Tax Relief or Nightmare?

Congressional Republicans are on the cusp of their first legislative victory this term. This feat will not be some minor change to infrastructure, agriculture, or food stamps. This legislation will touch every single American’s life. Benjamin Frankling once noted: “[I]n this world nothing can be said to be certain, except death and taxes.”

A fundamental rewriting of the tax code will affect the incomes of every single American; every income group and tax bracket will be impacted by this legislation. Republicans and President Donald Trump promise that this impact will be overwhelmingly positive.

But will this be so for everyone?

This analysis will be based on the most recent version of the tax bill that has come out of the reconciliation conference. Previously the House and the Senate passed separate bills with few differences. Those have now mended into a single bill that must pass both chambers and could be amended in the process. For now, analysis can use the version most current and most likely to prevail.

The most important question perhaps: do most Americans prevail?

As for the Senate version of the bill, 91% of Americans will see a tax cut next year. On the surface this is fantastic news for those people; however, are the 9% who will see a tax hike the wealthiest Americans or part of the middle and lower classes? Discovering this will help in discerning the fairness of this bill.

What are the main provisions of the legislation that will impact average Americans?

Before discussing the bill’s details, it is necessary to explain how tax filing generally works in the United States. The tax system is progressive meaning that higher amounts of income are taxed at higher percentages; an individual’s income can be taxed at several different rates also dependent on marital status which can be seen by this chart of the current structure:

From this structure taxpayers can choose to decrease their taxable income by either taking general deductions available to everyone or by itemizing their expenses (within limits). The latter is time consuming and requires receipt collection for spending such as charitable donations, business expenses, and more. Therefore, almost 70% of taxpayers take the general deductions that takes much less time even if that could possibly mean paying more in taxes depending on the specific situation. The main deduction taken by this 70% is the standard deduction set at $6,500 for 2018 according to current law. This means that a tax filer would be able to reduce their income by this amount allowing them to pay less in income tax or even fall into a lower tax bracket. There are more standard deductions available for the disabled and dependent. Additionally, each individual is allowed to deduct $4,150 for themselves and for any person dependent on that tax filer’s income. A family can also deduct $1,000 for each child dependent they have. There are myriad more deductions that filers take, but each familial situation is so specific that each one cannot be detailed concisely for this analysis.

The best way to detail the above deductions and tax rates is to provide an example filing:

Take an individual who makes the median personal income for the U.S. ($31,099). They are not married. This $31,099 would be reduced by $6,500 with the standard deduction then $4,150 with the personal exemption. This would reduce $31,099 in taxable income to $20,449. Thus, filing taxes as an individual, the person would pay 10% on the first $9,325 then 15% on $11,124–a total of $2,601.1. This would be an effective tax rate of 8.4% on $31,099.

Now, let’s compare this tax filing with the new GOP tax structure most likely to become law. $31,099 would be reduced by a new doubled standard deduction of $12,000, but the personal exemption would be eliminated entirely. This would reduce $31,099 of taxable income to $19,099–a lower amount than under the previous structure. Furthermore, the progressive tax structure would be reformed to the following:

This structure would tax $19,099 with $9,525 at 10% and $9,574 at 12% instead of the previous 15%. The total income tax burden would be $2,101.38–a savings of $499.72 or a 20% reduction.

While these individuals would see a tax cut under the new structure, it is possible to see how the change in the deductions and bracket structure could and would disadvantage certain specific cases. The original passed versions of the tax bill saw eliminations of popular deductions such as the medical expense deduction which has now been expanded, the state and local tax deduction which has now been limited instead of eliminated, the student loan interest deduction which has been kept, the teacher spending deduction which has been kept, and the mortgage interest deduction which has been kept yet reduced. The child tax credit will also be doubled as it was previously not changed significantly. These final alterations to the bill will seemingly reduce the amount of Americans that could see their taxes raised. This is all good news for the middle class.

But should all these savings for the middle class be paired with even larger savings for the wealthy and corporations? The wealthy would experience even greater percent increases in after-tax income. This is largely due to the reduction of the top tax rate from 39.6% to 37% and the increasing of that threshold from $418,401 to $500,000. The Congressional Budget office found the cost of the Senate tax bill to be $1.4 trillion. The final bill has not yet been scored but with an even lower top tax rate, the cost is presumably even higher largely due to the change to 37%. Additionally, the estate tax which taxes multi-million dollar estates would be limited costing tens of billions, and the corporate tax rate which is currently 35% would be cut to 21% while profits earned overseas by U.S. corporations would no longer face U.S. corporate tax rates. While the current statutory rate is 35%, the average corporation pays 12%. Without elimination of most deductions for corporations, the reduction in the statutory rate could mean even lower than 12% effective tax rates for corporations. Additionally, businesses that “pass through” their profits to their owners would see a significant tax cut. These changes could cost the government tens of billions in revenue. Furthermore, the tax cuts for individuals expire in ten years while the corporate tax rate cut does not.

There is an argument that repatriating foreign income and cutting corporate taxes will spurs investment in business and increased wages. However, companies would have to be trusted not to instead simply raise executive pay and increase shareholder dividends and stock buybacks. While companies could reasonably use dividends to encourage investors to buy their stock and use that income to invest in employees, corporations still have to be trusted to act in the best interest of the workers. Furthermore, stock buybacks benefit mostly wealthy people as only around 20% of Americans own stock outside of retirement plans, which are held by 50% of Americans. Thus, while buybacks gets more cash in the hands of some and that could be argued as stimulating economic growth, it at least does not directly help the majority of Americans. Companies would have to be trusted to invest directly in workers.

Outside of taxation, the legislation allows repeals the Affordable Care Act’s individual mandate which would eliminate the requirement for Americans to purchase health insurance. This could cause a death spiral in the insurance markets as young healthy people could opt out insurance leaving only sick expensive people in the marketplace.

On the whole, it is clear that virtually all Americans will receive a tax cut. The richest corporations and many owners will see permanent cuts while the average American’s taxes will rise in a decade if no other changes are to be made. The richest individuals will also see bigger cuts than the middle and lower classes; flattening out the progressive tax system and increasing wealth and income inequality–a problem already much worse in the United States than the rest of the developed world. While incomes will certainly rise, it seems that the price tag of the bill will almost certainly lead Republicans in Congress to attempt cutting social programs that benefit the lower and middle classes most. On top of the debt, a stimulus to the economy when it is already in a very healthy state may cause economic overheating which is discussed in “The Boom Goes Bust: Coming Soon?” If a recession occurs soon, the added debt will mean an increased debt-to-GDP ratio which is the key metric for measuring how much debt is healthy for a country. Even without a recession, most economic studies find the tax bill would deliver modest stimulation at best which could lead to an increased debt-to-GDP ratio regardless of a recession.

Considering all of this, is this the best deal for the American people, or should we renegotiate?

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