While one of the longest economic recoveries in U.S. history is still taking place, the current economic expansion has been disappointingly dull.
Keynesians in the Obama administration claimed that 2% annual growth was the “new normal,” scaling back from the 3.3% average the U.S. had experienced post-World War II. Others, ourselves included, believed that growth was being held back by high taxes and excessive regulation.
With the passage of the new tax reform package, we’ll soon find out who’s right.
President Trump and his staff have been peeling away regulations, such as net neutrality, which saddled the Internet with utility regulations written in the 1930s. Within 10 days after taking office, President Trump issued an executive order requiring that two existing regulations be stripped away for every new regulation — and the order has “far exceeded its promise,” according to The Wall Street Journal.
An analysis by the Tax Foundation found that the Tax Cuts and Jobs Act will reduce marginal tax rates on labor and investment, increase gross domestic product (GDP) by 0.29% a year over the next decade (0.44% in 2018), boost wages 1.5% and result in an additional 339,000 full-time jobs.
Making America Competitive Again
The most important result of the new Tax Cuts and Jobs Act is that it will make America competitive again. In recent years, taxes have been a competitive disadvantage, as America’s corporate rate of 35% is the highest in the developed world. Tax reform will drop the corporate rate to 21%.
It will also make tax payment territorial, so that American businesses pay taxes on corporate profits only in the country in which they’re earned. The U.S. is the only country that taxes earnings a second time when they are returned home.
In recent years, this resulted in many companies moving their headquarters to other countries, while holding at least $2.5 trillion abroad. Companies will have an opportunity to repatriate foreign assets at a one-time rate of 15.5% for liquid assets and 8% for illiquid assets. This will not only add new tax revenues, it will bring home assets for reinvestment in the United States, which will result in business expansion and job creation.
Small businesses, America’s greatest job creators, will benefit from a new provision that will allow S-corporations, LLCs and partnerships to deduct 20% of their income. They will also be able to immediately write off the full cost of new equipment, which will also create an incentive for business growth.
Tax reform also eliminates many of the write-offs and deductions that favored certain businesses. For example, tax deductions for businesses purchasing tickets to sports events will be eliminated. Companies will also no longer be allowed to deduct any settlements, payouts or attorney’s fees related to sexual harassment if the payments are subject to non-disclosure agreements.
Changes in Individual Rates
Provisions affecting individual taxpayers may disappoint some, as changes in tax brackets will result in a tax increase for moderately wealthy taxpayers. Others will see their federal rate drop by up to 4%. A family of four earning the median income of $73,000 will enjoy a tax cut of $2,059, according to U.S. Congressman Paul Ryan.For single taxpayers, the lowest bracket remains unchanged at 10% for those earning up to $9,525, but it drops from 15% to 12% for those earning up to $38,700. Beyond that low level, both rates and brackets change.
Today, taxpayers earning $38,700 to $93,700 pay at a 25% rate, those earning $93,700 to $195,450 pay 28%, and those earning $195,450 to $424,950 pay 33%. Under the new law, those earning $38,700 to $82,500 will pay 22%, those earning $82,500 to $157,500 will pay 24% and those earning $157,500 to $200,000 will pay 32%.
Currently, a 35% rate applies only to those earning $424,950 to $426,700, while those earning more than $426,700 pay the top rate of 39.6%. Under the new law, the 35% bracket expands to cover earnings of $200,000 to $500,000, while the top rate — for those earning more than half a million a year — drops to 37%.
For married couples filing jointly, the 10% bracket continues to apply to up to $19,050 of income. The 15% rate drops to 12% and will apply to the same bracket — $19,050 to $77,400. The 25% rate, which applies to earnings of up to $156,150, will drop to 22% and apply to earnings of up to $165,000. Those earning $156,150 to $237,950 currently pay 28%, while those earning $237,950 to $424,950 pay 33%. Under the new law, those earning $165,000 to $315,000 will pay 24% and those earning $315,000 to $400,000 will pay 32%.
Currently, the 35% rate applies only to married couples earning $424,950 to $480,050, while those earning above that amount pay at a rate of 39.6%. Under the new law, the 35% rate will apply to income of $400,000 to $600,000 and a 37% rate will apply to income exceeding $600,000.
In addition, the tax credit for children will double from $1,000 to $2,000 and the standard deduction will increase from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples.
The law preserves the alternative minimum tax, but increases the exemption level from $55,400 to $70,300 for single taxpayers and from $86,200 to $109,400 for married couples filing jointly. It also raises the phase-out level from $123,000 to $500,000 for single taxpayers and from $164,100 to $1 million for married couples filing jointly.
Tax reform also doubles the estate tax threshold. A 40% tax will apply to estate valued above $11.2 million for individuals and $22.4 million for couples.
Conversely, the new law eliminates many itemized deductions, including interest deductions on home equity loans, but retains deductions for charitable giving, mortgages, and state and local taxes. The cap on the mortgage deduction will drop from $1 million to $750,000. Deductions for state and local income, sales, and property taxes will have a combined cap of $10,000.
In addition, the corporate tax changes are permanent, but the individual tax changes will expire after 2025, which was required to comply with U.S. Senate budget rules.
Removing the Individual Mandate
While Congress was unable to agree on an overhaul of the Affordable Care Act, the Tax Cuts and Jobs Act takes a major step in that direction by removing the individual mandate, which taxed Americans who failed to purchase health insurance.
As the ACA relies on healthy people who may not want to pay for health insurance purchasing it to avoid the penalty, removing the penalty will likely result in even higher premiums through the ACA. Given that premiums have been increasing dramatically under the ACA, some believe eliminating the mandate will accelerate the “death spiral” and result in the ACA being repealed.
With fewer people signing up for subsidized health insurance, the Congressional Budget Office estimates that taxpayers will save $338 billion over the next 10 years.
Eliminating the mandate will especially help low-income taxpayers. Taxpayers in the $25,000 to $50,000 income range are the group most likely to pay the tax, according to The New York Times.
Impact on Federal Debt
Even with the elimination of many deductions, tax reform will cost an estimated $1.5 trillion over the next 10 years.
However, much of that cost is expected to be covered by economic growth that is created by the plan. The Tax Foundation estimates that tax reform will generate an additional $1 trillion in federal revenues from economic growth, leaving a net cost of about $500 billion.
That’s an investment worth making if tax reform spurs economic growth as much as expected.