Tax Less. Grow More. Bigly.
By Justin York
“Taxes” – the only four letter word in the English language with five letters. Taxes are a bounty to tax-preparers and a bane to sane individuals. Still, talk of taxes and the accompanying word salad of credits, deductions, and exemptions is in the holiday air.
On November 16, 2017, the U.S. House of Representatives passed The Tax Cuts and Jobs Act of 2017. The U.S. Senate Finance Committee passed companion legislation on the same day. The bills differ on details but both would dramatically lower taxes for individuals and businesses as well as make technical changes to the Internal Revenue Code. Since then, a hailstorm of media reporting, think-tank analyses and Congressional jostling has ensued. The rush to cameras to laud or condemn the bill would intimidate the heartiest of Black Friday shoppers.
A chief objection has been that the GOP tax reform proposals would increase deficits and debt. Keep this in mind. This package is fundamentally an economic growth package: not a straight, deficit-reduction package (like, for example, the 2010 Bowles-Simpson proposal).
America is in dire need of sustained and robust economic growth. Historic crises from the 2007-08 financial crisis, the ongoing Eurozone crisis, persistent Middle East turmoil and as well as general uncertainty about federal tax and spending policy have been major causes of economic mediocrity. Add a federal regulatory onslaught (20,642 new regulations since 2009 according to one study) and you have a recipe for 1% to 2% economic growth from 2009 to 2016. Crises come and go and can be managed. Regulations can be reexamined or repealed. However, tax reform is key to kick starting economic growth into the 3% and 4% range. Tax cuts have been a bipartisan policy to jumpstart economic growth supported in the past by Democrat John F. Kennedy and, of course, Republican Ronald Reagan.
Reagan famously enacted major tax cuts into law in 1981 and tax reform in 1986. The consequence was real economic growth averaging 3.2% in the Reagan years versus 2.8% during the Ford-Carter years. Real annual GDP growth under Reagan clocked in at 3.5%, the best since 1969 except for Bill Clinton at 3.8% who presided over the tech boom of the 1990’s. Clearly, tax reform has and can ignite the kind of economic growth America needs.
As mentioned above, both the House and Senate have put forward thoughtful plans to cut taxes. As an aside, when I worked in the Florida House Majority Office, it was common to (semi-humorously) characterize the Florida Senate as where “good conservative legislation went to die.” As we saw with the failed Obamacare repeal effort that could certainly be said of the U.S. Senate in 2017. In any event, the Senate proposal is likely to be more modest, particularly to shoehorn it through the Senate’s convoluted reconciliation procedure.
The House proposal collapses individual marginal tax rates from seven to four—12, 25, 35, and 39.6 percent—while increasing the income ranges affected by each rate. In other words, taxable income for the 2016 median household income, $57,617, would fall from a 15% to 12% marginal rate. In fact, the Act reduces marginal tax rates for Americans at every income level. By contrast, the current Senate proposal maintains seven marginal rates but lowers the top marginal rate from 39.6% to 38.5%. The House individual tax cuts would be permanent while the Senate cuts would be temporary or “sunset” beginning in 2025.
You may recall the Bush tax cuts of 2001 and 2003 had a similar sunset provision. President Barack Obama later extended those tax cuts in 2010 and again in 2012 except for top-earners, which is where the rates remain today. The prospective sunsetting of the individual rates has resulted in the misleading claim that middle-class Americans will be nailed with a tax hike in 2027. It is not a given that this will occur given prior extensions of individual income tax cuts by a Democratic president originally enacted by a Republican president. Moreover, it is understood by objective policy analysts that this kabuki accounting maneuver is merely another effort to comply with the Senate’s reconciliation procedures.
The bill also nearly doubles the standard deduction from $6,350 to $12,000 for individuals and $12,700 to $24,000 for married couples (most taxpayers elect to take the standard deduction—a fixed dollar amount one can subtract from gross income effectively lessening their income subject to taxation—versus itemizing their deductions). As a result, more Americans in the lowest tax bracket of 12% for individuals earning up to $45,000 and married couples earning up to $90,000 will pay zero income tax. The Act also establishes a new Family Credit, which includes expanding the Child Tax Credit “from $1,000 to $1,600 to help parents with the cost of raising children as well as providing a credit of $300 for each parent and non-child dependent to help all families with their everyday expenses.”
The Senate proposal would also roughly double the standard deduction and expand the child tax credit.
The House plan does eliminate the personal exemption (a deduction taken by individuals to further lessen their taxable income). However, the idea is that a combination of lowering rates and increasing deductions and credits will compensate for the loss. The same is true with the Senate proposal.
The mortgage interest deduction remains under the House plan but is less generous to high-cost homeowners. Currently, the deduction applies to interest on the first $1 million of debt used to purchase or build the home. Under the House plan, the deduction only applies to interest on the first $500,000 of debt. By contrast, the Senate plan keeps the deduction as is.
Hair and toupees have been lit on fire in the Acela Corridor regarding the House plan’s elimination of the SALT deduction—the deduction of state and local taxes. Individuals in high-tax states like New York, Illinois and California often take this deduction. It helps deduct state and local income taxes as well as property taxes. The House plan caps the maximum property tax deduction at $10,000 and ends the deduction for state and income taxes entirely. The Senate proposal goes even further and eliminates the SALT deduction for property taxes as well.
There is a genuine policy debate about the fairness of this deduction. Proponents will claim it helps finance state budgets and offers tax relief to taxpayers residing in high-tax states. Opponents claim the deduction is an unfair boon to high-tax, typically Democratic-controlled, states and allows these states to “export a portion of their tax burden to the rest of the nation.” Both argue over whether the deduction benefits the affluent or the middle class. However, Politifact agreed, contrary to Nancy Pelosi’s recent claim, “[SALT] is a tax deduction that disproportionately benefits higher-income taxpayers.” The left-leaning Urban Institute & Brookings Institution also found the share of people claiming the SALT deduction rises with income. Either way, eliminating the state and local income tax deduction may prompt a tax and spending reformation in these high-tax states and result in lower state and local tax rates for these taxpayers.
A major ingredient in this package for growth are tax cuts for businesses. Pass-through entities encompass various kinds of businesses—sole proprietorships, partnerships, limited liability companies, and S corporations. These are businesses whose income is treated as income for owners or investors rather than income of the business itself. Currently, these businesses face marginal tax rates exceeding 50% in some states even though they account for a large share of the private sector workforce. Under the House proposal, pass-through income will be taxed at maximum of 25% in addition to other tax relief. Under the current Senate proposal, the rate would be lowered by letting these entities deduct 17.4% of their income and allowing a 17.4% deduction for anyone in a service business with some exceptions. Because pass-through structuring is common for small to medium size businesses, a rate reduction will be a boon to Main Street.
The consensus to reduce America’s corporate tax rate has been bipartisan going back to 2004 when then-Democratic presidential candidate John Kerry endorsed reducing the rate. The corporate tax rate is currently 35%—the highest marginal rate in the industrialized world. This clearly encourages corporations to domicile outside America. Further, high corporate tax rates reduce the amount of company’s profit available for new investments and hiring.
Under the House proposal, America’s corporate tax rate will be slashed to 20%, the largest reduction in the U.S. corporate tax rate in history. This will dramatically increase America’s international competitiveness. Research has found that cutting corporate tax rates does spur investment, which in the United States has been remarkably low in recent years. The Senate proposal phases in a reduction to 20% to take effect in 2019 to make it “less expensive” and satisfy its reconciliation procedures.
The corporate taxing system is also being transformed. Currently, America uses a “worldwide” tax system for corporate profits. American multinational corporations must pay taxes on profits made overseas. Under the House and Senate proposal, America would transition to a new “territorial” tax system that taxes businesses only on income earned within the borders of the United States. Most nations operate under a territorial system, which puts American companies operating in foreign markets at a competitive disadvantage. By changing to a territorial system, American companies will pay taxes where the profits are generated and return the income to the U.S. without additional U.S. taxation. The House has also put in place a 10% tax on a portion of a foreign subsidiaries’ income if the subsidiaries book profits in excess of a certain threshold. This is designed to insure that this otherwise beneficial change does not set off a wave of profit shifting to overseas tax havens.
The goal of corporate tax reform is not merely to “line the profits of corporations”—it is to keep businesses in the United States, promote foreign investment in American markets, and ultimately increase take-home pay for all Americans.
For those concerned about “using the national credit card” to pay for a business tax cuts, remember, the 2010 Bowles-Simpson plan—which was designed to reduce deficits and debt—agreed that “a territorial tax system should be adopted to help put the U.S. system in line with other countries, leveling the playing field.” The plan also calls for lowering the corporate tax rate. Albeit, the plan to lower the corporate tax rate to 20% is more aggressive than Bowles-Simpson has recommended 23% to 29% rate. Nevertheless, the point is that even deficit-hawks recognize that lowering the rate can promote economic growth and in turn grow federal revenues. This makes it even clearer that these rates must be made permanent to promote certainty and in turn further business investment and hiring.
Segueing into the issue of deficit and debt addressed at the beginning, there is no question that deficits and debt are too high. The federal deficit in 2016 was $587 billion. Our national debt is over $20.5 trillion. A range of estimates pegs the cost of these tax proposals from $1.5 trillion to $1.7 trillion over 10 years on top of $10 trillion in deficits projected to be incurred in the same period.
However, deficits and debt are not exclusively a revenue problem—they are a spending problem, mainly entitlement spending on Social Security, Medicare, Medicaid, CHIP and marketplace subsidies as currently structured. In 2016, we spent $916 billion (or 24% of the federal budget) on Social Security and $1 trillion for Medicare/Medicaid/CHIP/ACA subsidies (or 26% of the budget). Spending on these programs, particularly health spending, is expected to balloon dramatically over the next 30 years.
Making entitlements sustainable will be critical to securing the future of these programs, and it will be an important part of a future deficit and debt reduction package. However, we should not let the separate need to reform entitlements prevent us from enacting tax measures to jumpstart the economic growth we need today.
Finally, a brief word about the Senate proposal. Unlike the House proposal, the Senate proposal includes a little unfinished business: a repeal of the ACA’s individual mandate. I can remember in college when a Democratic-controlled U.S. Senate passed the ACA on Christmas Eve 2009. That legislation included the despised individual mandate and ultimately became law in 2010. Later, the ACA was given constitutional “cover” by Chief Justice John Roberts when Roberts characterized the mandate as a tax saving it from being struck down.
I think it would be phenomenal symmetry if Congress could pass a tax reform bill this holiday season putting an end to the mandate eight long years later and delivering a welcome Christmas present to the American people. Don’t you?
Justin K. York is an attorney with Linebarger, Goggan, Blair & Sampson in Orlando. He is also a longtime Seminole County resident and conservative Republican activist. He has chaired the UCF College Republicans and the Florida Federation of College Republicans. He also headed the student and youth coalitions in Florida for both the John McCain and Mitt Romney presidential campaigns. He formerly served as Secretary and Treasurer of the Seminole County Republican Party from 2012 to 2016. He has been a member of the Lake Mary Planning and Zoning Board since 2014. In 2014, Justin was elected without opposition to the Seminole County Soil and Water Conservation District as a District Supervisor.