House and Senate Republicans released the text of a bill to overhaul the federal tax code on Dec. 15, with final votes expected the following week. The bill represents a compromise between two significantly different bills the two chambers passed over the preceding weeks.
Senate Republicans passed a bill overhauling the federal tax code in the early hours of Dec. 2, following a number of last-minute changes. Fifty-one senators voted for the “Tax Cuts and Jobs Act”; just one Republican, Bob Corker (R-Tenn.), voted against the bill, citing projections that it would raise the deficit. No Democrats supported the legislation.
That bill differed significantly from the version the House passed on Nov. 16. by a vote of 227 to 205. Thirteen Republicans voted against the legislation, most of them from high-tax states likely to be negatively impacted by its provisions. No Democrats supported it.
Following the Senate version’s passage, the two bills went into conference to be reconciled into a single piece of legislation. President Trump has called for a bill to be sent to his desk by Christmas, and Democrat Doug Jones’ victory in the Alabama special election adds to the pressure to work quickly: once Jones takes his seat, currently occupied by a Republican appointed by the state’s governor, the GOP will have just 51 senators. That is likely to happen in January.
On Dec. 14, Marco Rubio (R-Fla.) threatened to vote “no” on the joint agreement unless it was revised to include a more generous child tax credit; the GOP gave in, and Rubio is expected to vote for the bill. So is Corker, who promised his support despite his view that the bill is “far from perfect.”
If a version of the tax overhaul does become law, it would represent the most significant rewriting of the federal tax code since 1986.
The descriptions below come from the Joint Committee on Taxation’s explanation of the final joint agreement.
Income Tax Rates
The bill would retain the current structure of seven individual income tax brackets, but in most cases it would lower the rates: the top rate would fall from 39.6% to 37%, while the 33% bracket would fall to 32%, the 28% bracket to 24%, the 25% bracket to 22% and the 15% bracket to 12%. The lowest bracket would remain at 10%, and the 35% bracket would also be unchanged. The income bands that the new rates apply to would be lower, compared to 2018 brackets under current law, for the five highest brackets.
The changes would be temporary, going into effect in 2018 and expiring after 2025, as would be the case with most personal tax breaks included in the bill. The expiration date allows the Senate to comply with “reconciliation” rules that block a Democratic filibuster – which Republicans do not have the votes to defeat – only if the bill does not raise the deficit in any year outside of a 10-year window and if it stays within its $1.5 trillion budget constraint during the 10-year window. Republican congressional leaders have signalled that indidvidual tax cuts would be extended at a later date.
|Single filers, 2018-2025|
|Taxable income over||Up to||Marginal rate|
|Heads of household, 2018-2025|
|Taxable income over||Up to||Marginal rate|
|Married couples filing jointly, 2018-2025|
|Taxable income over||Up to||Marginal rate|
|Married couples filing separately, 2018-2025|
|Taxable income over||Up to||Marginal rate|
|Source: Joint Committee on Taxation.|
The bill would raise the standard deduction to $24,000 for married couples filing jointly in 2018 (from $13,000 under current law), to $12,000 for single filers (from $6,500), and to $18,000 for heads of household (from $9,550). These changes would expire after 2025. The additional standard deduction, which the House bill would have repealed, will not be affected. Beginning in 2019, the inflation gauge used to index the standard deduction will change in a way that is likely to accelerate bracket creep (see below).
The bill would suspend the personal exemption, which is currently set at $4,150 in 2018, through 2025. Withholding rules may not change until 2019, subject to the Treasury Secretary’s discretion.
The bill would end the individual mandate, a provision of the Affordable Care Act or “Obamacare” that provides tax penalties for individuals who do not obtain health insurance coverage, in 2019. (While the mandate would technically remain in place, the penalty would fall to $0.) According to the Congressional Budget Office (CBO), repealing the measure would reduce federal deficits by around $338 billion from 2018 to 2027, but lead 13 million more people to lack insurance at the end of that period and push premiums up by an average of around 10%. Unlike other individual tax changes, the repeal would not be reversed in 2025.
Senators Lamar Alexander (R-Tenn.) and Patty Murray (D-Wash.) proposed a bill, the Bipartisan Health Care Stabilization Act, to mitigate the effects of repealing the individual mandate, but the CBO estimates that this legislation would still leave 13 million more people uninsured after a decade, assuming the Senate’s tax bill becomes law.
The bill would change the measure of inflation used for tax indexing. The Internal Revenue Service (IRS) currently uses the Consumer Price Index for all Urban Consumers (CPI-U), which would be replaced with the chain-weighted CPI-U. The latter takes account of changes consumers make to their spending habits in response to price shifts, so it is considered more rigorous than standard CPI. It also tends to rise more slowly than standard CPI, so substituting it would likely accelerate bracket creep. The value of the standard deduction and other inflation-linked elements of the tax code would also erode over time, gradually pushing up tax burdens. The change would not expire.
Family Credits and Deductions
The House bill would raise the child tax credit to $1,600 from $1,000 and provide filers, spouses and non-child dependents with a temporary $300 credit. Only the first $1,000 of the child tax credit would be refundable initially, but this amount would rise to $1,600 with inflation. The $300 credit would end after five years.
The bill would temporarily raise the child tax credit to $2,000 – originally $1,650 – with the first $1,400 refundable, and create a non-refundable $500 credit for non-child dependents. The child credit can only be claimed if the taxpayer provides the child’s Social Security number. (This requirement does not apply to the $500 credit.) Qualifying children must be younger than 17. The child credit begins to phaseout when adjusted gross income exceeds $400,000 (for married couples filing jointly, not indexed to inflation). Unde current law, phaseout begins at $110,000. These changes would expire in 2025.
Head of Household
Trump’s revised campaign plan, released in 2016, would have scrapped the head of household filing status, potentially raising taxes on a large number of single parents. The conference bill would leave the status in place.
Mortgage Interest Deduction
The bill would limit the application of the mortgage interest deduction for married couples filing jointly to $750,000 worth of debt, down from $1,000,000 under current law, but up from $500,000 under the House bill. Mortgages taken out before Dec. 15 would be suject to the current cap. The change would expire after 2025.
State and Local Tax Deduction
The bill would cap the deduction for state and local taxes at $10,000 through 2025. The SALT deduction disproportionately benefits high earners, who are more likely to itemize, and taxpayers in Democratic states. A number of Republican members of Congress representing high-tax states opposed attempts to eliminate the deduction, as the Senate bill would have done.
The Senate bill was amended on Dec.1, apparently to win Susan Collins’ (R-Maine) support:
Other Itemized Deductions
The bill would leave the charitable giving deduction intact, with minor alterations (if a donation is made in exchange for seats at college athletic events, it cannot be deducted, for example). The student loan interest deduction would not be affected (see “Student Loans and Tuition” below). Medical expenses in excess of 7.5% of adjusted gross income would be deductible for all taxpayers in 2017 and 2018; the threshold under current law is 10%, and the age floor is 65.
The bill would however suspend a number of miscellaneous itemized deductions through 2025, including the deductions for home office expenses; laboratory breakage fees; licensing and regulatory fees; union dues; professional society dues; business bad debts; work clothes that are not suitable for everyday use; and many others. The moving expenses deduction would be suspended through 2025. Alimony payments would not longer be deductible after 2019.
Alternative Minimum Tax
The bill would temporarily raise the exemption amount and exemption phaseout threshold for the alternative minimum tax (AMT), a device intended to curb tax avoidance among high earners by making them estimate their liability twice and pay the higher amount. For married couples filing jointly, the exemption would rise to $109,400 and phaseout would increase to $1,000,000; both amounts would be indexed to inflation. The provision would expire after 2025.
Retirement Plans and HSAs
Health Savings Accounts (HSAs) would not be affected by the bill, as they would have under the version passed by the House.
Reports circulated in October that traditional 401(k) contribution limits might fall to $2,400 from the current $18,000 ($24,000 for those aged 50 or older). Individual retirement account (IRA) contribution limits, currently $5,500 ($6,500 for 50 or older), may also have been considered for cuts. The bill would leave these limits unchanged, but repeal the ability to recharacterize one kind of contribution as the other, that is, to retroactively designate a Roth contribution as a traditional one, or vice-versa.
Student Loans and Tuition
The House bill would have repealed the deduction for student loan interest expenses or the exclusion from gross income and wages of qualified tuition reductions. The conference bill would leave these breaks intact. It would also extend the use of 529 plans to K-12 private school tuition.
The bill would repeal the Pease limitation on itemized deductions. This provision does not cap itemized deductions, but gradually reduces their value when adjusted gross income exceeds a certain threshold ($266,700 for single filers in 2018); the reduction limited to 80% of the deductions’ combined value.
The bill would temporarily raise the estate tax exemption for single filers to $11.2 million from $5.6 million in 2018, indexed for inflation. This change would be reversed after 2025.
Corporate Tax Rate
The bill would set the corporate tax rate at 21%, beginning in 2018, and repeal the corporate alternative minimum tax. Unlike tax breaks for individuals, these provisions would not expire.
The Senate bill would also allow full expensing of capital investments — rather than requiring them to be depreciated over time – for five years, but phase the change out by 20 percentage points per year thereafter.
Owners of pass-through businesses – which include sole proprietorships, partnerships and S-corporations – currently pay taxes on their firms’ earnings through the personal tax code, meaning the top rate is 39.6%.
The bill would create a 20% deduction for pass-through income, down from 23% in the last version of the Senate bill (the House woud have introduced a new, 25% top pass-through rate). Certain industries, including health, law and financial services, are excluded, unless taxable income is below $157,500 (for single filers). To discourage high earners from recharacterizing regular wages as pass-through income, the deduction would be capped using a formula based on W-2 wages and qualified property.
Net Operating Losses
The bill would scrap net operating loss carrybacks and cap carryforwards at 90% of taxable income, falling to 80% after 2022.
The bill would eliminate the section 199 (domestic production activities) deduction.
The bill would enact a deemed repatriation of overseas profits at a rate of 15.5% for cash and equivalents and 8% for reinvested earnings. Goldman Sachs estimates that U.S. companies hold $3.1 trillion of overseas profits. As of Sept. 30 Apple Inc. (AAPL
) alone holds $252.3 billion in tax-deferred foreign earnings, 94% of its total cash and marketable securities.The bill would introduce a territorial tax system, under which only domestic earnings would be subject to tax.
Treasury Secretary Steven Mnuchin has claimed that the Republican tax plan would spur sufficient economic growth to pay for itself and more, saying of the “Unified Framework” released by Senate, House and Trump administration negotiators in September:
“On a static basis our plan will increase the deficit by a trillion and a half. Having said that, you have to look at the economic impact. There’s 500 billion that’s the difference between policy and baseline that takes it down to a trillion dollars, and there’s two trillion dollars of growth. So with our plan we actually pay down the deficit by a trillion dollars and we think that’s very fiscally responsible.”
The idea that cutting taxes boosts growth to the extent that government revenue actually increases is almost universally rejected by economists, and the Treasury has not released the analysis Mnuchin bases his predictions on. The New York Times reported on Nov. 30 that a Treasury employee, speaking anonymously, said no such analysis exists, prompting a request from Sen. Elizabeth Warren (D-Mass.) that the Treasury’s inspector general investigate. On Dec. 11 the Treasury released a one-page analysis claiming that the tax bill would increase revenues by $1.8 trillion over 10 years, more than paying for itself, based on high growth projections. (See also, Laffer Curve.)
Even the right-leaning Tax Foundation’s relatively sympathetic dynamic scores of the Senate and House bills forecast significant increases in the national debt: $516 billion over 10 years under the Senate’s version, $1.1 trillion under the House’s. Scott Greenberg, an analyst at the think tank, told the New York Times that the Treasury’s one-page analysis “does not appear to be a projection of the economic effects of a tax bill,” but rather “a thought experiment on how federal revenues would vary under different economic effects of overall government policies. Which is, needless to say, an odd way to analyze a tax bill.”
The Joint Committee on Taxation released an analysis (download) on Nov. 30 estimating that the Senate bill would increase the national debt by just over $1 trillion over 10 years. The estimate incorporates a slight boost to economic output, amounting to about 0.8% of GDP, which would offset the expected $1.4 billion increase in the debt (on a static basis).
The left-leaning Tax Policy Center (TPC) released an analysis on Dec. 1 forecasting a 0.7% boost to GDP in 2018 if the Senate bill became law. That additional growth would fade to zero by 2027, however, and be negligible in 2037.
The amended Senate bill was scored on Dec. 1 by the CBO, which found that it would increase the deficit by $1.4 trillion over 10 years on a static basis.
The Oil Addendum
The budget resolution authorizing the tax bill to raise the deficit by $1.5 trillion tasked the Senate Energy and Natural Resources Committee with achieving $1.0 trillion in savings; the tax bill would achieve that by allowing oil and gas drilling in the Arctic National Wildlife Refuge, which is located in committee chair Sen. Lisa Murkowski’s (R-Alaska) home state. Murkowski voted against multiple Obamacare repeal bills over the summer, making it important Republicans to secure her support for tax reform.
Automatic Spending Cuts
The idea of a fiscal “trigger,” a mechanism to enact automatic tax hikes or spending cuts that some senators have pushed for, was rejected on procedural grounds. The Senate bill could potentially lead to automatic spending cuts anyway, however, as a result of the 2010 Statutory Pay-As-You-Go Act: that law requires cuts to federal programs if Congress passes legislation increasing the deficit. The Office of Management and Budget, an executive agency, is in charge of determining these budget effects. Medicare cuts are limited to 4% of the program’s budget, and some programs such as Social Security are protected entirely, but others could see deep cuts.
Whose Tax Cuts?
Speaking at a rally in Indiana shortly after the release of a preliminary Republican framework in September, President Trump repeatedly stressed that the “largest tax cut in our country’s history” would “protect low-income and middle-income households, not the wealthy and well-connected.” He added the plan is “not good for me, believe me.” (That last claim is hard to verify, because Trump is the first president or general election candidate since the 1970s not to release his tax returns. The reason he has given for this refusal is an IRS audit; the IRS responded that “nothing prevents individuals from sharing their own tax information.”)
Both versions of the Tax Cuts and Jobs Act would cut the corporate tax rate, benefiting shareholders, who tend to be higher earners. The Senate version would only cut individuals’ taxes for a limited period of time. Both bills would eliminate the alternative minimum tax, which requires high earners to calculate their liabilities twice and pay the higher amount; scrap the estate tax; reduce the taxes paid on pass-through income (70% of which goes to the the highest-earning 1%); and cut the rate married couples pay on income from $480,050 to $1 million. Neither version would close the carried interest loophole. The Senate would scrap the individual mandate, driving premiums up on Obamacare exchanges.
While it is not certain what form an eventual unified bill would take, these provisions taken together are likely to benefit high earners disproportionately and – particularly as a result of scrapping the individual mandate – hurt some working- and middle-class taxpayers. Yet Senate majority leader Mitch McConnell (R-Ky.) said on Nov. 4 that no one in the middle class would experience a tax hike:
On Nov. 10 he told the New York Times he “misspoke”: “You can’t guarantee that absolutely no one sees a tax increase, but what we are doing is targeting levels of income and looking at the average in those levels and the average will be tax relief for the average taxpayer in each of those segments.”
According to a JCT analysis released Nov. 16, the revised Senate bill would raise taxes on households making from $20,000 to $30,000 by 13.3% in 2021 and 25.4% in 2027, compared to current law.
The Estate Tax
The GOP bill would double the estate tax exemption. Speaking in Indiana in September, Trump attacked “the crushing, the horrible, the unfair estate tax,” describing apparently hypothetical scenarios in which families are forced to sell farms and small businesses to cover estate tax liabilities; the 40% tax only applies to estates worth at least $5.49 million. According to TPC, 5,460 estates are taxable under current law in 2017. Of those, just 80 are small businesses or farms, accounting for less than 0.2% of the total estate tax take.
The estate tax mostly targets the wealthy. The top 10% of the income distribution accounts for an estimated 67.2% of taxable estates in 2017 and 87.8% of the tax paid.
Opponents of the estate tax – some of whom call it the “death tax” – argue that it is a form of double taxation, since income tax has already been paid on the wealth making up the estate. Another line of argument is that the wealthiest individuals plan around the tax anyway: Gary Cohn reportedly told a group of Senate Democrats earlier in the year, “only morons pay the estate tax.”
The bill would not eliminate the carried interest loophole, though Trump promised as far back as 2015 to close it, calling the hedge fund managers who benefit from it “pencil pushers” who “are getting away with murder.” Hedge fund managers typically charge a 20% fee on profits above a certain hurdle rate, most commonly 8%. Those fees are treated as capital gains rather than regular income, meaning that – as long as the securities sold have been held for a certain minimum period – they are taxed at a top rate of 20% rather than at 39.6%. (An additional 3.8% tax on investment income, which is associated with Obamacare, also applies to high earners.)
In his Indiana speech Trump said that cutting the top corporate tax rate from 35% to 20% would cause jobs to “start pouring into our country, as companies start competing for American labor and as wages start going up at levels that you haven’t seen in many years.” The “biggest winners will be the everyday American workers,” he added.
The next day, Sept. 28, the Wall Street Journal reported that the Treasury Department had deleted a paper saying the exact opposite from its site (the archived version is available here). Written by non-political Treasury staff during the Obama administration, the paper estimates that workers pay 18% of corporate tax through depressed wages, while shareholders pay 82%. Those findings have been corroborated by other research done by the government and think tanks, but they are currently inconvenient for the institution that produced them. Treasury Secretary Steven Mnuchin sold the Big Six proposal in part through the assertion that “over 80% of business taxes is borne by the worker,” as he put it in Louisville in August.
A Treasury spokeswoman told the Journal, “The paper was a dated staff analysis from the previous administration. It does not represent our current thinking and analysis,” adding, “studies show that 70% of the tax burden falls on American workers.” The Treasury did not respond to Investopedia’s request to identify the studies in question. The department’s website continues to host other papers dating back to the 1970s.
The White House continued to press the point, however, releasing an analysis in October predicting that lowering the top corporate tax rate to 20% would” increase average household income in the United States by, very conservatively, $4,000 annually.” The executives who were supposed to be giving these raises, however, signaled some hesitation at the Wall Street Journal CEO Conference in November, when the paper’s associate editor John Bussey asked the audience to raise their hands if they would be increasing capital investment due to a corporate tax cut. Few hands went up, prompting National Economic Council director Gary Cohn (who was on stage) to ask, “Why aren’t the other hands up?”
What’s Wrong With the Status Quo?
People on both sides of the political spectrum agree that the tax code should be simpler. Since 1986, the last time a major tax overhaul became law, the body of federal tax law – broadly defined – has swollen from 26,000 to 70,000 pages, according to the House GOP’s reform proposal. American households and firms spent $409 billion and 8.9 billion hours completing their taxes in 2016, the Tax Foundation estimates. Nearly three quarters of respondents told Pew in 2015 that they were bothered “some” or “a lot” by the complexity of the tax system.
An even greater proportion was troubled by the feeling that some corporations and some wealthy people pay too little: 82% said so about corporations, 79% about the wealthy. According to TPC, 72,000 households with incomes over $200,000 paid no income tax in 2011. ITEP estimates that 100 consistently profitable Fortune 500 companies went at least one year between 2008 and 2015 without paying any federal income tax. There is a widespread perception that loopholes and inefficiencies in the tax system – the carried interest loophole and corporate inversions, to name a couple – are to blame.
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