On Thursday, the House Republicans finally unveiled the details of their tax reform package. Taking on a tax code that is long and complex as ours means that the bill itself will also be long and complex. While nowhere near comprehensive, we hope that this will boil it down to the basics.
What is a tax code?
Okay, not that basic. But while we are here… the tax code should be utilized to collect enough revenue to fund the government. That’s not at all what it is. Instead, it is thousands of pages that cost billions to navigate and includes political preferences for how people and companies invest as well as special interest giveaways to the well connected. To learn more about the current state of the tax code and where all the giveaways are, check out the Tax Decoder report that Dr. Coburn released in 2014 that listed 165 tax preferences that cost $900 billion annually.
The tax code also does not collect enough revenue to fund all the government spending that Congress agrees to. Not even close. Thus, we have a $20 trillion debt that our children and grandchildren will be saddled with. That is the equivalent to a tax on the next generation.
What is in the reform proposal?
There are a ton of summaries and synopses available. Here are links to a few:
Did President Trump really want to call it the Cut, Cut, Cut Act?
Apparently so. But it wound up being titled the much more vanilla, “Tax Cuts and Jobs Act.”
What is the most important takeaway?
While it was not called the Cut, Cut, Cut Act, it could be called the Debt, Debt, Debt Act. We are at full employment and in peacetime. Yet we are running a $668 billion deficit that will be above $1 trillion in the next five years. We are already near all-time high debt levels. We are facing a retirement wave never seen before in American history that will strain and probably break our budget. The absolute last thing on Congress’s agenda should be a policy that adds $1.5 trillion to the debt.
But won’t economic growth make up for the costs?
That would be nice, but it’s doubtful.
So, the bill backtracks on a decade worth of Republican political promises about fiscal responsibility, but is there anything good about it?
Yes. Quite a bit. The current tax code is a complicated mess that is littered with special interest carve outs whose costs are borne by requiring others to pay higher rates. This bill does do a lot to fix that, mainly by broadening the base and lowering the rates.
What is the base, and why does it need to be broadened?
“Lower the rates and broaden the base” has been the mantra for tax reform for years. The phrase basically means that instead of taxing fewer things at higher rates, it taxes more things at lower rates. Instead of lobbyists, lawyers, and accountants skewing things, this relies on the principal that people or businesses that are similarly situated should be taxed similarly. It is a fairer way to collect taxes.
Will including more items in the tax base create political problems?
Absolutely. There has not been a major overhaul of the tax code in 31 years. That is 31 years worth of provisions won by special interest groups that have built up in the tax code that are now on the chopping block. These groups lean heavily on the tax provisions of the status quo and have an advantage based purely on their abilities to influence lawmakers.
For example, the housing industry is already up in arms about reducing the mortgage interest deduction from $1 million loans to $500,000 loans. They won’t advertise the fact that there are 160 federal programs and tax breaks administered by 20 federal agencies that support housing in the United States. The entire backbone of housing finance (Fannie Mae and Freddie Mac) was bailed out and is still backed by taxpayers. Yet, they are a powerful lobbying organization and will fight to protect and expand their tax provisions.
The housing industry hates it, anyone else?
Yes, many lobbyists will flood Capitol Hill to try to preserve their favorite tax provision.
Another provision that has been in the news a lot is the elimination of the state and local tax deduction – a provision that disproportionately benefits high-income earners in high tax states such as New York and California. The House bill eliminates the deduction, but does preserve a deduction for up to $10,000 for property taxes only to help appease some members from the most affected states.
The success or failure of comprehensive tax reform relies on a critical factor – will members look at the plan holistically, or will they be captured by parochial or special interests and concentrate on the elimination of loopholes rather than the broader rates being lowered?
Is cutting the corporate tax rate from 35 to 20 a partisan giveaway to big business?
Actually, lowering the corporate rate in exchange for eliminating loopholes was strongly pushed by the Obama administration as well – though not quite as low as 20 percent. The United States has the highest corporate tax rate in the developed world, but not many businesses actually pay that rate. They pay the best rate that their lobbyists, accountants, and lawyers can get them, including sometimes paying no taxes at all (on average they pay about 18 percent).
What in the world is repatriation?
Good question. The way our tax code treats overseas profits made by American corporations is incredibly dumb.
It taxes it at the 35 percent rate (again the highest in the world), but only when companies bring it back to the United States. This means that companies such as Apple that sell overseas choose to keep those profits overseas rather than being taxed at such an exorbitant high rate. Estimates are that trillions of dollars are trapped in foreign countries rather than being taxed and invested in the U.S. This part of the tax code incentivizes American companies to leave the United States to go to a jurisdiction that doesn’t have such a crazy tax system or makes them vulnerable to be acquired by a foreign competitor.
The bill does two things to address this. It levies a one-time tax on the overseas profits that have built up over time, which is called repatriation. It also changes the way that overseas profits are taxed moving forward to prevent this from happening again. These are both important provisions that will make our businesses much more competitive while also raising more revenue.
Will I still have to pay for professional sports stadiums?
The bill actually eliminates the federal subsidy for sports stadiums that provided $3.2 billion in support from Uncle Sam for new sports palaces. Beware, your local government may still try to charge you through local taxes.
Will I have to help pay for the DC Trump Hotel?
Yes, but the historic tax credit that the Trump Hotel in DC used to get a $40 million tax break will be eliminated, along with a list of other one-off tax provisions that skew investment decisions based on Congressional preferences.
What about me, will my taxes go down?
That depends, but most likely, yes. The bill lowers individual taxes by about $1 trillion over the next 10 years.
That is a factor of consolidating and lowering rates(except for people that make over $1 million in annual income), doubling the standard deduction (though eliminating the personal exemption), and increasing the value of credits for children and even non-children. The cumulative effect of all of these reforms will likely lower the tax bills for most Americans, though to what degree will depend on one’s circumstances. Also, there are high-income earners in high tax states that may see their tax bill go up. The House Republican conference plans to put up a calculator for people to find out how the plan impacts them.
Does the House bill use any gimmicks?
Yes, big time. Lowering tax rates is popular. Making up for the lost revenue of lower rates is not. The bill does eliminate a lot of tax provisions to help offset the costs of lower rates, including eliminating tax preferences for building sports stadiums and reducing the value of the mortgage interest deduction.
But, the bill uses several tricks to make the costs of the tax reform appear less expensive on paper than it will be in reality. This includes letting certain popular provisions expire (namely business expensing and child tax credits) so that they do not cost as much on paper, but in all likelihood Congress will extend them later on. This adds even more than to the burden of the next generation that will inherit the fiscal mess this generation of policymakers is leaving behind.
Is this bill going to pass?
President Trump wants to pass comprehensive tax reform by the end of this year. Senate Republicans will unveil their own plan soon, which will likely be similar to the House proposal.
Republicans believe their political fates ride on the success or failure of this bill, therefore there is a sense of urgency and momentum for this bill to pass – though maybe not in its current form. But, just like everyone witnessed during the health care debates, the problems will likely occur in the Senate – where its possible that Democrats could vote for it – but in all likelihood it will be Republicans only. That means that if three Republican Senators oppose it, the bill will tank.
Senators Flake and Corker have already indicated that they are worried about the budget impacts of the bill. Senators Collins and Rounds have stated that they do not support the estate tax repeal. Senators Rubio and Lee want a larger child tax credit. Plus, who knows who will go to bat for various special interest groups that will lose their favorite provision.
Tax reform as a concept is easy to sell. A detailed tax bill that effects every single person and business will be much more difficult.
The bottom line:
Our tax code is broken. Tax reform is absolutely necessary and can help spur economic growth. But, financing $1.5 trillion of this tax overhaul through the future earnings of the next generations is simply not fair. The plan should either completely pay for itself by eliminating more loopholes or Republicans should pair the bill with a plan to reduce spending so it does not add to the already enormous debt load that his being foisted on to the next generation.