In his Sept. 27 speech at the Indiana State Fair, President Trump announced a tax reform plan that he calls a “middle-class miracle.” The idea of tax reform is a lofty goal. Ultimately, if there is a tax package passed, it will most likely be tax cuts. This is because tax reform requires writing a new tax code from the ground up which is quite hard (nearly impossible) to do in the current Congressional climate. The last tax reform legislation, the Tax Reform Act (TRA) of 1986, passed over 30 years ago. Many experts predict that if there are significant changes to the current tax code, it will be reflected in tax cuts rather than the GOP’s goal of tax reform.
This tax plan is aligned with the traditional Republican philosophy of lowering tax rates, closing tax loopholes, and broadening the tax base. Gary Cohn, the president’s director of the National Economic council, said in his Sept. 28 press conference, “our plan is based on lowering rates and expanding the [tax] base; it’s very simple…you expand the base by getting rid of the loopholes…that the wealthy taxpayers have used to pay tax on less of their income. We have designed a plan where you’re going to pay a lower rate but you’re going to pay it on more of your income. That is a basic core premise of our plan.”
The administration’s timeline for the tax plan is passage in the House in October, passage in the Senate and becoming law by the end of the year. This is likely an optimistic trajectory for any tax reform.
In response to criticism that the Trump tax plan may actually increase taxes on middle and working-class families, Gary Cohn said that “our tax plan is aimed at making sure we give middle-class Americans a tax cut; we are going to give middle-class Americans a tax cut. That is what we are spending all of our time on doing.” But he also couldn’t “guarantee that” middle-class Americans would receive less of a tax burden.
“I’ll guarantee you could find someone in this country – maybe one person – who their taxes may not go down.”
Mr. Cohn is very confident that this tax plan will help the middle-class and that everyone – except for this sole unlucky person – will benefit from. However, it’s hard to reconcile this rhetoric with the fact that most middle-class families do not pay federal income tax, assuming they file for a tax return, or if they do, it is typically a very small amount.
The Trump tax plan does contain some very interesting specifics, whenever specifics can be found. Following the traditional GOP tax reform blueprint, the Trump administration hopes to cut corporate taxes but also allow small corporations to pay their tax liability under “pass-through” taxation which allows a business owner to pay corporate taxes through their individual income tax. Critics on the left fear that a pass-through tax reform will cause large corporations to game the system, restructuring into small, limited liability corporations (LLCs) to avoid a higher tax burden.
Proponents like economist Glenn Hubbard point to the fact that small-to-medium-sized businesses employ the majority of workers and create the most jobs. Thus, a reduction in tax liability for these firms would be an economic boom. Hubbard also cites that labor bears an estimated 60 percent of the cost of corporate taxation. Lowering corporate tax liabilities, particularly in those businesses that create and maintain the most jobs, will create much-needed wage growth for the working-class of this country, per Hubbard.
Additionally, this tax plan would double the standard deduction, the amount of money that can be claimed as tax exempt, to $12,000 and $24,000 for individuals and joint tax filers respectively. This is up from $6,000 and $12,000 under current law. The increase in the standard deduction allows for the collapsing of marginal tax rates to three, down from seven. The lowest rate would raise to 12 percent from 10 percent, which is a sticking point with Democrats.
Senate Minority Leader Chuck Schumer has made his objection to this aspect of the tax reform package known. Despite the higher marginal tax rate, it is unclear how the tax burden of middle-income families will change under this plan due to factors like the higher standard deduction. This bolstering of the standard deduction promises simplicity and ease-of-use to the average American. It also may have some serious consequences for itemized deductions.
The Trump tax plan pledges to eliminate the estate tax and Alternative Minimum Tax (AMT). The estate tax is a tax on the inheritance of wealth as it is passed from one generation to another. For example, a plot of land that parents leave to their child may fall under this tax. Republicans are opposed to it because they view it as taxing money twice; the money has undergone tax in its earning and investing phases, only to be taxed again as it is transferred. For the current fiscal year 2017, the estate tax applies to estates (generational wealth, not necessary a house) valued at $5.49 million or more.
This tax is paid by the wealthiest families in the country. While the estate tax does not generate a great deal of revenue for the federal government (less than $10 billion in any given year), it will have no real benefit for the vast majority of Americans. The AMT is a more significant tax, generating over $28 billion in 2015. It acts much like a standard deduction for millions of American taxpayers that “itemize” their taxes. This occurs when a tax-filer claims several deductions – charitable giving, church donations, mortgage interest, etc. – and prevents him from claiming the full benefits of standard deduction (along with the tax advantages of itemized deduction).
The AMT acts like a surtax on income in most cases, meaning that taxpayers pay the AMT on top of their federal income tax liabilities. Scraping this would benefit many Americans (it disproportionately hurts families with children in high-tax states), but it would also limit tax revenue significantly.
A significant consequence of GOP-led tax reform its losses in tax revenue and growth of the U.S. national debt. Estimates of revenue lost range from the Trump administration’s $1.5 trillion figure, which is optimistic, to upwards of $5 trillion in lost revenue. To find the estimate budget deficit, the amount of debt accrued in one fiscal year and the difference between expenditures and tax revenue, divide the sums by 10 because these projections are forecasted over a 10-year period. These budget deficits could explode since the federal government has run a string of deficits such as a $603 billion deficit in fiscal year 2017; this is a projected $440 billion deficit for fiscal year 2018. An argument for taking in even less revenue is going to be a hard sell in Congress.
In an attempt to balance the budget while cutting taxes, President Trump’s plan will get rid of several popular deductions. State and local taxes will no longer be exempted from federal income tax. This means that when a homeowner pays his property tax to the county, it will still count as if he kept his money. Eliminating this deduction will disproportionately target high-tax Democratic-leaning states like California and New York. It will make up for quite a bit of the lost revenue but its consequences may be less money in the economy, defeating the purpose of tax reform.
Another way the Trump tax plan attempts to save revenue is by discouraging the mortgage interest deduction. By doubling the standard deduction, many Americans would not itemize their taxes, claiming the default deduction. Currently, the mortgage interest deduction is a roughly $70 billion tax expenditure. Limiting this could save a great deal of money. The last thing this tax plan uses to reconcile the federal budget is a process called dynamic scoring. Dynamic scoring accounts for the economic growth propagated by the fiscal stimulus of tax reform and how it could increase tax revenues as a result. Republicans love dynamic scoring as it argues that lost revenue from tax cuts will be made up by consequent economic growth.
The reality is that dynamic scoring can be wildly inaccurate, as there are too many variables such as energy prices, employment trends, natural disasters, etc. These cannot be foreseen, nor reliably predicted. Hence the large disparity between the Trump administration’s $1.5 trillion shortfall (using dynamic scoring) and the $5 trillion shortfall from other estimates.
It’s October. The beginning of a new fiscal year. W-2 forms are being filled out, social security contributions are being tallied and seasonal I-9 labor is being contracted. And to top it all off, there is a possibility that the entire system as we’ve known it for the past 30 years is going to change.