of a fiscal crisis. In this context, the Tax Foundation’s latest publication serves as an invaluable, evidence-based tool, moving beyond superficial discussions to model the nuanced economic impacts of various tax policy adjustments. It underscores a fundamental principle: while two tax increases might yield similar revenue on a conventional (static) basis, their broader economic consequences can diverge significantly, affecting national GDP, employment, and the overall efficiency and fairness of the tax system. Some reforms may inadvertently complicate the tax code or introduce new inefficiencies, while others can streamline it and foster greater neutrality, aligning with established principles of sound tax policy.
The Imperative for Thoughtful Tax Reform
The Tax Foundation’s Options for Reforming America’s Tax Code 3.0 is the latest iteration in a series designed to arm policymakers with rigorous economic analysis. Previous editions have been instrumental in informing debates around major tax legislation, including the Tax Cuts and Jobs Act of 2017. The current guide distinguishes itself by utilizing dynamic scoring, a methodology that accounts for how tax changes alter economic behavior, such as work, saving, and investment, which in turn affects the tax base and ultimately, revenue. This approach provides a more realistic picture of the long-term fiscal impact compared to conventional static scoring, which assumes no behavioral changes.
The guide emphasizes four core principles of good tax policy: simplicity, neutrality, transparency, and stability. A simple tax code is easy to understand and comply with, reducing administrative burdens for taxpayers and the government. Neutrality means taxes should interfere as little as possible with economic decisions, allowing capital and labor to flow to their most productive uses rather than being diverted by tax incentives or penalties. Transparency ensures that taxpayers understand how much they are paying and why, fostering trust and accountability. Finally, a stable tax code provides certainty for businesses and individuals, encouraging long-term planning and investment. Many existing tax provisions, while often well-intentioned, deviate from these principles, creating distortions and inefficiencies that the Tax Foundation’s options aim to address.
Below, we delve into five revenue-raising options highlighted in the guide, examining their trade-offs and broader implications for the U.S. economy and society.
1. Eliminating the Income Tax Exclusion for Other Employer Fringe Benefits (Option 32)
One of the long-standing features of the U.S. tax code is the exclusion of certain employer-provided benefits from federal income taxation. Beyond well-known exclusions for health insurance premiums and retirement plan contributions, a wide array of "fringe" benefits—such as the use of on-site gyms, employer payments for student loans, and employee discounts—also enjoy tax-free status. These benefits are immensely popular, offering employees valuable perks and employers a competitive edge in attracting talent. However, they introduce a significant non-neutrality into the tax code.
Consider two individuals earning $50,000 in total compensation. If one receives all $50,000 as taxable wages and the other receives $48,000 in wages and $2,000 in tax-free fringe benefits, the latter pays less in taxes despite the identical overall compensation. This creates an uneven playing field, distorting compensation decisions and favoring certain forms of remuneration over others. Economists argue that this non-neutrality can lead to a misallocation of resources, as employers and employees might opt for tax-preferred benefits even if their economic value is less than that of taxable wages.
Option 32 proposes to eliminate the income tax exclusion for these miscellaneous fringe benefits, meaning their monetary value would be included in an employee’s taxable income. This reform would broaden the tax base, aligning the treatment of these benefits more closely with wages and salaries. On a dynamic basis, this option is projected to decrease the primary deficit by $396.8 billion from 2027 through 2036.
The Tax Foundation compares this to raising the top marginal individual income tax rate to 50 percent. While both options generate revenue, the latter results in a significantly larger decrease in Gross Domestic Product (GDP) and a greater reduction in work incentives. Broadening the tax base by eliminating fringe benefit exclusions offers a more neutral and transparent approach, raising substantial revenue with less economic drag. This highlights a crucial trade-off: reforms that broaden the tax base often prove less economically damaging than those that increase marginal tax rates, as higher rates can discourage productive economic activity.
Table 1. Eliminating the Income Tax Exclusion for Fringe Benefits vs. Raising the Top Marginal Individual Income Tax Rate to 50 Percent, Revenue and Economic Effects
(Note: As the actual table content is not provided, I will indicate its presence as per the original structure, but cannot recreate specific numerical values beyond the narrative summary.)
Source: Tax Foundation General Equilibrium Model, August 2026.
2. Repealing the Low-Income Housing Tax Credit (LIHTC) and the New Markets Tax Credit (NMTC) (Option 76)
The Low-Income Housing Tax Credit (LIHTC) and the New Markets Tax Credit (NMTC) are federal programs designed to stimulate investment in specific areas and for particular purposes. LIHTC, established in 1986, is the primary federal program for encouraging the development and rehabilitation of affordable rental housing. The NMTC, enacted in 2000, aims to spur economic development and job creation in low-income communities by providing tax credits to investors who make equity investments in Community Development Entities (CDEs). Both credits have historically enjoyed bipartisan support, reflecting a shared desire to address critical social and economic needs.
However, these credits have also faced scrutiny from nonpartisan policy experts, including the Government Accountability Office (GAO) and the Congressional Research Service (CRS), regarding their complexity and efficiency. The LIHTC, in particular, has been criticized for its high cost per unit built and its perceived inefficiency in delivering truly affordable housing to the most vulnerable populations. Studies suggest that a significant portion of the subsidy value is captured by developers and intermediaries rather than directly benefiting residents or leading to cost reductions. Similarly, the NMTC’s effectiveness in generating additional economic activity that would not have occurred otherwise has been questioned, with some analyses pointing to its high administrative costs and limited direct impact on poverty reduction.
Option 76 proposes to repeal both the LIHTC and NMTC, which would broaden the business tax base. On a dynamic basis, this option is projected to decrease the primary deficit by $202.7 billion from 2027 through 2036.
This option is contrasted with capping the business state and local tax (SALT) deduction. While both actions broaden the tax base, capping the business SALT deduction leads to a much larger decrease in GDP and a greater loss of jobs. This comparison illustrates that targeting narrow, inefficient business tax credits can be a more effective revenue-raising strategy, with less economic harm, than broadly limiting a widely claimed deduction for taxes paid. The rationale is that eliminating subsidies that distort investment decisions and have questionable efficacy can improve overall economic efficiency, whereas limiting a deduction for taxes already paid could effectively increase the tax burden on businesses in high-tax states, potentially affecting their competitiveness.
Table 2. Repealing LIHTC and NMTC vs. Capping the Business SALT Deduction, Revenue and Economic Effects
Source: Tax Foundation General Equilibrium Model, August 2026.
3. Eliminating the Income Tax Exclusion for Municipal Bond Interest (Option 29)
For over a century, since the inception of a permanent income tax in the U.S. in 1913, interest earned on municipal bonds (muni bonds) has been exempt from federal income tax. This exclusion, deeply entrenched in the U.S. tax code, allows state and local governments to borrow at lower interest rates than they otherwise could, thereby reducing their financing costs for public projects such as schools, roads, and hospitals. For investors, particularly high-income individuals, muni bonds offer an attractive, tax-advantaged investment vehicle, providing a safe harbor from federal taxation.
While the muni bond interest exclusion enjoys bipartisan support and is seen as a crucial tool for state and local finance, it violates the principle of a neutral tax code. By favoring one type of savings vehicle over others, it distorts investment decisions. Investors might choose muni bonds not solely based on their intrinsic risk-adjusted return but also for their tax-exempt status, potentially diverting capital from more productive private sector investments. Moreover, the benefits of the exclusion are often disproportionately captured by wealthy investors who are in higher tax brackets and by municipal bond underwriters, rather than fully translating into lower borrowing costs for municipalities.
Option 29 proposes to eliminate this long-standing income tax exclusion for municipal bond interest. On a dynamic basis, this option is projected to decrease the primary deficit by $155.2 billion from 2027 through 2036.
The Tax Foundation compares this reform to eliminating the entire State and Local Tax (SALT) deduction. Both the SALT deduction and the muni bond interest exclusion indirectly subsidize state and local government spending. However, eliminating the SALT deduction is modeled to cause more economic harm. This is because the SALT deduction, when available, reduces the marginal tax rate on labor income, pass-through business income, and investment in owner-occupied housing. Its repeal would effectively raise these marginal rates, potentially discouraging work, investment, and homeownership. In contrast, while eliminating the muni bond exclusion would raise borrowing costs for state and local governments and reduce returns for investors, its impact on broader economic activity (like labor supply or business investment) is generally considered less direct and therefore less damaging from an economic efficiency standpoint.
Table 3. Eliminating the Income Tax Exclusion for Muni Bond Interest vs. Eliminating the SALT Deduction, Revenue and Economic Effects
Source: Tax Foundation General Equilibrium Model, August 2026.
4. Tightening the Limitation on Itemized Deductions (Option 24)
Itemized deductions allow taxpayers to reduce their taxable income by deducting specific expenses, such as state and local taxes, mortgage interest, and charitable contributions. While these deductions serve various policy goals, they also complicate the tax code and disproportionately benefit higher-income taxpayers who are more likely to itemize. In an effort to broaden the tax base and simplify the system, Congress has, at various points, introduced limitations on itemized deductions. The "One Big Beautiful Bill Act of 2025" established a new limit, effective from 2026, capping the value of itemized deductions at 35 percent for taxpayers in the top (37 percent) tax bracket. This means a $10,000 deduction for a taxpayer in the 37 percent bracket translates to a $3,500 tax cut, rather than the full $3,700 it would have been without the cap.
This existing limitation already broadens the tax base and, at the margin, encourages some taxpayers to opt for the simpler standard deduction over itemizing. Option 24 proposes to further tighten this cap, reducing it to 28 percent. This would further reduce the tax benefit of itemized deductions for high-income earners, thereby increasing their taxable income and federal revenue. On a dynamic basis, this option is projected to decrease the primary deficit by $139.0 billion from 2027 through 2036.
The guide compares this option to taxing capital gains and dividends at ordinary income tax rates. Both options are primarily targeted at high-income taxpayers. However, tightening the overall cap on itemized deductions broadens the tax base by reducing the value of existing deductions, rather than increasing marginal rates on investment income. Raising rates on capital gains and dividends can discourage saving and investment, potentially leading to a more significant negative impact on economic growth and job creation. The approach of capping deductions is generally seen as less economically distorting than raising marginal rates on capital, as it maintains incentives for capital formation at existing rates while still generating revenue.
Table 4. Tightening the Limit on Itemized Deductions vs. Taxing Capital Gains and Dividends at Ordinary Income Rates, Revenue and Economic Effects
Source: Tax Foundation General Equilibrium Model, August 2026.
5. Introducing a Vehicle Miles Traveled Tax (VMT) (Option 79)
The Highway Trust Fund (HTF), established in 1956, is the cornerstone of federal funding for the nation’s interstate roads, bridges, and highways. Its primary funding source has historically been the federal gas tax, an excise tax levied on motor fuels. However, this funding mechanism has faced increasing challenges. The federal gas tax rate, currently $0.184 per gallon, has not been adjusted for inflation since 1993. Over three decades, the purchasing power of this revenue has significantly eroded, while the costs of road maintenance and new infrastructure projects have surged. Consequently, the HTF has run persistent deficits and faces long-term solvency concerns.
A related and growing challenge is the rapid adoption of electric, hybrid, and other clean energy vehicles. These vehicles, while offering environmental benefits, pay little to nothing in gas taxes, despite contributing to the wear and tear of road infrastructure. Additionally, heavy vehicles like tractor-trailers often pay less into the system than the disproportionate damage they inflict on roads. This creates an inequitable "user fee" system where some users pay less than their share of infrastructure costs.
Option 79 proposes a transformative shift: repealing the federal gas and diesel taxes and instituting a Vehicle Miles Traveled (VMT) tax, adjusted by vehicle weight. Under this model, all vehicles would contribute to road maintenance based on their usage and impact. The guide suggests an average passenger vehicle would pay approximately 0.9 cents per mile, while an average freight vehicle would pay about 10.6 cents per mile. This system aims to create a more equitable and sustainable funding source for the HTF. On a dynamic basis, this option is projected to decrease the primary deficit by $133.7 billion from 2027 through 2036.
Comparing this to simply increasing the federal gas tax from $0.184 to $0.28 per gallon, the guide notes that while the gas tax increase raises more revenue over the initial 10-year window, it also leads to more significant job losses. More importantly, the VMT tax represents a more sustainable long-term solution to HTF solvency, particularly as electric vehicle adoption continues to grow. Several states, including Oregon and Utah, have already piloted VMT programs, demonstrating their feasibility and potential. While implementation challenges, such as privacy concerns and administrative complexity, exist, the VMT tax offers a forward-looking solution to a critical infrastructure funding crisis.
Table 5. Introducing a Vehicle Miles Traveled Tax vs. Increasing the Federal Gasoline Tax, Revenue and Economic Effects
Source: Tax Foundation General Equilibrium Model, August 2026.
The Broader Implications and Path Forward
The findings presented in Options for Reforming America’s Tax Code 3.0 underscore a fundamental truth in fiscal policy: all tax policies involve trade-offs. As federal debt and deficits continue to rise beyond historic norms, these trade-offs become increasingly difficult and consequential for policymakers. The choices made today will shape the nation’s economic landscape for decades to come.
The guide powerfully illustrates that not all revenue-raising measures are created equal. While the immediate goal might be to close the fiscal gap, Congress must weigh broader core tax principles—simplicity, neutrality, transparency, and stability—along with the projected economic effects of various reform options. Reforms that broaden the tax base and eliminate distortions often prove less damaging to economic growth than those that significantly raise marginal tax rates. Similarly, modernizing antiquated funding mechanisms, like the gas tax, can address long-term structural issues more effectively than temporary rate hikes.
The Tax Foundation explicitly states that the options presented in its guide are for illustrative purposes, modeling the economic, revenue, and distributional trade-offs, and are not necessarily endorsed or opposed by the organization. This objective, analytical approach is precisely what policymakers need as they navigate the complex and politically charged terrain of tax reform. The challenge ahead is to move beyond partisan rhetoric and embrace evidence-based policymaking to ensure a fiscally sound and economically vibrant future for the United States.
