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Date Posted: December 19, 2023

Current Tax Law Sunsets in 2025–2024 Elections Key to Future Tax Changes Next year’s elections will prove crucial for investors as the 2017 Tax Cuts and Jobs Act (TCJA) sunsets at the end of 2025. The next President and Congress will need to address this challenge amid record budget deficits and interest costs. Those imbalances will limit fiscal spending flexibility for defense and social programs and likely lead to higher taxes to generate additional revenue.

Revising 2017 Tax Law in the Face of Record Level Debt and Interest Costs
The issue starts with rapidly growing budget deficits (see Figure 1) leading to the highest level of public debt relative to GDP since World War II (see Figure 2.) This record borrowing coupled with anticipated higher interest rates, compared to the previous decade, could double interest costs relative to GDP, reaching an all-time peak (see Figure 3.)

Figure 1

Federal Deficit and Surplus, 1963-2053 (%GDP)


Source: Congressional Budget Office

Figure 2

National Debt will Exceed its Historic Peak as a Percent of GDP by 2029


Sources: Congressional Budget Office, Peter G. Peterson Foundation

Figure 3

Net Interest Cost Projections as a Percent of GDP and Billions of Dollars


Sources: Congressional Budget Office, Peter G. Peterson Foundation

Rising Interest Costs Exceed Spending on Defense and other Discretionary Programs—Limiting Federal Budget Spending Options

Rising interest costs will become a significant political concern in coming years. By 2033, projected interest costs will exceed spending on all discretionary social and defense programs. In fact, as of 2023, interest costs already approach defense spending. This poses a challenge for a politically divided Congress as it limits funds for other crucial discretionary programs (see Figure 4.)

Figure 3

By 2033 Federal Interest Spending Will Exceed Every Federal
Discretionary Spending Category—Limiting New Program Spending


(Note: Social Security and Medicare come under mandatory programs not directly subject to Congressional budgetary actions.)

Source: Congressional Budget Office

Fiscal Limits—Defense vs Social Programs—Political Divisions will Grow

As fiscal constraints tighten, sharp Congressional battles will likely arise between proponents for defense spending and advocates for discretionary social programs. Despite global security concerns, currently projected defense spending will fall further below its historical share of GDP (see Figure 5.) More than likely, that spending direction will be reversed. Competing with defense spending, discretionary spending addresses diverse social needs, including child welfare. For instance, discretionary spending on children under eighteen runs about one-third the level of mandatory spending on seniors. In 2023, interest costs exceeded Federal support for children for the first time (see Figure 6.) How will increased discretionary spending for defense and social needs be funded?

Figure 5

Discretionary Defense Spending Projected to fall further below historical share as % GDP

Sources: Congressional Budget Office, Office of Management and Budget

Figure 6

Net Interest Spending vs. Federal Support for Children (1) ($Billions)

(1) Includes tax credit payments
Source: Committee for a Responsible Budget

Given Budget Pressures Higher Corporate Tax Rates Likely in 2026

The 2024 elections will prove crucial to future tax laws with the current 2017 Tax Cuts and Jobs Act (TCJA) sunsetting at the end of 2025. Without new tax legislation, tax laws will revert to those pre-TCJA. As a reminder, the TCJA implemented the largest corporate tax cut in history, lowering the tax rate from 35 percent to 21 percent (see Figure 7.) It also shifted taxation on U.S. global corporations from global to modified territorial taxation. This shift sharply reduced the tax advantage for non-U.S. corporations acquiring U.S. global firms. With the current tax law expiring at the end of 2025, the corporate tax rate will likely rise from its current 21% but not likely to the previous 35% rate. Congress may opt for a compromise around 28%.

Figure 7

The Decline of Effective Corporate Tax Rates

Sources: Compustat data

Raising Personal Income Taxes will not Solve the Budget Deficit

Over half of the Federal government’s revenues come from personal income taxes (see Figure 8.) To make a significant dent in the federal deficit, personal tax rates (see Figure 9) would need a substantial increase. John Mauldin pointed out, in his weekly economic letter, that raising taxes by 50 percent across all income brackets would raise $850 billion or less than half the true 2023 federal deficit. One potential change could involve reducing or eliminating the tax benefits for flow through businesses if the corporate tax rate increases.

Figure 7

Federal Taxes–Source—(% Share)

Sources: Congressional Budget Offices

Figure 9

Average Federal Tax Rates by Income Bracket—1979-2019

Sources: Aspen Economic Strategy Group, Congressional Budget Office,

Reaching Political Limits in this Country on Taxing Income? Value Added Tax (VAT) an Alternative?

Raising personal income taxes to reduce the budget deficit may soon face political limits. Consequently, consideration of a Value Added Tax (VAT) by the end of the decade would not be surprising. Currently, 174 countries, including all OECD members except the United States, impose a VAT. Among the 35 OECD countries, VAT tax rates range from 5 to 27 percent. Economists suggest a 10 percent VAT for this country. The Congressional Budget Office estimates that a tax on consumption like a VAT could raise $2-3 trillion over a decade.

Investment Conclusions
2024 Elections-Market Reaction: As we enter the New Year, we looked at what may prove to be pivotal for investors beyond 2024—the outcome of next year’s elections. We anticipate higher taxes for corporations and individuals in the not too distant future, as the current tax law expires in 2025. Financial markets may respond more positively if the elections result in a split government in Washington.

Fixed Income-Fed Policy Shift-Lengtrhen Duration: At its December meeting, the Fed shifted its focus from inflation back to its dual mandate which includes employment. With that, the Fed increased its expected rate cuts in 2024 from two to three. Futures markets expect more and earlier cuts. If this Fed scenario unfolds, then new short-term fixed income investments will likely face increasing reinvestment risk. Therefore, we continue to view extending fixed income duration will likely prove even more attractive for investors. Current interest rates on Treasury notes and bonds offer an attractive real rate of return for the first time since the Great Financial Crisis.

Alternatives: With the changes occurring in the financial industry and markets, alternatives can prove attractive by both providing the diversification benefits of lower correlations with stocks and bonds. In this highly uncertain investment environment, alternative investments can both help manage risk and potentially enhance returns.