Tax Day: Understanding Changes to the Tax Code
Tax Day is just around the corner, and the changes to the tax code have been in effect for over two months - many Americans are starting to notice the changes coming taking effect in their paychecks.
The Tax Cuts and Jobs Act (TCJA) ratified a host of wide-ranging measures that affect seemingly every corner of the tax code. It enacts the largest corporate tax cut in American history, incorporates an additional massive cut for other business owners, and re-configures the tax rates and brackets for individuals and families. The biggest takeaway is that most Americans will see lower tax bills this year. However, most observers agree that most of the bill’s measures disproportionately the wealthy and foreign investors. There’s also a sizeable minority of Americans who won’t see any change in their taxes, or will see their tax bills go up.
Ultimately, though, the range of benefits isn’t clear cut for any bracket. For instance, while some provisions will help cut taxes for lower- and middle-income families (like the expanded standard deduction and child tax credit), other measures (like the repeal of the personal exemption and SALT cap) could serve to raise taxes for other lower- and middle-income families. And while most changes in the bill disproportionately benefit the wealthy, some high-income earners could see their tax bills go up as well thanks to the SALT cap (although tax cut for the top bracket coupled with many other provisions will offset the effects of the SALT cap for many high-income families).
Let’s dive in, first with a brief overview of some of the key features of the bill, and then by looking at some of the potential consequences and criticism of some specific components of the bill and more broadly of the bill itself.
The TCJA is widely recognized as providing a massive boost for business. It cuts the corporate tax rate from 35% to 21%, and almost doubles the pass-through deduction, raising it to 20%. Pass-through corporations are businesses which taxable profits on to owners’ individual tax bills, rather than paying corporate tax. The deduction is intended to provide a boost to small businesses.
In addition to the bonuses for business, there are a variety of measures which will affect family and individual returns. First and foremost among the many changes is the adjustment of the income tax brackets. While the number of brackets stays the same at seven, the upper and lower thresholds for most brackets are cut; only the lowest bracket remains unchanged. The upper and lower bounds of the middle threshold, for example, both drop - the income needed to qualify for the middle bracket drops from $93,700 to $82,500, while the upper threshold drops from $195,450 to $157,500. The rate that taxpayers in the middle bracket must pay also drops by 4%.
The bill’s two measures which will provide a boost for working and middle class families are the expanded standard deduction and the child tax credit (CTC). The standard deduction was also almost doubled - the main reason why the majority of Americans will see a lower tax bill this year. The standard deduction - the biggest reason most Americans will see a tax cut this year - almost doubles, as does the CTC. The CTC's expansion, included in the bill thanks to a late push by Senators Mike Lee and Ricky Rubio, means some families will be able to deduct up to $2,000 per child. The new bill also makes the credit refundable, meaning some low-income families who don’t owe any federal income taxes will get a sizable rebate from the government.
Other major changes include a new $10,000 cap on the State and Local Tax deduction (SALT), a doubling of the threshold for the Estate Tax (meaning far fewer taxpayers will have to pay the tax on inheritance), and a repeal of the controversial individual mandate - the Obamacare feature which penalized citizens without health insurance - and of the personal exemption. These measures are all controversial, and have sparked the most opposition to the bill.
Most of these measures would seem to be universally popular - lowering rates for almost every bracket, doubling the standard deduction and CTC (two moves which should benefit working class households), and of course, massive tax cuts for businesses of all sizes, the effects of which will boost the economy and, sooner or later, employees’ paychecks. Nonetheless, the TCJA has attracted heavy criticism, and its passage was particularly acrimonious, even by today’s hyper-partisan standards. So what are some of the negative ramifications of these measures? Why did it attract so much criticism?
There are several reasons, ranging from general trends, like the affect it could have on the deficit, to more specific ones, like the fact that some democrats see the SALT cap as nothing more than partisan-point scoring since it disproportionately affects taxpayers in blue states. Even the expanded CTC has come in for criticism.
The SALT cap, which limits the amount of state and local taxes citizens are able to deduct to $10,000, hurts taxpayers in high-tax states. Coincidentally (or not), most of these states lean democratic. Some commentators even believe that the SALT cap was included specifically for that reason - an attack on parts of the country where the Administration and Congress enjoy some of their lowest approval ratings.
More pragmatically, many also worry that the cap (plus the reduction of housing-specific deductions like the mortgage interest credit deduction) could cause property values in high-tax cities to fall, which in turn would lead to a drop in revenue.
Another consequence of the TCJA is the expected drop in charitable donations. The SALT cap coupled with the expanded standard deduction should mean that a huge number of taxpayers will no longer itemize. This means that millions of Americans will no longer have a tax incentive to donate to charity. This will have a major impact on many nonprofits and charitable causes. Here in Massachusetts, for example, one group is expecting a drop of over $250 million in donations - a 4.6% decline from 2015 figures. Many high-tax states are already looking at possible changes to their tax codes to work around these issues.
One of the more publicized components of the bill is the repeal of the individual mandate. The measure, which imposed a tax penalty on those with no health insurance as part of the Affordable Care Act, was viewed by some as draconian overreach by the federal government, and by others as a necessary measure to keep the cost of insurance premiums under control.
Although this provision won’t have much of an impact on Massachusetts, which will revert to the similar penalties encoded in state law, independent watchdogs/budget groups warn that it might lead to negative consequences nationwide. The Congressional Budget Office, for example, predicts that it could lead to higher premiums and 13 million fewer insured Americans within a decade. The elimination of the ban, however, doesn’t come into effect into 2019, by which time some Republicans are planning to have passed additional legislation intended to offset some of these negative effects. Plus, any taxpayer who wants to take advantage of the new penalty-free world and give up their insurance plan will actually see there taxes increase, since he/she will no longer be collecting tax the Obamacare tax-credits that helped offset insurance costs, despite the penalty no longer being in place.
Child Tax Credit
Even the Child Tax Credit, lauded as one of the few TCJA concessions meant to help lower- and middle-income taxpayers, has attracted some criticism. Although the bill doubled the maximum tax credit from $1,000 to $2,000, the Tax Policy Center writes that some 29 million children will miss out on the maximum amount because their families earn or owe too little in wages and taxes. For example, a single mother with one child working full time at minimum wage would qualify for a $1,400 credit. “To be eligible for the full credit, she would need to earn at least $24,000 a year, about one and two-thirds times the minimum wage at full time.” In other words, it hurts (or at least doesn’t benefit fully) families who don’t bring in much more than the equivalent of full-time minimum wage. This is because these families largely benefit form the refundable chunk of the credit, which is capped at $1,400 (although without the final push from Senators Rubio and Lee the refunds would have been capped at $1,100).
Despite the fact that most Americans will see tax cuts because of the TCJA, there is still a sizeable minority who will not, and a great number of those Americans will actually see their taxes rise because of the bill. According to the left-leaning Institute on Taxation and Economic Policy, 7% of all taxpayers will face a tax hike in 2019. That figure jumps to 27% (including 29% for the bottom 40% of taxpayers, and 34% for the middle 20% of taxpayers) in 2027, although this is largely because much of the bill expires in less than a decade. Indeed, the only major component of the bill with permanence s the corporate tax cut. All of the individual and family measures expire after 2025, as does the pass-through deduction. The temporary nature of the majority of the bill has also been a target of criticism in and of itself.
Disproportionately Affects the Wealthy (and Foreign Investors):
Another of the TCJA’s common criticisms is that while most Americans will see smaller tax bills, the TCJA disproportionately benefits the wealthy. The richest 5% of Americans will get back much larger shares of their incomes than the bottom 95%, and more than half of the benefits of the bill will flow to the richest 5% of taxpayers in 2019, and more than a quarter will flow to the richest 1%. To put it another way: the tax cut that the average American in the middle 20% of income earners will be worth about $800. The tax cut for the average American in the top 1% of income earners works out to roughly $55,000.
In addition to the tax cut and readjustment of the brackets, many of the bill’s other measures affect the well-off more directly than the average American. For instance, many of the benefits of the massive corporate tax cuts will be conferred on executives and shareholders - who are mostly high-income earners. In addition, foreign investors own some 35% of American companies, meaning a large portion of these will be heading overseas. And despite being touted as a boon to small businesses, the pass through deduction will also benefit many larger corporations. 95% of American businesses qualify as pass-through companies, including hedge funds, law firms, and many other large corporations. Again according to ITEP, “most pass-through income flows to the richest 1% of Americans.
Bad for the Budget?
Finally, as with every tax cut, questions (and criticisms) remain about how the loss in revenue from the tax cuts will affect government spending and the deficit and national debt. The CBO and other bipartisan scorekeepers project that as it stands today the TCJA could add up to $1 trillion cumulatively to the deficit. As is usually the case, many worry that expanding the deficit could hamper economic growth, and force cuts in government spending. This could mean cuts to welfare programs, higher education, etc.
However, supporters of the bill point out that government revenue and spending doesn’t happen in a vacuum. The hope is that these trickle down economics and cuts to corporations’ tax bills will make up for the loss in revenue by boosting the (already strong) economy. The tax-cuts to the middle class and (especially) the wealthy will boost the demand for consumer goods, while at the same time the enormous corporate tax cuts will attract more companies to American shores, and spur American companies to add more jobs and capital.
Most estimates agree that these tax cuts will be beneficial for business and the economy, that workers eventually will benefit directly by seeing higher wages, and these measures collectively will make up for at least some of that lost revenue the government faces. As always the questions opponents of the bill will ask is how long will these outcomes take to happen, how much, and most importantly, is it worth the loss in revenues, and the cuts in spending.