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Trump’s Tax Reform Plan

On September 27, several media outlets published a nine-page document in which the “Big Six” group of White House and congressional Republican negotiators laid out their plans for a bill to overhaul the federal tax code. No bill has been released as of October 10, when President Trump told reporters that the plan would be adjusted over the coming weeks. Press secretary Sarah Huckabee Sanders contradicted that statement a few hours later, saying, “We don’t have any adjustments to make to the framework at this time.”

The framework proposes cuts to personal and business tax rates, in line with previous Trump campaign and House Republican proposals. It would simplify the tax code by scrapping most itemized deductions and reducing the number of personal income tax brackets. Many important details have been left out, however, such as the income levels the proposed tax brackets would apply to. The ambiguity is likely intentional, as it gives negotiators room to maneuver in the face of opposition from powerful business and taxpayer interests.

Provisions

The Big Six framework lays out the following changes to the federal tax code:

Collapse the current seven tax brackets into three, paying marginal rates of 12%, 25% and 35%. The framework does not specify what income levels these rates would apply to. It also leaves open the possibility of adding an additional top rate “to ensure that the reformed tax code is at least as progressive as the existing tax code.” The current top individual tax rate is 39.6%; the lowest is 10%. In an analysis released September 29, the nonpartisan, left-leaning Tax Policy Center assigned the following income levels to the proposed brackets, making inferences based on the 2016 House Republican plan:

Raise the standard deduction to $24,000 for married couples filing jointly (from $12,700 in 2017 under current law) and to $12,000 for single filers (from $6,350). There is no mention of the standard deduction for those filing as heads of household (currently $9,350), meaning the filing status – which benefits single parents – could be eliminated, as the Trump campaign proposed in its revised 2016 tax plan.

  • Scrap the additional standard deduction ($1,550 for single filers who are blind or over 65).
  • Scrap the personal exemption ($4,050 per person, subject to phaseout at higher incomes).
  • Introduce a “more accurate measure of inflation” for tax indexing. The Internal Revenue Service (IRS) currently uses the Consumer Price Index for all Urban Consumers (CPI-U), which both the Tax Policy Center and the nonpartisan, right-leaning Tax Foundation assume would be replaced by 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.

Increase the child tax credit, leaving the first $1,000 refundable as under current law, and increase the income levels at which the credit begins to phase out (currently $110,000 for married couples filing jointly, $55,000 for married couples filing separately and $75,000 for all others). The Tax Policy Center and Tax Foundation assume the credit would rise to $1,500 as proposed in the House Republican plan. The Big Six proposal says these measures would eliminate the marriage penalty the child tax credit currently imposes.

  • Create a $500 non-refundable credit for non-child dependents.
  • Repeal the alternative minimum tax, a device intended to curb tax avoidance among high earners.
  • Eliminate most itemized deductions, with the exception of those for mortgage interest and charitable contributions. The state and local tax deduction, which benefits taxpayers in Democratic states more than Republican ones, is not mentioned, implying it would be eliminated. Republican House members in high-tax states have objected to plans to eliminate the deduction.
  • Repeal the estate tax and the generation-skipping transfer (GST) tax.

Business Taxes

  • Establish a top pass-through rate of 25%. 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. The Big Six proposal says unspecified measures would be adopted to discourage high earners from reclassifying their earnings as business profits and benefit from the lower pass-through rate.
  • Lower the top corporate tax rate to 20% from the current 35%.
  • Eliminate the corporate alternative minimum tax.
  • “Consider methods” to reduce corporate double taxation.
  • Allow businesses’ capital investments (excluding structures) to be immediately expensed, rather than depreciating the value of these assets over time as under current law. The provision would extend at least through 2022.
  • Place unspecified limits on the net interest deductions enjoyed by C-corporations.
  • Eliminate the domestic production (section 199) deduction.
  • Introduce a “territorial tax system” by exempting dividends from foreign subsidiaries (defined by an ownership stake of at least 10%).
  • Treat foreign earnings held overseas as repatriated. Cash and equivalents would be taxed at a lower rate than illiquid assets, though neither rate is specified. Firms would be given several years to pay off the resulting bill.
  • Introduce measures to discourage offshoring and corporate inversions.

Whose Tax Cuts?

Speaking at a rally in Indiana shortly after the Big Six framework’s release, 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 claim is hard to verify because Trump is the first president – or general election candidate for that matter – to refuse to release his tax returns since the 1970s. The reason he has given for his refusal is an IRS audit; the IRS responded that “nothing prevents individuals from sharing their own tax information.”)

There are reasons to doubt that the Big Six’s plan represents a “middle class miracle,” as Trump called it in Indiana, or that it would be anything but a boon to the highest earners.

The framework is missing fundamental details, but the Tax Policy Center published an analysis on September 29 that fills in the blanks in the proposal with details from previous ones made by the Trump campaign and House Republican leaders. The think tank finds that – as in previous Republican plans – every band of the income spectrum would see their after-tax incomes rise.

The highest earners, however, would benefit far more than anyone else. Whereas the bottom four income quintiles would gain from 0.5% to 1.2% in after-tax income in 2018, the top 1% would gain 8.5%, and the top 0.1% would gain 10.2%.

Put another way, 1.1% of the overall tax cut would go to the lowest-earning 20% of the population, while 74.5% of the cut would go to the highest-earning 20%. The top 1% would receive the majority of the tax cut (53.3%), and the top 0.1% would receive close to a third (30.3%).

The Tax Foundation did not incorporate expected macroeconomic effects in its analysis, citing the Big Six proposal’s lack of detail.

A Middle Class Tax Hike?

While the standard deduction would increase under the Big Six framework, that increase would be mostly offset by the loss of the personal exemption. Currently a middle-income single filer does not pay tax on the first $10,400 they earn: the $6,350 standard deduction plus one $4,050 personal exemption. In other words, the Big Six proposal is only “roughly doubling the standard deduction” in the most technical sense; it is raising the amount that can be earned tax-free by a single filer with a moderate income by 15.4%. For people who are blind or older than 65, who will no longer receive the $1,550 additional standard deduction, the increase is just 0.4%.

At the same time, the rate on the lowest tax bracket – for which no income threshold has been proposed – will rise from 10% to 12%, so some lower-income, over-65 taxpayers may not see any benefit from the increased standard deduction.

For families with children, the loss of the personal exemption could result in a tax hike. The Big Six framework promises a bigger child credit, but does not specify how much bigger. The changes could be especially disappointing for single parents, since it appears that the Big Six plan would eliminate the head of household filing status.

In an assessment of the Trump campaign’s revised 2016 tax plan, the Tax Policy Center gives the example of a single parent earning $50,000 who has three school-age children and no childcare costs. Under current law they would claim the $9,300 head of household standard deduction and four personal exemptions ($4,050 each), bringing their taxable earnings to $24,500. They would owe $3,012 before the $3,000 child tax credit, which would ultimately bring their liability to $12.

Under Trump’s campaign plan, that tax burden would have risen by 9,900%: the parent would have become a single filer rather than a head of household, entitling them to a $15,000 standard deduction (the level proposed by the plan). Personal exemptions would have been eliminated, yielding a taxable income of $35,000 and a bill of $4,200, which would have fallen to $1,200 after the child tax credit.

In all, the think tank estimates, at least 8.5 million households would have experienced tax hikes under Trump’s campaign plan, largely as a result of the head of household filing status being scrapped. The Big Six framework appears not to include the head of household filing status, meaning Republicans’ tax reform could wind up having a similar effect. On the other hand, Tax Foundation assumes that the bill would retain the filing status and set its standard deduction at $17,650.

The Estate Tax

Unveiling the Big Six plan in Indiana, 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, however. According to the Tax Policy Center, 5,460 estates will be taxable under current law in 2017. Of those, just 80 are small businesses or farms, and these will account 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.”

Carried Interest

Trump promised as far back as 2015 to close the carried interest loophole, 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 at least a year – 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.)

While Trump’s plan proposes taxing carried interest as regular income, the Tax Policy Center pointed out in its analysis of the Trump campaign’s revised 2016 plan that hedge funds would likely qualify for the pass-through rate, so closing the loophole may have actually reduced taxes on these high earners. The proposed pass-through rate was 15% at the time; the Big Six framework raises that to 25% and mentions “measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.” Even so, closing the carried interest loophole may not be as effective as it sounds.

Corporate Tax

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, September 28, the Wall Street Journal reported that the Treasury Department had deleted a paper saying the exact opposite from its site. 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 inconvenient for the institution that produced them. Treasury Secretary Steven Mnuchin is selling 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 immediately respond to a request to identify the studies in question. The department’s website continues to host other papers dating back to the 1970s.

Can Tax Reform Be Done?

The Republican push to overhaul the tax code has proceeded at a slower rate than the Trump administration initially promised. Mnuchin said in February that a bill would be passed and signed before Congress’ August recess. In September he shifted that target to the end of the year.

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