By James Dail (CMC ’20)
Congressional Republicans have talked about overhauling the tax code for years, and it is now going to be the next item on their agenda since their healthcare push is winding down. They have partnered with two senior Trump administration officials, Director of the National Economic Council Gary Cohn and Treasury Secretary Steve Mnuchin, to release a framework proposal. While there is a chance that the plan will increase business investment in the U.S., it raises tax rates on the middle class and will cause a significant revenue shortfall if this is left unchanged.
The framework changes the tax code for middle-class and poor Americans in two significant ways. First, the number of tax brackets will decrease from eight to three, and they will be set at 12, 25, and 35%. The plan leaves room for a fourth tax bracket that would tax some of the highest earners at a rate higher than 35%. This bracket will be established by Congress at a later date should they choose to do so. Given the Republican penchant for cutting taxes, instituting a higher fourth rate seems unlikely. Second, the plan makes the current tax code significantly smaller by eliminating most tax deductions, including those for state and local taxes. While this would normally put a huge burden on taxpayers, it partially makes up for its impact by doubling the standard tax deduction, increasing it to $24,000 for couples and to $12,000 for individuals. Combined, these two measures are expected to increase federal revenue by $470 billion.
Even though they will be given a slight tax cut if the fourth rate is not passed, the plan affects wealthy Americans mainly through the abolishment of the estate and gift taxes. It is predicted that abolishing these two taxes will do little to increase growth in gross domestic product. Supply side economics holds that cutting taxes for the wealthy will stimulate GDP growth by allowing the wealthy to spend more of their money. The key distinction here is that while that may hold true for income taxes, the estate and gift taxes are essentially inheritance taxes that tax overall wealth. The money being taxed in this case would not be spent or used to generate any economic activity. It sits on itself waiting to be passed down from generation to generation. Repealing these two taxes results in a large amount of lost revenue for little growth in return, as the Congressional Budget Office estimates that repealing these taxes would add $270 billion to the deficit annually.
The part of the framework that looks most promising for economic growth is changes in how businesses are taxed. The corporate tax rate would be cut from the current rate of 35% to 20%. Currently, the U.S. has the highest corporate tax rate in the world, and cutting this tax rate will make the U.S. businesses more competitive globally. It would generate new business development here at home and would encourage foreign companies to relocate here. There is also a change in the tax rates for what are known as “pass-through companies,” which are usually sole proprietorships or partnerships. Because they tend to be smaller, they are taxed at the top individual rate, which if this plan is passed would be 35%. The framework proposes that they would be subject to a separate tax rate of 25%. The growth of small businesses in the U.S. has declined in recent years, and cutting the pass-through rate could reverse this trend by making it cheaper to start a business.
So, what’s the verdict? Admittedly, a precise analysis of the true impact of the rate changes is impossible because the administration has not yet released all of the specifics about the individual tax brackets or if the fourth rate will be instituted at all. However, the Tax Policy Center, a non-partisan think-tank, released an estimate for how much it will cost if there is no restructuring and current brackets are merged into the new ones. It estimated that the government will earn an extra $470 billion over the next decade from the public. It also found that the proposal will increase our deficit by $2.5 trillion over the next ten years, most of this comes from abolishing the estate and gift taxes and cutting corporate tax rates. This will make it very difficult for the U.S. to meet its financial obligations. Although it remains to be seen what portions of this framework are adopted when it turns into a bill.