How Big, Bad, or Beautiful?

Donald Trump never does anything in a small way, and, with a bit of cajoling of his conservative flank and utter indifference to his Democratic opposition, Trump’s new tax bill of undisputed bigness but debatable beauty has become law. The general classical liberal response to all tax challenges is to prefer low, flat, and broad taxation, with a balanced budget. The logic here is simple: flat taxes for general revenues tend to minimize the distortions that any tax system necessarily imposes on the productive economy. Favor one set of activities or one set of taxpayers, and those activities or persons who once competed at parity in a non-tax world will take the hit; the tax skew allows an inefficient competitor armed with a tax subsidy to outdo a more efficient rival burdened with heavier taxes. And, yes, the correct mix is to keep tax rates low and use the proceeds of taxes only to fund standard public goods, since the effective tax burden of these expenditures is zero if the tax expenditures generate benefits for each party taxed that exceed the cost of the taxes imposed. Keeping the budget balanced prevents passing the taxes on to future generations that do not share in the short-term consumption gains created. Thus, one preliminary estimate that lost tax revenues could reach $4.0 trillion over the next ten years on top of today’s rising budget deficits, which according to the Congressional Budget Office, will increase from $1.6 trillion, or 5.6 percent of GDP, in fiscal year 2024 to $2.6 trillion, or 6.1 percent of GDP, in 2034.

Even with these negatives, the most important features of the current legislation are the two bad progressive ideas that the new legislation wisely ignores. During the Biden years, the major structural reform proposals were two. First, a wealth tax on people, say, with over $50 million in assets, that would extract some fixed percentage of that wealth, say between three and six percent annually, regardless of whether the taxpayer had any income during that year: pure confiscation of dubious constitutionality. The second was to keep the progressive income tax and impose it on the unrealized appreciation of all assets, or more modestly all publicly-traded stock, which would require forced liquidations of productive assets in prosperous years, but which might not generate a government refund from them in years, like 2022, where there was unrealized depreciation. The debate over these items was deflected in the Supreme Court in Moore v. United States (2024). Keeping both items off the table introduces a measure of stability into the system, at least until the progressive forces regroup to reintroduce them as part of their ongoing campaign to undermine the institution of private property.

The same can be said, sort of, to allow the estate tax exception to rise slightly to $15 million per person, and $30 million per couple for 2026, with upward adjustments, which will induce a sigh of relief across the professional classes who are the major beneficiaries of this policy. But what about the billionaires who receive the worst possible press? To a progressive, the answer is to keep the squeeze on them because the function of taxation is not what it is for classical liberals, which is to pay for public goods that markets cannot supply, like defense, courts, and infrastructure. Rather, the good progressive wants heavy taxes and massive redistribution even in a world that miraculously does not need to spend a penny on a public good. When all is said and done, the argument rests on the conviction that the marginal value of money decreases with wealth. This factual observation is surely true, which is why the bulk of charitable giving, both before and after the income tax, has always been in one direction. But it does not follow that these transfers should be mandated when they are already made voluntarily by well-heeled donors who understand that point.

The classical liberal is in favor of a single, unitary tax base and would thus abolish the estate tax for both the rich and the poor. Voluntary charitable payments increase, not reduce, the incentive to earn money, and donors who put their millions on the line are likely to monitor the recipients of their expenditures. Tax that money, and the government will not monitor the recipient’s activities to avoid the kinds of political deals that can disqualify any private charity. Therefore, wasteful government grants will dissipate wealth, especially when majoritarian politics allow people to vote for their benefits or to avoid their liabilities.

Yet in this context, the diminishing marginal utility of wealth also has its unrecognized benefits in a flat tax world. Poorer people attach greater value to their dollars. Thus, they will be sensitive to an increase in total tax burden, which they will seek to reduce if a flat tax regime bars them from forcing redistributive regimes on others. If the government wants to intervene, it should grant a charitable deduction (worth less in a low, flat tax world), whereby the government provides a matching grant without having the power to direct the wealth to its favored class. Here, we do not want to worry about relative preferences (which spark jealousy at every level of society), but to ensure that overall gains are as widely distributed as possible. And it is an empirical question as to whether the relatively poor receive social compensation for the loss of growth resulting from aggressive redistribution.  Look at the desperate poverty in places like Cuba, and imagine what is going to happen if Rachel Reeves’ draconian tax regime on world-wide income drives wealthy individuals from Great Britain’s shores, a move that could well be replicated in New York City if Zohran Mamdani can adopt his punitive tax and transfer programs. The best way to avoid that rupture is never to start down that road.

That said, the remainder of the Big Bill focuses more on incremental adjustments than on major transformations. But they are important both for what they do and for what they portend. By this measure, a level of social quiescence should greet the modest increase in the standard deductions of five percent for both individuals and married couples. It is hardly a change from the status quo, and that exemption tends to modestly reduce administrative costs without creating major social changes. However, a far higher level of intellectual uneasiness should attach to the expansion of bonus deductions awarded to people over 65, which previously ranged from $1,600 to $2,000, and are now increased to $7,600 to $8,000 in the future. Unlike the standard deduction, which saves administrative costs, these changes violate the norm of broad, uniform taxes, skewing investment incentives and holding the promise of further increases down the road.

Nonetheless, these extensions are not as ominous as the obvious populist move that created a deduction of tips up to $25,000 a year from 2025 to 2028, matched by an equally unprincipled exemption for the first $12,500 of overtime income through 2028. It is hard to imagine a worse pair of provisions. Tips are considered income, and if they are exempt from taxes, we can expect taxable salaries to decrease as tip income increases, and salaried employees to lose ground relative to tipped workers, similar to the impact of strategic increases in overtime. There will be lots of gamesmanship to shift excess tips or overtime earned in one year to the next, which makes good sense for employees who plan to quit or change jobs. It is, moreover, simple naivete to assume a return to the pre-2025 world. These provisions will put additional pressure on the economy, manifesting itself through higher taxes, increased debt, or higher inflation.

The same divisive populist instincts are also at play in connection with the increase in the state and local tax deduction (SALT) from $10,000 to $40,000 in 2025, with a one percent increase to 2029, after which it is magically reverts to the 2025 level, unless politics intervene. Trump, sensing the political winds, supported the limitation in 2017, only to reverse his stand on a highly political issue. The apparent interstate conflict is that without the cap the states with no income tax—Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming (predominantly red states)—subsidize places like New York and California that now have even less reason to rein in their local taxes. But there is a wrinkle in shifting the emphasis from the state to the individual. Wealthy taxpayers in places like California and New York are well aware that their taxes do not personally benefit them with public goods, but rather fuel the appetite for redistribution. For them, it is an insult to pay federal taxes on tax dollars at the state level from which they derive no benefit. So, the question is, which imperfection is worse?  And here, the size of the benefit will diminish if the local tax and business environment sparks further exodus.

This, in turn, raises the key question that presents yet another conundrum: five years from now, how will we empirically know whether the big bill is good or bad? We won’t. The situation is more complex than it was for the earlier 2017 legislation, as numerous other developments complicate the analysis. Any Trump tariffs or tariff threats will exacerbate the situation; the energy reforms will improve it, but no one knows by how much. All these events are big enough to matter, as will be future shocks from uncertain sources. So here is yet another deep disagreement. Folks like me, who are weak at conducting empirical studies, like to start with theory to tease out individual factors. Those who are tech-savvy tend to start from the opposite pole. Ideally, the two approaches should converge. In practice, they rarely do, so that all sides can always claim victory, which is why we ought to prefer the intellectual rigor of a simple tax regime to the glorified confusion of the modern alternatives.

Richard A. Epstein is a senior research fellow at the Civitas Institute. He is also the inaugural Laurence A. Tisch Professor of Law at NYU School of Law, where he serves as a Director of the Classical Liberal Institute, which he helped found in 2013.