Status of Republican tax plan

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With efforts to “repeal and replace” GovCare having fallen short, at least for now, Republicans are pinning much of their hopes for the 2018 mid-term elections on enacting tax legislation that could be hailed as pro-growth, pro-jobs, pro-worker, pro-family, and pro-American.

This project was extensively discussed among the so-called Big 6: HOUSE: Speaker Paul Ryan, Ways and Means Chair Kevin Brady; SENATE: Majority Leader Mitch McConnell, Finance Chair Orrin Hatch; ADMINISTRATION: Treasury Secretary Steven Mnuchin, Chief Economic Adviser Gary Cohn. Their consensus outline of a “tax reform” proposal (hereinafter Tax Plan) was published in late September: United framework for fixing our burdensome tax code,
9/27/17 (pdf).

Having previously touted the forthcoming Tax Plan in Missouri & North Dakota, the president gave a third talk last week to officially put his imprimatur on it. President’s remarks on tax reform, Harrisburg, PA,
10/11/17.

This entry will offer some thoughts about the Tax Plan: substance, sales pitch, and legislative prospects.

I. Substance – The Tax Plan has two components, re the taxation of individuals and of businesses, which in some instances are overlapping.

#INDIVIDUAL TAXES – The standard tax deduction (sometimes referred to as the “zero tax bracket”) would be increased from current levels to $12,000 ($24,000 for joint returns). Current personal tax exemptions would be eliminated – offsetting a considerable portion of the standard tax deduction increase.

Thus, assume John & Jane Doe are both over 65 and file a joint tax return. For 2016, their standard deduction (age-adjusted) was $15,100 and their personal exemptions totaled $8,100. With the $24,000 standard deduction, their taxable income would be reduced by $800.

The Tax Plan would cut the number of tax brackets from 7 to 3 (or possibly 4). Details have yet to be determined, but it’s generally assumed that the new lowest rate (12%) would supplant the current two lowest rates (10% and 15%). Let’s further assume that the 25% rate bracket would remain as is, with the principal uncertainty being the point at which the new top rate(s) of 35% (and 39.6% if a 4th bracket was added) would kick in. This would result in the following tax schedule for married taxpayers filing a joint return with taxable income of up to $153,100.

Screen Shot 2017-10-14 at 12.41.28 PM

If the Does’ taxable income was $28 thousand or higher under current law, their tax liability would be reduced:

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The Tax Plan would not eliminate current tax deductions for mortgage interest and charitable contributions, nor would it affect (aside from possible simplification) “benefits [including income exemptions and tax credits] that encourage work [e.g., earned income tax credit], higher education and retirement security.”

Many other tax preferences would supposedly be eliminated, although the framework neglects to enumerate them. One tax deduction understood to be on the chopping block is the deduction for state and local taxes (more on this in Section III); another may be the deduction for medical expenses above specified percentages of adjusted gross income

Numerous other exemptions, deductions and credits for individuals riddle the tax code. The framework envisions the repeal of many of these provisions to make the system simpler and fairer for all families and individuals, and allow for lower tax rates.

Every tax exemption, deduction or credit in existence has supporters, who will predictably object to its elimination (or even devaluation due to raising the standard deduction). How Trump tax plan would alter mortgage interest deductions, Josh Boak, USA Today,
10/11/17.

Even though the Trump measure would preserve the mortgage interest deduction, it's confronting resistance from the real estate industry because it would likely reduce the number of people seeking the deduction. Estimates by the real estate firm Zillow suggest that someone buying a home worth at least $305,000 today would still qualify for the deduction. But under the Trump plan, only homes worth $801,000 or more would receive the deduction.

At this point, it’s difficult to predict how the Tax Plan would affect taxpayers who itemize their deductions – no doubt there would be both winners and losers.
Ibid.

Trump administration officials say their tax plan is designed to benefit the middle class. Yet it's not clear from the scant details of the framework released so far how many families would enjoy lower tax bills and how many would face higher bills.

The elimination of personal exemptions would also apply to children covered by a return, with a roughly offsetting increase in child tax credits. And there would be a new $500 tax credit “to help defray the cost of caring for other dependents.”

Further, congressional committees would consider “additional measures to meaningfully reduce the tax burden on the middle-class.”

There are two other notable tax law changes, both of which would primarily benefit the affluent: Eliminate the alternative minimum tax and the estate (aka death) tax.

Our take: The foregoing tax law changes would provide a tax cut for most Americans who are not currently itemizing their tax deductions. For itemizers, there would be winners and losers. Tax effects for high bracket taxpayers cannot be assessed until the proposed new tax brackets are available, and the economic benefits/fiscal effects are also uncertain. The only clear reason for making these changes is political expedience.

#BUSINESS TAXES – Here are the proposed changes for (1) regular (Subchapter C) corporations, which are subject to tax at both the corporate and shareholder (via tax on dividends and capital gains) levels, and (2) pass-through entities (sole proprietorships, partnerships, and S corporations) whose income is taxed only at the owner level.

•Corporations - The top corporate income tax rate would be reduced from 35% to 20%, and the corporate alternative minimum tax would be eliminated. Current expensing of capital investments (other than structures) would be assured for at least 5 years. The deductibility of interest expense “would be partially limited.”

The domestic production deduction would be eliminated, and “numerous other special exclusions and deductions will be repealed or restricted.” However, the R&D and low-income housing tax credits would be retained, and “the committees may decide to retain some other business credits to the extent budgetary limitations allow.”

Re special tax regimes for specific industries, “the framework [committees?] will modernize the rules to ensure that the tax code better reflects economic reality and that such rules provide little opportunity for tax avoidance.”

A one-time tax would be imposed on accumulated foreign earnings (some $2.6 trillion) that would have been subject to US income tax (with foreign tax credit) if repatriated. The rate isn’t specified, beyond saying that it would be higher for earnings held in cash versus earnings that have been reinvested in foreign business assets and that the tax would be due over several years rather than in a lump sum.

More recently, it has been suggested that the applicable rate (without foreign tax credit) might be around 10%. [Gary] Cohn: Repatriation tax rate will be in “10-percent range,” Mark Lennihan, newsmax.com,
10/2/17.

Going forward, it is said, international operations income of US corporations would be taxed on a territorial basis vs. the current US tax (in theory) on worldwide income.

The framework . . . ends the perverse incentive to keep foreign profits offshore by [providing] a 100% exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake).

“To protect the U.S. tax base,” however, foreign profits of US corporations could be taxed “at a reduced rate and on a global basis” so as “to level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies.”

This provision would undermine the benefits of switching to a territorial tax system by converting a theoretical tax liability into a real one. Tax reform should avoid the global minimum tax, Veronique de Rugy, townhall.com,
10/12/17.

Territoriality with a global minimum tax would equal a full worldwide system because the current deferral protection would be effectively gone. Yet we're told not to worry because the rate would be so low that it wouldn't really matter. Not true. First, this bad fiscal policy would simply encourage companies to find ways to escape the system. Second, the minute Democrats are back in power, they could raise that rate, and companies could end up in a worse situation than the one they're already in. Besides, given that no one is serious about cutting spending, the pressure of future deficits almost guarantees that rate would go up.

•Pass-through entities – PTEs are identified as “small business,” although some of them are substantial in size. The top tax rate would be reduced from the owner’s top rate (up to 39.6% under current law) to 25%. That would be higher than the new corporate tax rate of 20%, which however would be augmented by taxes at the shareholder level so the two rates may be roughly equivalent.

Other tax changes for corporations would generally apply for PTEs too, e.g., current expensing of capital investments, potential limitation on the deductibility of interest expense, and repeal or restriction of various other tax preferences.

Measures are contemplated to prevent “wealthy individuals from avoiding the top personal tax rate” by recharacterizing personal income as business income. Critics have suggested, however, that such measures might not be entirely successful.

Our take: The proposed business tax changes would boost the economy, especially the cut in the corporate tax rate and current expensing of capital expenditures. We would hope for resolute follow through on proposed elimination of existing business tax preferences. The one-time levy on un-repatriated foreign earnings should be set at a lower rate than is reportedly contemplated (e.g., 5% vs. 10%), and the idea of a minimum tax on global income should be dropped.

II. Sales pitch – Supporters of the Tax Plan emphasize favorable attributes while glossing over drawbacks, thereby materially exaggerating its attractiveness. Herewith are some examples from the president’s talk last week. President’s remarks on tax reform, Harrisburg, PA, 10/11/17.

•Action needed – The stock market is up by an aggregate of $5.2 trillion since the 2016 election – “a quarter of the $20 trillion that we owe” – “but our country, and our economy, cannot take off like they should unless we transform America’s outdated, complex, and extremely burdensome tax code.”

Comment: There is no clear connection between stock market values and the national debt (which has also continued to rise), nor would the Tax Plan bring about a true transformation of the tax code.

•Standard tax deduction – “Under our framework, the first $12,000 for a single individual and the first $24,000 for a married couple, will be tax free. No tax at all.”

Comment: A large part of the benefit being lauded is currently available via a lesser standard tax deduction plus personal exemptions.

•Tax brackets – “Under our framework, we make the zero bracket bigger and get rid of the 10 percent bracket, and we're reducing the 15 percent rate down to 12 percent. So that's a massive amount of money.”

Comment: Much of the income in the current 10% bracket would now be taxed at 12%, reducing the implied gains considerably.

•Child tax credit - “[We] will substantially increase the child tax credit to save working families even more money.”

Comment: This fails to mention the elimination of personal exemptions for children.

•Tax breaks – “By eliminating tax breaks and special interest loopholes that primarily benefit the wealthy, our framework ensures that the benefits of tax reform go to the middle class, not to the highest earners.”

Comment: Some middle-class taxpayers itemize their deductions and would wind up paying more tax rather than less.

•Complexity – “American families and businesses waste billions of hours, and tens of billions of dollars, on excruciating paperwork -- you see that, I mean it's all over the place, and you have no idea what you're doing anyway -- and compliance every single year.”

Comment: One can always go to a tax preparer or use a tax preparation program. Also, it’s unclear how much tax complexity would be eliminated under the Tax Plan.

•Small business – “The more than 30 million Americans who have small businesses will see -- listen to this -- a 40 percent cut in their marginal tax rate -- 40 percent.”

Comment: The current top rate for pass-through entities would be cut by up to 37% (from a top rate of 39.6% to 25%), but many of these 30 million Americans haven’t progressed beyond the 25% tax bracket and therefore wouldn’t experience any tax reduction at all on their business income.

•Economic stimulus – “Rocket! You know what we're talking about, folks, don't worry about it. [The Tax Plan] will be rocket fuel and it will be rocket fuel for our economy.”

Comment: Reduced business taxes should stimulate the economy, but this analogy strikes us as “over the top.”

•International business – “Our framework encourages American companies to bring back the trillions and trillions of dollars in wealth parked overseas. Trillions of dollars.”

Comment: This is not an unmixed benefit. Said companies would be required to pony up some $200 billion in taxes whether they brought back the accumulated earnings or not.

•Payoff – “My Council of Economic Advisers estimates that this change, along with a lower tax rate, would likely give the typical American household a $4,000 pay raise.”

Comment: This envisioned “pay raise” would represent a cumulative gain over the next 8 years. Why Trump says his tax plan could imply a $4,000 pay raise” for the middle class, Jeanne Sahadi, cnn.com, 10/11/17.

III. Legislative prospects – The Tax Plan seems to be more about tax cuts than tax reform, and even with dynamic scoring there would be a resultant uptick in deficits and debt. Overall, we’re not very enthusiastic. Republicans pivot to tax reform, 9/4/17.

Nevertheless, the Tax Plan would stimulate economic growth – notably due to the corporate tax rate cut and current expensing of capital investment over the next five years – and some of the liberal criticisms seem overstated. Kevin Hassett spanks the Tax Policy Center, Larry Kudlow, townhall.com,
l0/10/17.

President Trump's new chair of the Council of Economic Advisers, Kevin Hassett, walked into the lion's den last week with his first official speech. He used the moment to pound the leftist Tax Policy Center. It was a wonderful sight. When Hassett wasn't pounding the TPC, he was spanking them. He took them to the woodshed and disciplined them in public view.

Democrats see the Tax Plan as skewed in favor of the affluent, with the claims of middle class benefits being mere window dressing, and also maintain that tax cuts are out of order given the dismal fiscal outlook. See this statement by Senator Tom Carper (D-DE), which says that the Tax Plan would increase the deficit by $2.4 trillion [over 10 years, per the Tax Policy Center] and ends by advocating that Congress “do this the old-fashioned way – by working together.” Carper’s connection,
10/13/17.

We should hold public, bipartisan hearings, have witnesses from all walks of life with different perspectives, and reform our tax code the right way that works for all Americans, not just some.

In the absence of Democratic support, a handful of GOP senators could (for whatever reasons) block the Tax Plan. GOP hog-tied by a divided Senate, Jonah Goldberg, townhall.com,
10/13/17.

The House has passed a good deal of legislation -- 305 bills, according to GovTrack.us. Admittedly, a lot of it is minor, but there's some meaty stuff as well, including Obamacare repeal-and-replace. The problem is that very little of it can get through the narrowly Republican-controlled Senate, the burial ground where the GOP elephant goes to die.

As the proposed legislation is crafted in coming weeks, look for efforts to defer objections by preserving tax preferences (thereby diluting the tax reform aspects of the bill, such as they are), making the proposal more generous for middle class taxpayers (with resultant revenue losses), reducing proposed tax cuts (e.g., bumping up the proposed corporate tax rate from 20% to say 22%), etc.

For example, there has been considerable discussion about proposed elimination of the deduction for state and local taxes. It’s rumored that this issue may be compromised, e.g., by allowing middle class taxpayers to deduct state taxes while limiting the ability of high bracket taxpayers to do so. Tax revenue would be reduced as a result, while the tax complexity that everyone is so fond of complaining about would increase. Republicans mull compromise on biggest revenue-raiser for tax reform, Joseph Lawler, Washington Examiner,
10/12/17.

House Republicans were set to meet Thursday to discuss the possibility of changing one of the major provisions in the GOP tax reform plan meant to pay for tax rate reductions: the elimination of the deduction for state and local taxes. Republicans from blue states that rely heavily on the deduction were scheduled to meet with the lower chamber's top tax-writer to discuss ways to make sure the tax proposal doesn't raise taxes for their constituents, a conversation also unfolding among Republicans on the House floor and in phone calls.

It’s hard to imagine that the overall merit of the Tax Plan will improve as a result of such discussions, but negotiations on this issue and a host of others will be unavoidable. The Speaker of the House is already talking about staying in session over the holidays if necessary. Paul Ryan warns Congress he’ll keep them voting on Christmas for tax reform, Joseph Lawler, Washington Examiner,
10/12/17.

While legislation based on the Tax Plan may be enacted eventually, we don’t believe there is much chance of a tax bill reaching the president’s desk by December (as Secretary Mnuchin has been quoted as foreseeing).

**********FEEDBACK**********

#The balanced budget and miniaturization of debt is a pipe dream. We need to cut taxes and spur growth or we will be swamped with debt. – SAFE director

Comment: If the budget doesn’t get balanced, a fiscal meltdown is inevitable. While it’s arguable that tax cuts could boost the economy enough to recoup the initial revenue loss, this probably wouldn’t happen in practice (current tax rates simply are not high enough on the Laffer curve). Tax cuts are bound to increase the national debt, Debra Saunders, townhall.com, 10/15/17.

#As your very able and correct observations imply, Congress must bring Total Fiscal SPENDING under control before they start cutting taxes. As you further imply, and as Milton Friedman said many decades ago, the federal government's Total Spending determines the Total Resources taken from the economy.

Since the government is non-productive, existing exclusively for other purposes, such as the promotion of justice and property rights, the House of Representatives must pass a SPENDING Limit before it deals with taxes. The Spending Limit should be a total that is virtually certain to be realized, and that is last year's total tax revenue. This procedure must come first--prior to any decisions on how to spend it. Otherwise, Congress will be subject to every congressman's special pleading for money that goes to his constituents. That attitude must be faced and disposed of before any tax cuts are discussed. The main lesson, again, is that whatever the government spends is necessarily taxed by one means or another from individual or corporate incomes. It may be transferred to other people but it is a net burden on someone.

So, let's concentrate on the government's Total Spending first, and then squabble over who pays the balanced budget taxes. Keep up the very valid comments. – SAFE member (Georgia)

# This seems like an excellent summary of the proposed tax plan, but I would add that the plan is on balance unfriendly to seniors. Here are some examples: (1) For seniors living in a retirement community, a portion of the monthly fee is considered an advance payment on future healthcare expenses; this amount (on top of out of pocket medical expenses) would no longer be tax deductible (if above the applicable AGI threshold). (2) Increasing the Child Tax Credit would benefit very few seniors. (3) Allowing mortgage interest deduction would be of little help to seniors because most of them have paid off their mortgages, whereas denying a deduction for state and local taxes could penalize them due to their payment of high property taxes. (4) As the entry notes, some non-itemizers in the 10% bracket would move up to the 12% tax bracket. – SAFE director

Comment: This is a good example of the sort of objections against the tax plan that can be expected; every economic or social faction will have a point of view depending on their circumstances and there will be no way to please everyone.





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