The Federal Income Tax Overhaul in the Twenty First Century From Reform to Redistribution
On December 22, 2017, President Donald Trump signed into law, The Tax Cuts and Jobs Act of 2017(Public Law no.115-97).
The Act, according to news sources, is hailed as the “biggest rewrite of the individual and corporate tax in 30 years”, affecting the pocketbooks of most Americans (Fisher-Baum, Kim Soffen and Heather Long (the Washington Post, Business. Analyses. 12/4/2017).
Before providing an analysis of the new tax act, it is instructive to point out that during the period 1932 to 2017, over 20 revenue acts were enacted for the purpose, in addition to raising the income of the federal government, of achieving a modicum of fairness and—equity in the distribution of the tax burden, and, stimulating the growth potential of the economy. Of interest is to view the progress of the development over time of the individual income tax schedule and the corporation income tax beginning in the 1930’s when the Revenue Act of 1932 raised the individual income tax rates from 1 ½ %- 3% to 4%-8%; the corporation income tax rate from 12%, to 13 ¾%. Under the new act, enacted in 2017 the rates for the individual income tax are in the range of 10% -39.6%; for single households, and, from 10% to 37% for married couples’ households. The corporate sector’s rate is reduced to 22% from the current 35%
The “declared” intent that underlie the frequent change in the tax code; the individual income tax’s base and rates, including the legislated changes under current law, was said to be, for the purpose of achieving “fairness” in the distribution of the income tax burden, “simplifying” the tax code and “promoting” economic growth. Hence:
“A new tax law for individuals and corporation greeted America in the New Year of 2018”.
On November 2, 2017, President Trump applauded the House Ways and Means Committee for introducing the Tax Cuts and Jobs Act of 2017, describing it as an important step toward providing massive tax relief for the American People. As the president describes it: “My tax reform priorities have been the same since day one: bringing tax cuts for hardworking, middle-income Americans; eliminating unfair loopholes and deductions; and slashing business taxes so employers can create jobs, raise wages, and dominate their competition around the world”(The White House Press office). On December 22, 2017, President Trump signed into law his tax plan for the United States of America; the Tax Cuts and Jobs Act of 2017.
Before addressing what the new Act entails, in particular, its redistributive features, it is instructive to briefly point out that in revisiting the tax legislative history of the US in the 20th century, one discovers that over eighty five years (between 1932- 2017), there were more than 20 so called reform acts to “reform” the federal income tax system.
1. The Federal Income Tax: A look at the Legislative History: 1932-2018
Inspection of the tax acts enacted over the period 1932- 2017, reveals the “fundamentals” of tax reform pursued buy successive presidents: enhancement of the revenue raising capability of the federal income tax, through successive increases in the tax rates on both the individual and corporate incomes, and secondly, a restructuring of the tax structure through a shift in the distribution of the tax burden away from the household sector to the corporate sector. In few instances the shift was the other way around.
The latest version of the tax law changes (the Tax Cuts and Jobs Act of 2017), may be viewed as a noticeable departure from earlier tax reform legislations. The Act (as will be shown below) tend to favor the corporate sector over the households sector, through its most dramatic cut of the tax on corporate income, and secondly, for setting no time limits on the favorable treatment of corporate income, while imposing a time limit on tax changes benefitting (according to the declared statement of the President) US household. An expiration date for the “favorable” changes introduced for the tax treatment of individuals is scheduled to take place in the year 2027. No such expiration date was set for changes in the tax treatment of corporate income. Below is a summary of provisions affecting both individuals and corporations under the new Act.
2. The Tax Cuts and Jobs Act: Plan Elements
The Act introduces several new elements affecting the tax treatments of the household sector or individuals, as well as, the corporate sector. I begin with major provisions affecting the tax treatment of the household sector.
2.1 The Individual Income Tax: Major Provisions
The Tax Cuts and Jobs Act of 2017, calls for several changes affecting households’ after-tax income as well as the distribution of the tax “burden” across income classes. Because the tax born by the individual or the household depends on income and circumstances, the first step in assessing the impact of the new provisions is to view the changes introduced by the Act of 2017.
Given that the tax revenue collected under a progressive tax structure depends on the definition of the width of the base at a given level of income as well the rate structure, taxes due under the new act will depend on the legislative changes introduced to the tax base as well as to the tax rates applicable to the base. Below, I provide bird’s eye view of the income tax structure under the new act.
- Tax rates and brackets width for the household Sector
The Tax Cuts and Jobs Act, maintains the number of tax brackets at 7 brackets, although the income ranges have been changed. To gauge the width of the bracket with the inflation rate, the Act will apply a chained index (CPI or C-CPI) instead of the consumer price index which is currently used. This effectively is a tax increase over time, as households move more quickly into higher brackets as income rises over time. This change is effective until 2027.
In Table 2 below, tax rates (in %) by income bracket (in $), and by marital Status under present law and the Tax Cuts and Jobs Act is given, for single households and for married households by income class.
- Major provisions affecting the Tax Base: Deductions
The Act, besides changing the rate schedule, contains other provisions affecting the structure of the income tax and hence the distribution of tax burden. Major changes in the tax law introduced by the Act are listed below:
(1) Personal Exemption:
Personal Exemption is eliminated. This is equivalent to an increase of the tax base for the individual (single person) equals to $4,150.
The tax law contains provisions affecting both types of deductions currently used by US households; the standard deduction and the itemized deductions.
(2.1) The standard deduction:
Under the new act, for single person households, the standard deduction is scheduled to increase from $6,350 to $12,000. For married couples the standard deduction nearly doubles, from $ 12,700 to 24,000. In addition, the child tax credit is raised from $1,000 to $2,000. A $500 tax credit is allowed for other dependents.
(2.2) Itemized Deductions:
Several provisions are legislated which either eliminate or reduce the allowable itemized deductions. These are:
- A limit of $10,000 is set for deductions for the sum of state and local income taxes, sales taxes and property taxes.
- Mortgage interest deductions for newly purchased homes (and second homes) would be allowed but reduced from $1 million to $750,000.
- Interest on home equity loans (aka second mortgages) will no longer be deductible.
- Casualty loss deduction is eliminated. The exception being a loss connected with a disaster declared by the president.
- Alimony paid to an ex-spouse deduction, is eliminated as a deduction by the payer; it will not be included as income for the recipient. This provision is applicable for agreements signed after December 2018.
- Moving expenses related to employment will no longer be deductible.
- Expenses related to tax preparing and filing are eliminated as deductions.
- For returns using the “alternative minimum tax”, the exemption level is increased from $84,000 -$109,400 for married couples and from $54,000 to $70,000 for single households.
Other provisions altering the structure of the individual income tax is contained in the Tax Cuts and Jobs Act affecting corporations, education institutions as well as farmers.
2. 2 The Corporate Sector
The Tax Cuts and Jobs Act clearly favored the corporate sector through a significant reduction of the “current” tax rate of 35% to 21% on corporate income. In addition, the corporate “Alternative Minimum Tax”—the equivalent of the minimum tax on individuals, has been totally eliminated. Other favorable provisions are provided with regard to income earned outside the US.
3. Expectations of the effects of tax law changes on US Households and the corporate Sector.
Because the effective date for the full implementation of the tax is the year 2018, the full effects of the tax law provisions over the period 2018-2027, on the after-tax income, saving and consumption of the household sector, during this period and beyond can only be speculated about. As to the effect of tax law changes on the corporate sector, because they are permanent, only partial effects may be forthcoming during this period. Nonetheless, few effects may be speculated upon.
First, the tax tables presented above suggest that most, if not all, taxpayers are likely to experience tax cuts. This conclusion however, cannot be supported without the knowledge of gross income, and taxable incomes of both single person households and married households, as well as the number of exemptions and the values of itemized deductions on itemized returns.
Second, as the tax law eliminates the deductions for health care expenditures, state and local taxes, the data in the table does not differentiate between those individuals and families who are saddled with these costs as compared with individuals and households who do not bear such burden.
Third, the tax payment by income class reported in the tables ignores the incentive effects induced by the new provisions. Major studies of tax law changes show that individuals do react to changes in tax laws leading to different outcomes. In other words, only first order effects of tax changes are considered.
Fourth, whether one considers the first or second order effects of the Act on the corporate sector, the sector is clearly a winner. A win for the country is anticipated if the Act induces corporations to move their overseas corporate activities to the US.
It is to be emphasized at this point that the likely impact of the Act presented above on US households and the US economy should be viewed as first order effects of the Act.
What stands out, however, is the fact that the Tax Cuts and Jobs Act introduces fundamental changes in the tax treatment of the household sector viz a viz the corporate sector in that, it shifts some of the burden of taxation from the business sector to the household sector. This shift fundamentally will alter, not only for this generation but also for succeeding generation, the distribution of the tax burden born by members of the two sectors.
It is worth noting that this considerable shift in the allocation of the tax burden is, unprecedented in the history of the US tax reform. Moreover, because the Act’s provision, which disallows the deduction of state taxes on individuals’ federal income tax returns, most likely will have an adverse impact on the budget most state governments.
Clearly then, it is to be empathized that it is early to assess the full impact of President Trump’s Tax Cuts and Jobs Act, for as every scientist will tell you, every “action” brings about a “reaction”. Accordingly, quantifying the effects of the President’s Tax Cuts and Jobs Act, at this point in time must be viewed as a “guess-estimate” at best. Any attempt at quantifying the redistribution of the tax burden associated with changes in the tax laws, by necessity, must assume no change in the behavior of taxpayers.
Over the past 50 years or so, using the Treasury Department tax file (not always available), or income tax returns reported in the Treasury Department Statistics of Income, the researcher is able to provide estimates of the distribution of tax changes by income class and /or the distribution of tax changes falling on households at given level of income. IN providing these calculations, the economist usually warns that these calculations must be taken as representing the “first order” effects of tax law changes, as it is commonly assumed in the computation, that everything else remains the same. Such estimates, however were often used by policy makers, as a guide to gauge the effects of a given change of the tax law on a the distribution of the tax burden by income classes as well as on the tax yield associated with a given change in the tax code.
As the new tax act, will become effective beginning in the year 2018, most estimates provided currently, if not all, must be viewed as “best guess-estimates”. What should not be viewed as guess-estimates however is President Trump’s expectation about his legislation. As quoted earlier, the President expectation (referred to earlier) is such that, the Tax and Jobs Act of 2017 is to be viewed as an important step towards producing “massive tax relief for the American people”.
How the Act fared in the popular press in the US?
Aside from releases of analyses of the Act conducted by government departments, namely the Treasury Department, and by the Congressional Budget Office, (which are mostly favorable), doses of journalistic assessment and analyses are provided to the reader. Among the many excellent analyses provided by journalists, two articles appearing in the Washington Post (reflecting my reading choice) stand out. These are: “How the tax overhaul could affect your bottom line” coauthored by, Reuben Fischer-Baum, Kim Soften and Heather Long (December 2, 2017), and a “Wonk blog” by Andrew Van Dam appearing in the Washington Post ( December 5, 2017) under the title: “Where the Republicans Tax Cuts Stand in History”.
The Post article of December 5th made a valuable contribution to the readers’ understanding of the effects of the 2017 tax act on the distribution of the tax burden on US households compared to previous efforts spanning 50 years. The analyses focus was mainly on the distribution of the income tax by income class under six (6) US presidents; 4 Republicans and 2 Democrats. Under Republican administrations, the following acts were enacted: Richard Nixon’s Revenue Act of 1971, Ronald Reagan’s Economic Recovery Tax Act of 1981, George W. Bush’s Economic Growth and Tax Relief Reconciliation Act of 2001, Jobs and Growth Tax Relief Reconciliation Act of 2003, Economic Stimulus Act of 2008, and President Trump’s Tax Cuts and Jobs Act of 2017. Under Democratic Presidents, the following acts were enacted: Jimmy Carter’s Tax Reduction and Simplification Act of 1977, and, Revenue Act of 1978, Barack Obama’s American Recovery and Reinvestment Tax Act of 2009; Tax Relief, unemployment Insurance Reauthorization and job creation act of 2010, and American Taxpayers Relief Act of 2012.
Using historical data about the 10 largest tax cuts in US history, an attempt was made to contrast the effects of the “tax cut” provisions of said plans, with those contained in President Trump’s Tax Cuts and Jobs Act (effective in 2019-2027) on the distribution of the tax cuts by income class. The findings are reported by income class ($0-10k to 1m and over).
Taking into account the fact that the estimates reported by government agencies, as well as in the press, for President Trump’s tax plan are preliminary at best, the analysis reported in the Washington Post, which is produced below is valuable nonetheless, in that not only does it provide a way to gauge tax reform efforts of Republican Presidents compared to their counterparts—Democratic Presidents, but also it provides lessons learned from the history of income tax reform efforts spanning a one-half century. A brief summary of some of the findings concerning winners and losers under the six Presidents tax plans are given below.
The analyses, in comparing winners and losers under each of the above-mentioned plans gave rise to the following conclusions:
“Our main takeaway: under the Trump plan, 6.7% of US household units that earn between $200,000 and $500,000 would receive 26% of the total tax cut in the year 2019”.
Of note is the finding reported in the Post piece, that purports to show, if the tax plan on US households were to expire (as legislated) in 2027, individuals earning more than 1million dollars, would pull in 60.7% of the entire tax cut in that year; whereas individuals in the middle-income range—$30,000-40,000 would see their tax bill rises by 2.2%
Although, these estimates of president Trump tax plan must be viewed as “guess-estimates” at best, they paint an “incontestable” shift in the distribution of the income tax burden that favors upper income classes. The author nonetheless warns the reader that assessing the impact of the new act on US household is a “tricky research”. Yet the general tenet in my view, as future research will document is unassailable.
Almost one-half century ago (1957), then Secretary of the Treasury, William E. Simon told a Tax Foundation audience that the income tax system was badly in need of a thorough overhaul. Since that speech, we have witness an abundance of Revenue Acts, all of which were designed to achieve the elusive dream of “equity, efficiency and simplicity”. Perhaps, the new Act may succeed where others have failed, in achieving that elusive dream.
A final note: “In the history of the federal income tax (1932-present), no reform has ever been adopted without a renewed call for reform on its wake!