Trump Tax Reform Road Map Released
On Wednesday, September 27, several media outlets published a nine-page document in which the White House and Congressional Republican leaders – collectively known as the "Big Six" – laid out their plans for an eventual tax overhaul bill.
The framework proposes cuts to personal and business tax rates, in line with previous Trump campaign and House Republican proposals. It advocates a broad simplification of the tax code, 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 lobbies.
The framework lays out the following changes to the federal personal and corporate income 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%.
- • Raise the standard deduction to $24,000 for married couples filing jointly (from the current $12,600) and to $12,000 for single filers (from $6,300). There is no mention of the standard deduction for those filing as heads of household (currently $9,300), perhaps indicating that the filing status – which benefits single parents – would be eliminated, as Trump proposed during the campaign. The plan proposes scrapping the additional standard deduction and personal exemptions (currently $4,050 per person, subject to phaseout) for filers and spouses.
- • Introduce a "more accurate measure of inflation" for indexing the tax code. The IRS currently uses the CPI-U to adjust for inflation and prevent bracket creep.
- • Increase the child tax credit, leaving the first $1000 refundable as under current law, and increase the income levels at which the credit begins to be phased out (currently $110,000 for married couples filing jointly, $55,000 for married couples filing separately and $75,000 for all others). The document says these measures will eliminate the marriage penalty the credit currently imposes.
- • Eliminate most itemized deductions, with the exception of those for mortgage interest and charitable contributions. State and local tax deductions, which benefit taxpayers in Democratic states more than Republican ones, are not mentioned, but may be eliminated.
- • 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 individual tax code. The document says that measures will be adopted to discourage high earners from reclassifying their earnings as business profits in order to 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 for a period of at least five years, rather than depreciating the value of these assets over time as under current law.
- • Place limits on the net interest deductions enjoyed by C-corporations.
- • Eliminate the domestic production (section 199) deduction.
- • Introduce a "territorial tax system" by providing a 100% exemption for dividends from foreign subsidiaries (defined by a 10% or greater ownership stake).
- • Treat foreign earnings currently held overseas as repatriated. Cash and equivalents will 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 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 said the plan is "not good for me, believe me."
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 not benefit the highest earners.
The Trump Campaign Plan
Estimates of how the Big Six tax framework will affect taxpayers in different segments of the income distribution are not available yet, but analyses of a tax proposal released by the Trump campaign in 2016 showed hefty tax breaks for the highest earners and more modest ones for everyone else. Some working and middle class households, experts found, would see their taxes rise significantly. In speeches in Detroit and New York, Trump in outlined a revised tax plan (his first plan, released in 2015, was scrapped after experts found it would balloon the deficit and slash taxes on the rich).
Trump promised in his New York speech that "tax relief will be concentrated on the working and middle class taxpayer," but the non-partisan, right-leaning Tax Foundation found that the after-tax income of the highest-earning 1% would rise by 10.2% to 16.0% on a static basis, while that of the lowest-earning 10% would rise by just 1.2%. Incorporating expected macroeconomic effects, the Tax Foundation forecast that the plan would boost the after-tax earnings of the top 1% by 12.2% to 19.9%. The boost to the bottom 20% would be 6.9% to 8.1%.
The ranges of potential impacts are due to ambiguity in Trump's revised plan: it was not clear what the pass-through rate would be, so the think tank produced two estimates, one based on a 15% pass-through rate (equal to the top corporate tax rate Trump proposed at the time) and one based on a 33% rate (the top personal income tax rate he was proposing).
The Big Six proposal puts the pass-through rate at 25%, so presumably the impact would be near the midpoint of these estimates, but other differences between Trump's campaign proposals and September's Big Six proposal are likely to affect forecasts.
A Middle Class Tax Hike
The non-partisan, left-leaning Tax Policy Center's analysis tells a slightly different story. The think tank also estimated the effects of the 2016 Trump proposal on each income quintile's after-tax incomes, and the findings were broadly in line with the Tax Foundation's. But a more granular look at the proposal shows that some middle class filers would see a tax hike: single filers earning between $15,000 and $19,625 per year and childless married couples making between $30,000 and $39,250, who pay a 10% marginal rate under current law, would pay 12% under Trump's 2016 plan.
That plan would also eliminate the head of household filing status, which benefits single parents. In a separate report, 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 revised plan, that tax burden would rise by 9,900%: the parent would be a single filer, since the head of household filing status would disappear, meaning they would receive a $15,000 standard deduction (the level proposed by the plan). Personal exemptions would be eliminated, so their taxable income would be $35,000. Their bill would be $4,200, which would fall to $1,200 after the child tax credit.
In all, the think tank estimates, at least 8.5 million households would experience tax hikes under Trump's 2016 plan, largely as a result of the head of household filing status being scrapped. Since the Big Six framework appears not to include the head of household filing status, Republican tax reform could wind up having a similar effect.
The Estate Tax
Unveiling the 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. But the tax only applies to estates worth at least $5.49 million. According to the Tax Policy Center, 5,460 estates will be taxable under current law in 2017. Of those, just 80 small businesses and farms will be taxable, accounting for less than 0.2% of the total estate tax take (these are defined as estates in which farm and business assets of $5 million or less represent at least half of the total value of the estate).
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.
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 were had 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 2016 that hedge funds would likely qualify for the proposed pass-through rate (15% at the time, currently 25%), so closing the loophole might not have the desired effect. (See also, Mnuchin: Trump Tax Plan Will Close Carried Interest Loophole.)
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. Treasury Secretary Steven 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.
Byrd Is the Word
A string of efforts to repeal and – ideally – replace the Affordable Care Act (ACA or "Obamacare") set the GOP's tax reform push back in a number of ways. The White House and congressional Republicans decided to pursue healthcare legislation first because, by cutting funding for premium and cost-sharing subsidies and programs such as Medicaid, they could create some room to introduce tax legislation that would not be strictly revenue-neutral: the Senate's Better Care Reconciliation Act, for example, would have shaved an estimated $321 billion from the federal deficit over a decade.
Balancing the books in this way is not just prudent; it's politically necessary for Republicans, who control only 52 of 100 seats in the Senate. Since they don't have the 60 seats needed to defeat a Democratic filibuster, the party must use a fast-track process called reconciliation, which requires 50 votes plus Vice President Pence's tie-breaking vote. To use reconciliation, however, they must do two things: pass a fiscal 2018 budget authorizing its use, and comply with the 1985 Byrd Rule, which bars the use of reconciliation to pass bills that increase the federal deficit over a 10-year timeframe, as assessed by the Congressional Budget Office (CBO).
Since they've been unable to create fiscal space for themselves through Obamacare repeal, Republicans' tax reform must pay for itself. Supply-side economics, an influential idea in the GOP, contends that tax cuts do just that through the relationship described by the Laffer curve: lower taxes encourage higher rates of investment, spurring economic growth and ultimately increasing the government's tax take. The CBO, however, "doesn't always measure all the dynamic effects," Diana Furchtgott-Roth, a Trump transition team member and Labor Department chief economist under George W. Bush, told Fox Business in March.
Maya MacGuineas, president of the fiscally hawkish Committee for a Responsible Federal Budget (CRFB), is skeptical that Trump's tax cuts can pay for themselves. In a statement emailed to reporters following the release of the Republican framework on Septmber 27, she wrote, "Without sufficient details on how or even if these tax cuts will be fully paid for, this outline is nothing more than a fiscal fantasy." Trump has repeatedly assered that gross domestic product (GDP) growth could exceed 3% per year following a tax overhaul; during the campaign he went as high as 6%, and speaking in Indiana following the release of the Republican framework he predicted that "everything takes off like a rocketship."
MacGuineas' reaction was skeptical: "tax cuts that would grow the debt cannot be made up for with wishful thinking or magical economic growth." A CRFB estimate released later on September 27 put the Big Six's proposed tax cuts from 2018 to 2027 at $5.8 trillion. The tax base would be broadened by $3.6 trillion, the think tank estimated, for a net cut of $2.2 trillion. (See also, CRFB: Trump's 'Incredibly Rosy' Budget Doesn't Balance.)
What About the Democrats?
President Trump has been openly flirting with Democrats in the context of tax reform, reflecting his frustrations with the Republican Congress following repeated Obamacare repeal failures and a bipartisan desire to simplify the gargantuan tax code. The fact that his top tax negotiators, Mnuchin and National Economic Director Gary Cohn, are both former Democratic donors may also play some role in attempts to woo the left.
(The remaining members of the Big Six Republican tax negotiators are Senate Majority Leader Mitch McConnell [R-Ky.], Senate Finance Committee Chairman Orrin Hatch [R-Utah], House Speaker Paul Ryan [R-Wis.] and House Ways and Means Committee Chairman Kevin Brady [R-Texas].)
In order to gain Democratic support, Trump has promised repeatedly not to cut taxes on the wealthy, but those promises are difficult to square with analyses of tax plans released by his campaign and Republican leaders in the House. The most recent framework, while less detailed than previous proposals, is also likely to provide tax relief to the highest earners by scrapping the estate tax, lowering the top marginal income tax rate and setting a relatively low pass-through rate.
Congressional Republicans have been less eager to reach across the aisle. McConnell said in August that his party intends to use reconciliation to pass an eventual bill, rebuffing an offer by 45 of 48 senators in the Democratic caucus to work with Republicans on the issue – albeit with preconditions, among them no tax cuts for the rich.
Speaking on tax reform in Missouri at the end of August, Trump preemptively laid the blame for failure at Congress' feet, saying, "I don't want to be disappointed by Congress, do you understand me?" He referenced Republicans' failed attempts to pass healthcare legislation and blamed congressional Democrats in particular, saying that Senator Claire McCaskill (D-Mo.) should vote for an eventual proposal or lose her seat.
Speaking North Dakota the following month, he invited another Senator Heidi Heitkamp (D-N.D.), to the stage; the gesture followed a deal struck the previous day between the president and Democratic senators, which raised the debt ceiling and provided relief for those affected by Hurricane Harvey. Heitkamp and McCaskill are among the 10 Democratic senators facing reelection in 2018 whose states went for Trump.
Before they can worry about the Democratics, however, Republicans must shore up support in their own party. GOP factions clashed during the spring over a border-adjustment tax proposed by Republicans in the House. The New York Times reported that three groups funded by the Koch brothers – influential Republican donors – were running campaigns against the proposal, arguing it would lead to higher prices for consumers.
The fight ended in July, when the Big Six issued a statement saying they would drop border adjustment, but that is unlikely to be the only rift within the GOP over taxes. As the healthcare battle showed, the priorities of the party's moderate and Tea Party wings are difficult to reconcile, and proposals put forth by the leadership tend to alienate both camps – for diametrically opposed reasons.
To rework the tax code, Trump and Congress will have to pick their way through a minefield of vested interests. As the Economist puts it, "Where once the passage of bills was smoothed by including federal money for pet projects in congressmen's districts, tax breaks are now the preferred lubricant."
This trend has created a difficult situation for would-be reformers of either party: while the overall benefits of an overhaul would be enormous, they would be diffuse, with each household and firm saving some money and some time. For a few interest groups, on the other hand, particular carve-outs and loopholes are essential, meaning they are willing to expend significant time and money lobbying against reform. (See also, Goldman Reduces Buyback Forecast After Trump Tax Reform Delay.)
One group is dependent not on any particular aspect of the complex tax system, but on the complexity itself: as NPR and ProPublica have reported, TurboTax maker Intuit Inc. and H&R Block Inc.) lobby against bills that would allow the government to estimate taxes, saving much of the hassle on which the firms' business depends. Tax-preparation firms may also oppose bills aimed at simplifying the code itself, rather than the filing system.
As of the previous (113th) Congress, only 16 Republicans in the House and six in the Senate have failed to sign Norquist's pledge not to raise taxes. If Norquist decides that an aspect of a Republican proposal violates the pledge – or Republicans decide to invoke it to avoid a showdown with special interests – the bill could be dead on arrival.
That some American households would see their tax bills rise is not exactly a remote possibility, given the range of proposed changes: the bottom personal tax bracket's rate would rise, which may not be fully offset for all households by a higher standard deduction. A number of itemized deductions are set to be eliminated, along with personal exemptions and potentially the head of household filing status. Some households – and perhaps millions – are likely to end up owing more.
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. In particular they were 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 the Tax Policy Center, 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.