On April 21, Donald Trump promised to release a tax reform plan the following week, as soon as Wednesday the 26th, though the White House later issued a statement saying the plan would come “as quickly as possible while still doing it right.” If passed, it would be the first major tax reform legislation since 1986.
Such wavering has been going on for weeks. On March 24, shortly after calling off a vote to repeal and replace Obamacare, Trump told reporters, “we will probably start going very, very strongly for the big tax cuts and tax reform. That will be next.”
Earlier on the day of the canceled healthcare vote, Treasury Secretary Steve Mnuchin gave an interview in which he said the administration aimed to pass comprehensive tax reform before Congress’s August recess – and failing that, “absolutely” by the fall. He avoided giving details about the plan’s specifics.
On Monday, April 17, however, Mnuchin backtracked. He told the Financial Times that the August target is “highly aggressive to not realistic at this point,” adding, “it is fair to say it is probably delayed a bit because of the healthcare.”
The preceding weekend saw over 100,000 demonstrators across the country demand that Trump release his tax returns, while Senate minority leader Chuck Schumer said that the president’s proposed tax cuts represent “his own self-interest.” White House press Sean Spicer on Monday repeated Trump’s line that he will not release his tax returns while they are under IRS audit, though the agency clarified last year, “nothing prevents individuals from sharing their own tax information.” In a tweet, Trump questioned the demonstrations, citing his election win:
I did what was an almost an impossible thing to do for a Republican-easily won the Electoral College! Now Tax Returns are brought up again?
— Donald J. Trump (@realDonaldTrump) April 16, 2017
Can Reform Be Done?
People on both sides of the political spectrum agree that the tax code should be simpler. Since 1986, 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 they were bothered “some” or “a lot” by the complexity of the tax system in 2015. 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 widespread perception that loopholes and inefficiencies in the tax system – the carried interest loophole and corporate inversions, for example – are to blame.
Congress is partly responsible for this state of affairs. According to the Economist, “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 points to a major sticking point for reform efforts: while the overall benefits would be enormous, they would be diffuse, with each household and firm saving some money and some time. For a few interest groups, however, 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. (INTU) and H&R Block Inc. (HRB) have lobbied 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 tax campaigner Grover Norquist’s pledge not to raise taxes. If Norquist decides that an aspect of a Republican proposal violates the pledge, for example by scrapping the state tax deduction or the mortgage interest deduction, it could be dead on arrival. Even if he does not weigh in, however, Republicans who fear a primary challenge could invoke the pledge to avoid supporting reform.
Norquist told Yahoo Finance in late March that the Republicans must repeal Obamacare before moving on to tax reform, since eliminating the taxes associated with the 2010 health law would give the federal government an additional $1 trillion in fiscal space. The concern that tax reform must not raise the deficit goes beyond politics and economics: according to the 1985 Byrd Rule, the reconciliation process can only be used to pass legislation that would not raise the deficit outside of a 10-year window. With 52 seats in the Senate, Republicans must use the reconciliation process or risk a Democratic filibuster.
Before they can worry about the prospect of a Democratic filibuster, however, Republicans must shore up support in their own party. Divisions are emerging between the Trump administration, which produced a proposal during the campaign, and Republicans in the House, who have their own. (See also, Investors May Have to Settle for “Tax Reform Lite.”)
Money is fueling the dispute. According to the New York Times, three groups funded by the Koch brothers – influential Republican donors who opposed the failed health bill – are running campaigns against the border adjustment tax laid out in the House GOP’s proposed tax reform. They argue that border adjustment would lead to higher prices for consumers. Big importers such as Target Corp. (TGT) and Wal-Mart Stores Inc. (WMT) are also lobbying against the measure. Norquist supports it; Trump, who prefers tariffs, is skeptical. He told Fox’s Maria Bartiromo on April 12, “When I hear border adjustment, adjustment means we lose. We lose.”
House Republicans, however, are not interested in abandoning their plan to suit the Trump administration’s needs. “We’re not discouraging other ideas,” Representative Kenny Marchant told Politico in March, but “they’re going to need to be prepared to do more than just, ‘I woke up last night, in the middle of the night, and thought this was a good deal.'” (See also, Cisco CEO on Trump’s Proposed Tax Reforms.)
Nor is the Trump administration itself fully unified on the issue: the populist faction led by Steve Bannon may push back against a proposal from the more centrist Mnuchin and his former colleague at Goldman Sachs Group Inc. (GS), Gary Cohn (to be fair, Bannon is also a Goldman alum).
Trump’s Tax Plan
In September 2015, Trump unveiled “tax reform that will make America great again.” The four-page document laid out steep cuts to personal and business income tax rates and promised that, by closing loopholes and pushing companies to repatriate foreign profits, the reform would be “fully paid for.”
Experts begged to differ. The conservative Tax Foundation estimated that the deficit would balloon by $11.98 trillion over 10 years. The more liberal Tax Policy Center came up with a similar estimate, adding that by 2036 the debt would have risen by $34.1 trillion, due to higher interest. As of March 28 the national debt stands at $19.9 trillion.
The Tax Foundation backed up Trump’s claim that the plan provided “tax relief for all Americans,” but forecast that some would be more relieved than others. The lowest-earning 10% of taxpayers would get a 1.4% break. The richest 1%, a 21.6% break. These disparities narrowed slightly after factoring in the plan’s expected macroeconomic effects. The Tax Policy Center also found the plan’s benefits to be top-heavy. (See also, Opinion: Will Donald Trump’s Tax Reforms Reform Anything?)
Given that 79% of respondents surveyed by Pew think the wealthy don’t pay their fair share in taxes (see above), these findings proved to be a liability. In an August 2016 speech in Detroit, Trump presented the outlines of a revised tax plan, which he fleshed out in a speech in New York the following month.
Individual Income Tax
Trump’s current plan would cut the top individual rate to 33%. It would eliminate the head of household filing status, the personal exemption, the net investment income tax and the alternative minimum tax. It would increase the standard deduction from $6,300 to $15,000 for single filers (the amounts are doubled for married couples).
|Trump’s 2016 plan|
|Income tax rate||Long-term capital gains, dividend rate||Single filers||Married filers|
|12%||0%||$0 to $37,500||$0 to $75,000|
|25%||15%||$37,501 to $112,500||$75,001 to $225,000|
It would cap itemized deductions – including state and local tax deductions – at $100,000 for single filers and $200,000 for married couples. Estate and gift taxes would be repealed, but step-up in basis would not be allowed for estates over $10 million. It would close the the carried interest loophole. (See also, An Overview of Itemized Deductions.)
The proposal includes a number of breaks designed to make childcare more affordable, including deductions, rebates, new tax-advantaged savings accounts offering 50% matching on contributions, and incentives to businesses to offer daycare services.
Corporate Income Tax
The top business rate would fall to 15% under Trump’s proposal. It would eliminate the corporate alternative minimum tax and a number of business credits (with the exception of one encouraging research and development), expand manufacturing firms’ options for the treatment of capital investment and repatriate profits at a one-time 10% rate. (See also, What If You Were Taxed Like a Multinational?)
Government Revenue and Macroeconomic Forecasts
The estimated hit to national coffers, according to the Tax Foundation, fell to $4.4 trillion-$5.9 trillion in Trump’s new plan, from a revised estimate of $12.3 trillion for his original plan. The range of potential impacts on government revenue is so wide due to ambiguity in the proposal: pass-through income – business earnings that are taxed as personal income – could be taxed at the 15% business rate, the 33% personal rate, or somewhere in between. The Tax Policy Center believes that the rate would be 15%, except for income from “large” pass-through businesses, which would be taxed as dividends.
The Tax Foundation expects Trump’s plan to have positive macroeconomic effects: a 6.9% boost to 2016-2025 gross domestic product (GDP) growth (assuming the higher pass-through rate) or 8.2% (assuming the lower one), over and above the 19.2% real growth forecast by the Congressional Budget Office. The think tank forecasts that capital stock would rise by 20.1% to 20.3%, wages by 5.4% to 6.3%, and full-time jobs by 5.3 million. These effects would offset the hit to government revenues, bringing it to $2.6-$3.9 trillion.
|Forecasts under Trump’s 2015 and 2016 plans, 2016-2025|
|Real GDP||11.5%*||6.9% to 8.2%†|
|Capital investment||29.0%||20.1% to 23.9%|
|Wages||6.5%||5.4% to 6.3%|
|Full-time equivalent jobs (thousands)||5,329||1,807 to 2,155|
|Government revenues (trillions)||-$12.3 (static, revised)||-$4.4 to -$5.9 (static)|
|-$2.6 to $3.9 (dynamic)|
|Source: Tax Foundation; *”long term” boost to growth; †in addition to 19.2% 2016-2025 growth forecast by CBO|
The Tax Policy Center, on the other hand, cautions that the Trump plan would push up the national debt by an estimated $20.7 trillion by 2036 – more than doubling the total, in other words. The resulting rise in interest rates would crowd out private investment and offset “some or all of the plan’s positive effects.” Despite an initial boost to the economy, the eventual effect would be lower GDP, capital stock, wages and labor supply compared to forecasts under current law.
By the Tax Foundation’s reckoning, Trump’s revised plan would not benefit the wealthy quite as lavishly as his first proposal would have: on a static basis – ignoring estimated macroeconomic effects – the highest-earning 1% would gain 12.0% to 16.0%, while the lowest-earning 20% would gain 1.2%.
Incorporating estimates of the plan’s macroeconomic effects, Trump’s 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%.
Middle Class Tax Hike?
The Tax Policy Center’s analysis tells a slightly different story. The think tank also estimated the plan’s effects on each income quintile’s after-tax incomes, and the results were broadly in line with the Tax Foundation’s. A more granular look at the proposal shows that some middle-class filers would see a tax hike, however: 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 plan.
|Tax Policy Center: 2016 tax rates under current law and Trump proposal|
|Single filers||Childless married couples filing jointly|
|Adjusted gross income (up to)||Current marginal rate||Trump marginal rate||Adjusted gross income (up to)||Current marginal rate||Trump marginal rate|
|Over $425,400||39.6%||33%||Over $487,650||39.6%||33%|
|Note: only applies to filers who take the standard deduction; bold typeface denotes a tax hike under Trump’s plan|
These groups would not be the only ones to pay more. According to Lily Batchelder, a former deputy director of Obama’s National Economic Council, 8.7 million households with children would experience a tax hike under Trump’s plan. Most (5.8 million) would be led by single parents, and most single-parent households (51%) would end up paying more, as would 21% of all households with children.
Batchelder gave the example of a single parent with $75,000 in income and two children. Currently they could file as a head of household – receiving a $9,300 deduction – and claim three personal exemptions of $4,050 each to reduce their taxable income to $53,550. Under Trump’s plan their filing status would be single. The standard deduction would be much higher at $15,000, but the inability to claim personal exemptions would result in a taxable income of $60,000. The tax bill would ultimately rise by $2,440.
Effects on Incentives
The Tax Policy Center expects that Trump’s plan would “boost incentives to work, save and invest if interest rates do not change.” The result could be rising labor productivity and wages. Changes to corporate taxes, meanwhile, would reduce marginal effective tax rates on new investment, making equity financing more attractive compared to debt financing. Individual tax cuts and newly introduced childcare benefits would increase incentives for second earners to work; they often face high marginal tax rates on their income under the current system.
Due to the reform’s effect on the deficit, however, the Tax Policy Center projects that rising interest rates would cancel out these benefits.
The think tank adds that the repeal of the estate tax would reduce incentives to donate to charity. It would raise incentives for high earners to reclassify themselves as pass-through entities providing services to their employers, allowing them to take advantage of the gap between the 15% corporate rate and the 33% personal rate. Half of high-wage workers would exploit this loophole, the outfit estimates. (See also, Tips on Charitable Contributions: Limits and Taxes.)
Trump announced his candidacy in June 2015 with a promise to slap tariffs on the cars Ford Motor Co. (F) produces in Mexico: “Every car and every truck and every part manufactured in this plant that comes across the border, we’re going to charge you a 35% tax, and that tax is going to be paid simultaneously with the transaction, and that’s it.” He has also promised 45% tariffs on Chinese imports.
Trump’s tax plans have not explicitly included such tariffs. In April he discussed the idea of matching tariffs, telling Fox’s Maria Bartiromo, “You can call it a reciprocal or a matching tax or a mirror tax. There are numerous terms.” He added, “nobody gets angry when you say reciprocal tax. When you say we’re going to charge a border tax – we’d be a rich nation if we did it, by the way … but when you say reciprocal, nobody fights you.”
Since these taxes would vary depending on the trading partner, they would probably be a matter of trade policy, rather than appearing in a tax reform bill.
The House GOP’s Plan
On June 24, 2016, Speaker of the House Paul Ryan and House Ways and Means Committee chair Kevin Brady, both Republicans, released a tax plan that differs from Trump’s plan in a number of key ways.
Individual Income Tax
The House Republican plan would collapse the current seven individual income tax brackets into three, cutting the top marginal rate to 33% from 39.6%. It would not eliminate the head of household filing status, as Trump’s current plan would. The House plan would tax dividends, long-term capital gains and interest as ordinary income and exclude the first 50% of such income from tax. It would also repeal the 3.8% net investment income tax, yielding a top effective rate of 16.5% on dividends; the current rate, including the surtax, is 23.8%.
|House GOP Plan|
|Income tax rate||Long-term capital gains, dividend rate||Single filers||Married filers||Heads of household|
|12%||6%||$0 to $37,650||$0 to $75,300||$0 to $37,500|
|25%||12.5%||$37,651 to $190,150||$75,301 to 231,450||$37,501 to $75,000|
|33%||16.5%||$190,151+||$231,451+||$75,001 to $225,000|
The plan would raise the standard deduction from $6,300 to $12,000 for singles; it would be $24,000 for married couples and $18,000 for heads of household. The plan would eliminate all itemized deductions except for the mortgage interest deduction and the charitable giving deduction. That would include the state and local tax deduction, which mostly benefits residents of blue states: New Yorkers reduced their tax bills by 9.1% of adjusted gross income in 2014 using the deduction, according to the Tax Foundation, while Californians received a 7.9% break.
The plan would increase the child tax credit to $1,500 per child, $1,000 of which would be refundable. The credit would begin to phase out at $150,000 rather than $110,000. It would scrap the personal exemption and replace it with a $500 non-refundable credit for dependents who are not children.
The proposal would also eliminate the alternative minimum tax, the estate tax, the generation-skipping transfer tax and the gift tax.
Corporate Income Tax
The House Republican plan would cut the top corporate tax rate to 20% from the current 35% (Trump proposes a cut to 15%). The top rate for pass-through businesses would be 25%.
The plan includes a number of changes that would fundamentally change the corporate tax system. First, businesses would be allowed to immediately deduct the full cost of capital investments, rather than depreciating them over the life of the investments. Land and inventories would be excluded from this change. Second, net interest expense would no longer be deductible. (See also, What is the tax impact of calculating depreciation?)
Third, the plan would introduce a destination-based cash-flow tax (DBCFT), the most notable feature of which would be border adjustment: companies would pay taxes on imports and domestic sales but not on exports. Since only sales to U.S. consumers would be taxed, the system is also referred to as a consumption tax. The current system focuses on production, which encourages companies to shift profits – and occasionally their headquarters – to overseas subsidiaries in lower-tax jurisdictions. (See also, Manufacturing Giants Back US Tax Reforms.)
According to one interpretation, the DBCFT is a value-added tax (VAT) of the kind most countries already have. It would replace the corporate income tax, making the U.S. the only advanced economy not to have one. On the other hand, wages would be deducted, meaning that the World Trade Organization (WTO) might consider the proposal an income tax. The WTO permits border adjustment on VATs, and most countries include it, but prohibits it on income taxes. (See also, IMF, WTO and World Bank: How Do They Differ?)
VATs were until recently anathema Republican purists. Norquist called them “an extremely efficient money machine for big government,” arguing that since they were mostly hidden from view, they could be hiked relatively easily. Heading into the 2016 elections, however, two Republican senators – Kentucky’s Rand Paul and Texas’ Ted Cruz – proposed VATs; fearing ideological challenges, they labeled them a “business activity tax” and a “business flat tax,” respectively.
The proposal would require repatriation of U.S. companies’ foreign profits at a rate of 8.75% for cash profits and 3.5% for other profits. It would restrict deductions for net operating losses to 90% of net taxable income; it would allow these losses to be carried forward indefinitely, instead of the current 20 years, and adjusted for inflation. It would not allow them to be carried back, as they currently can for two years. The plan would scrap the corporate alternative minimum tax and all section 199 deductions with the exception of the research and development credit.
Government Revenue and Macroeconomic Forecasts
The Tax Foundation forecasts that the GOP plan would reduce federal government revenues by $2.4 trillion over the course of a decade, but factoring in the macroeconomic effects it expects the proposal to have, it forecasts a more modest reduction of $191 billion. The think tank bases that assessment on estimates that the House GOP plan would boost GDP by 9.1% over the long run, as well as growing wages, capital stock and the pool of full-time equivalent jobs.
|Forecasts under House GOP’s plan, “long run”|
|Full-time equivalent jobs||1,687,000|
|Government revenues*||-$2.4 trillion (static)|
|-$191 billion (dynamic)|
|Source: Tax Foundation; *next decade|
The Tax Policy Center is less optimistic. On a static basis, it expects a $3.1 trillion fall in federal revenues over the next decade under the House GOP’s plan. After factoring in macroeconomic effects, it expects a reduction of $2.5 trillion to $3.0 trillion. As with Trump’s plan, it expects an initial boost to GDP, wages, capital stock and labor supply. As the rising federal deficit drives up interest rates, however, it expects these benefits to fade; wages, growth and investment would eventually begin to lag behind forecasts under current law.
As with Trump’s proposal, the wealthiest would enjoy the largest tax cuts under the House GOP plan. According to the Tax Foundation, the bottom 20% of earners would see a 0.3% boost in after-tax earnings, while the top 1% would emerge with an extra 5.3%. Factoring in expected macroeconomic effects, the think tank sees after-tax incomes rising 8.4% for the bottom quintile and 13.0% for the top 1%.
The Tax Policy Center comes to similar conclusions: The lowest-earning 20% would enjoy a $100 tax cut or a rise of 0.5% in after-tax income. The highest-earning 1% would receive a $239,720 break, for a 10.6% rise in after-tax income. This segment of the population would receive a 99.6% share of the overall tax cut. The top 0.1% would get a 13.5% boost to after-tax income, paying $1.4 million less in tax. They would account for over 60% of the tax cut. (See also, How Tax Cuts Stimulate the Economy.)
Effects on Incentives
The Tax Policy Center expects the House GOP plans’ incentives to be largely in line with those of the Trump plan. It would lower marginal effective tax rates, encouraging new investment. It would make equity financing more attractive than debt financing. It would drive up wages and encourage more workers to enter the labor force. These benefits would be temporary, however: rising deficits would drive up interest rates, offsetting the tax reform’s benefits.
Unlike the Trump plan, which would scrap the deduction for charitable donations, the GOP plan would not reduce the incentive to donate money to nonprofits.
The House GOP plan would reduce the incentive for U.S. multinationals to shift their profits abroad in order to avoid U.S. taxes. Corporate inversions, an extreme version of this tax avoidance method, would lose their appeal. (See also, Corporate Inversion: How It Works.)
While the border adjustment provision would appear to favor exporters over importers, most economists tend to think that currency exchange rates would adjust to cancel out these effects.
Take the Tax Foundation’s example: a business imports goods to sell in the U.S. It takes in $100 in revenue from domestic sales and spends $60 on imports, making its taxable income under the current system $40. It pays a 20% rate, or $8, for $32 in after-tax income. Under the GOP proposal that business would no longer be able to deduct the $60 cost of its imports, so its taxable income would be $100, leaving with $20 in after-tax income. If reality cooperates, however, market forces will correct this imbalance: the prices of imported goods will rise, reducing demand for them, making dollars more scarce and therefore more valuable abroad and driving the value of dollar up by somewhere around 20%. The hypothetical business’ costs of goods sold will accordingly drop to $48, leaving it with the same $32 in after-tax income it started with.
Effects on firms that import goods to sell domestically
|Current law||After border adjustment||After 20% rise in USD|
|Cost of goods sold||$60||$60||$48|
|Adapted from the Tax Foundation|
An exporter would experience the same shifts in mirror image. Under the current system, $100 in sales abroad and $60 in domestic production costs yields a taxable income of $40 and an after-tax income of $32. Under the GOP proposal its taxable profits would be -$60, so the Treasury would write it a $12 check for an after-tax income of $52. If the dollar appreciates, however, its revenues would drop to $80, leaving its bottom line unchanged at $32.
Effects on firms that produce goods domestically for exports
|Current law||After border adjustment||After 20% rise in USD|
|Cost of goods sold||$60||$60||$60|
|Adapted from the Tax Foundation|
The Tax Foundation points out that these exchange rate adjustments could be expected to take place fairly quickly, but affected companies’ lobbying efforts indicate that not everyone is convinced by the economists’ neat theorizing.