The Senate’s Magical Disappearing Tax Cut

November 28, 2017

Previous | Next

The tax bill proposed by Senate Republicans differs in at least two noteworthy ways from the version already passed by the House: It repeals the individual mandate in the Affordable Care Act, and it makes the tax cuts for individuals expire after only eight years. These provisions make the bill an even worse deal for the middle class than the House version, which was already bad enough.

The individual mandate

What is another attempt to repeal Obamacare doing in a tax bill? Technically, it can be there, because the mandate to buy health insurance depends on tax penalties for failing to do so. The tax penalties also give the mandate a legal basis in the government’s power to tax, instead of just in the government’s power to regulate interstate commerce, an argument that proved decisive when the Supreme Court found the law constitutional. Without those tax penalties, most experts worry that too few healthy people will choose to carry insurance, forcing insurance companies to raise premiums on those with pre-existing conditions. If millions of them go without coverage too, that will defeat the whole purpose of the law. According to the Congressional Budget Office, “Healthier people would be less likely to obtain insurance; especially in the nongroup market, the resulting increases in premiums would cause more people to not purchase insurance.” The CBO estimated that the number of insured Americans would drop by 13 million.

Republicans have a twofold purpose in slipping this into their tax bill. Not only do they strike another blow against Obamacare, but they save the government an estimated $318 billion they can use to carry out their prime objective–tax breaks for corporations and the wealthy. If fewer people sign up for health insurance, the government pays out that much less to subsidize their premiums.

Tax cuts, permanent and temporary

Both the House and Senate bills cut the corporate tax rate from 35% to 20%. The Senate bill starts the cut one year later, but makes the cuts permanent from then on. For the individual tax changes, however, the Senate bill includes sunset provisions to end them after 2026. That applies to the rate cuts, the increase in the standard deduction, the elimination or scaling back of certain itemized deductions, the repeal of personal exemptions, and the cuts in estate taxes. It even applies to the tax cuts for small businesses such as partnerships and S-corporations, which currently pass through their income to individuals to be taxed at individual rates. Large corporations get a permanent tax cut, while small businesses get only a temporary one.

The reason for these differences is both fiscal and political. Republican tax writers found that they couldn’t make all the cuts permanent without adding more to the federal deficit than is allowed by the budget reconciliation process. The bill can only add $1.5 trillion to the deficit over ten years and no more after that. Only if they play by the rules of reconciliation can they pass the bill with a simple majority, so they can do it with Republican votes alone and prevent a Democratic filibuster.

On a deeper level, this is an admission that the country cannot really afford both the corporate and individual cuts. Republicans are evading this truth by assuring the country that the individual cuts can be made permanent later. Treasury Secretary Steven Mnuchin has said that he has “every expectation that down the road Congress will extend them.” The Republicans want to have their cake and eat it too, describing the cuts as temporary for purposes of squeaking the bill through Congress, but describing them as permanent for purposes of selling the bill to the public.

When “later” actually arrives, the country will face a stark choice: Either raise taxes by letting the cuts expire, or allow the kind of massive deficits that Republicans have always claimed to be against, or cut popular programs like Medicaid and Medicare (which many Republicans would love to do but hate to admit it publicly). In any case, this curious bill is an admission that they do not know how to fulfill President Trump’s promises for massive middle-class tax relief, debt reduction, and protection of entitlement programs. They are no closer to pulling that off than they are to creating a better health insurance system to replace Obamacare.

Winners and losers

The Tax Policy Center has released its independent analysis of the Senate bill. It shows that upper-income taxpayers gain more than the middle class, even before the individual tax cuts expire.

In 2019, 76% of taxpayers would get at least some tax cut. One reason why that percentage isn’t even higher is that some taxpayers lose more in itemized deductions than they gain in lower tax rates, especially because the Senate bill eliminates the deduction for state and local taxes. On the average, taxpayers in the middle quintile (40th to 60th percentiles of the income distribution) see a cut of $850 and an increase of 1.4% in after-tax income. But taxpayers in the richest quintile (top 20%) see a cut of $5,740 and an increase of 2.2% in after-tax income. Overall, 63.2% of the individual tax cuts go to the richest 20%.

In 2027, after most of the individual tax changes expire, only 28% of taxpayers still get a cut, while 50% pay a little more than they would under current law. One reason for that is that the bill changes the way tax brackets are indexed for inflation, and does it in a way that favors the government. In the middle quintile, after-tax income would be only slightly lower than it is now. But in the top quintile, after-tax income would be 0.6% higher, for an average gain of $2,230. That’s probably because the top quintile owns about 80% of the corporate stock, and so they benefit most from the permanent cut in corporate taxes.

The Congressional Budget Office has done a different kind of distributional analysis, focusing on how much it will cost the government to provide tax-cuts affecting different income groups. The CBO found that most of the cost–85% in 2019 and 100% by 2027–will be incurred by providing tax cuts for people with incomes over $75,000. Little is actually devoted to tax relief for the mid-to-lower part of the distribution.

A successful con?

In the name of tax reform and simplification, Senate Republicans have produced a masterpiece of obfuscation that shortchanges those it claims to benefit. They are aided in this effort by a President who speaks regularly in oversimplifications, exaggerations, and outright lies. Essentially, Senate Republicans are cutting taxes for corporations and the wealthy, while letting their Con-Man-in-Chief tout the bill as the biggest middle-class tax cut ever, which it certainly is not. All that the middle class actually gets is a small, temporary tax reduction. That is supposed to fool them into supporting a permanent corporate tax cut that will primarily benefit wealthy shareholders. When the day of fiscal reckoning comes, middle- and lower-income people will bear the brunt of the program cuts required to manage the debt.

Part of the con is the endless repetition of the dubious claims of “trickle-down economics.” Very little evidence supports the idea that corporations will use their tax cut to raise wages or hire more workers. Because of the numerous tax breaks already in the code, most of which are left standing in the proposed legislation, the average corporation pays far less than the official 35% rate. The effective tax rate on US corporations is not out of line with other wealthy countries. The corporate share of the federal tax burden has already declined dramatically since the mid-twentieth century, when the economy flourished despite high taxes.

As of this writing, polls show that most Americans are not being fooled by this proposal. Whether that will make any difference is not clear, since so many Republicans listen to their wealthy donors more than to the public. If the Senate does pass this Thanksgiving turkey, one can only hope that there is hell to pay in 2018 and 2020.

Trump Tax Cuts–Dangerous for the Deficit

October 6, 2017

Previous | Next

Here I mention one other problem with the Trump tax proposal, besides its potential to increase economic inequality by favoring the wealthy. The Tax Policy Center estimates that it would “reduce federal revenues by $2.4 trillion over the first ten years and $3.2 trillion over the subsequent decade.” Without offsetting cuts in federal spending, it could add hundreds of billions to annual deficits and trillions to the national debt.

The question of how tax cuts influence deficits and the debt is complicated by their uncertain effects on economic growth. If the rate of growth goes up, incomes should rise, and taxes on those incomes should bring in additional revenue. Back in 1974, University of Chicago economist Arthur Laffer proposed that a tax cut can actually pay for itself by stimulating growth, while a tax increase can actually reduce revenue by inhibiting growth. This has become a popular argument for tax cuts, despite the weakness of the evidence supporting it. The big tax cuts under Ronald Reagan and George W. Bush did not pay for themselves, but contributed instead to soaring budget deficits.

Tax analysts have two different ways of evaluating the impact of tax changes on revenue. Conventional scoring makes no assumptions about the effects of the changes on economic growth. Dynamic scoring tries to incorporate an estimate of those effects (known as “macroeconomic feedback effects”) into the prediction model.  The Tax Policy Center said this in their first evaluation of the Trump plan:

This report uses conventional scoring methods that assume the tax proposals do not affect the overall level of economic activity. TPC will release supplemental estimates that include macroeconomic feedback effects soon. Based on TPC and the Penn Wharton Budget Model’s analyses of the macroeconomic effects of the House Republican leadership tax blueprint of 2016 (which shares many characteristics with the [Trump] unified framework), we would expect the framework to have little macroeconomic feedback effect on revenue over the first decade.

Translation: Revenue losses might be a little offset by economic growth effects eventually, but don’t hold your breath.

The Trump economic team has been vigorously promoting the idea that the tax cuts will pay for themselves. They seem to be reading from a familiar Republican playbook: Dismiss concerns about the deficit when calling for tax cuts. Then when the deficit goes up, blame federal spending rather than tax policy. Issue dire warnings about bankrupting future generations and call for cuts in programs that primarily help the middle class and the poor. According to the Republican Party line, the country can always afford another tax cut aimed mainly at the wealthy. What it can’t afford is programs like Medicaid or Obamacare to help people pay for health care.

That the current administration would play the same game is disappointing, considering how much Donald Trump has marketed himself as a champion of the working class. His positions on immigration, foreign trade and race do appeal especially to less educated voters. But on fiscal policy, his thinking seems very much in line with the Republican establishment, favoring tax cuts for the wealthy and spending cuts for the poor. He is very good at hiding his real aims behind a populist, pro-worker, pro-growth rhetoric. So far, most of his supporters are sticking with him, even as he sticks it to them with his economic policies.

Trump Tax Cuts–Meager for the Middle Class

October 5, 2017

Previous | Next

Whatever else President Trump’s “tax reform” proposal is, it is a big tax cut for the wealthy (see previous post). Adding a higher bracket to the three listed in the proposal (12%, 25% and 35%) would help (and is reportedly under discussion), but other goodies for the rich would still remain, such as the repeal of the estate tax.

How do the benefits for other taxpayers compare to those for the wealthy? The Tax Policy Center combined the President’s “Unified Framework” with the House Republican leaderhip’s “A Better Way” tax plan to estimate how different income groups would fare. The researchers divided the population into five quintiles by income, and then estimated how each group’s after-tax income would be affected. They calculated that in 2018, after-tax income would rise 3.3% for the top quintile, but no more than 1.2% for any of the other quintiles. The big winners would again be the top 1%, whose after-tax income would rise by 8.5%. In 2027, the gains would be 8.7% for the top 1%, 3.0% for the top quintile, and no more than half of one percent for any of the other quintiles.

In dollar terms, the average taxpayer in the middle quintile would save $660 on their taxes in 2018 and $420 in 2027.

Why are the middle-class tax cuts so small?

The Trump tax plan adds some tax breaks, especially for the wealthy, but it also eliminates some tax benefits that go to millions of people, such as the personal exemption and the state income tax deduction.

The most obvious new benefit for the masses is the increase in the standard deduction, which would go from $6,350 to $12,000 for single taxpayers, and from $12,700 to $24,000 for married couples filing jointly. However, the elimination of personal exemptions would increase taxable income by $4,050 for each taxpayer or dependent in the household. A one-person household would gain $5,650 in deductions but lose one $4,050 exemption, coming out a little ahead. A family of four would gain $11,300 in deductions but lose $16,200 in exemptions, coming out behind.

The proposed increase in the child tax credit could offset some of the loss in personal exemptions, but the proposal did not specify the amount of the increase. The Tax Policy Center assumed that it might go from $1,000 to $1,500 per child.

Many taxpayers itemize because their specific deductions exceed the standard deduction. Under the Trump plan, there would be less to itemize. Mortgage interest and charitable donations would still be deductible, but many others would disappear, including deductions for state, local and real estate taxes. Taxpayers whose interest and charitable deductions were greater than or equal to the new standard deduction would get no benefit from it, but they could lose many thousands of dollars in other deductions and exemptions. That’s one reason why about one in every eight taxpayers would get an immediate tax increase.

The promise of growth

The President’s proposal says a lot about lowering the tax burden on the middle class and making the tax code fairer. That’s more than a little disingenuous, given that the benefits go primarily to the wealthy. But the proposal makes brief reference to another rationale, creating a “tax code built for growth.” The assumption is that tax cuts will stimulate economic activity, creating jobs and raising wages for many.

If that’s true, maybe it doesn’t matter as much how much the cuts directly benefit the middle class. Middle-income people would presumably benefit indirectly from the increase in general prosperity. Even benefits focused mainly on the rich could “trickle down” to benefit people of more modest means. The proposal can’t make that argument explicitly, since it is pretending to cut taxes primarily for the middle class. Too obvious an endorsement of trickle-down economics helped defeat Mitt Romney in 2012.  Nevertheless, it is what most Republicans still believe.

Why should tax cuts for corporations and the wealthy accelerate economic growth? Supposedly, because it will give them the means and the motivation to invest more in business expansion. The underlying assumption is that money in private hands will be used productively, while money in the government’s hands is more likely to be wasted.

Many economists have their doubts about this theory. Here are a few that I’ve heard expressed:

  1. Cutting taxes to stimulate the economy may work in times of recession, but it isn’t as likely to help when the economy has been growing for some time. Instead of putting idle resources to work, the extra capital may just feed inflation. That in turn may induce the Federal Reserve to cool the economy by raising interest rates.
  2. As countries go, the United States is not particularly over-taxed. The top personal rate is much lower than it used to be. The official corporate rate is high, but most companies pay far less after deductions.
  3. Companies are not generally suffering from a lack of capital, but are often sitting on piles of money they are not investing productively.
  4. When companies do invest in new plants and equipment, it is often in industrial robots that destroy jobs instead of creating them.
  5. The government will need to pay for the tax cuts either by cutting spending or increasing borrowing. Spending cuts can cost jobs, and increased borrowing can raise interest rates and encourage Treasury bond purchases instead of more productive investments.
  6. The economic data do not support the generalization that countries with lower taxes have greater economic growth.

What is more certain is that tax cuts aimed at the wealthy generate more economic inequality, and we have enough of that already.


Trump Tax Cuts–Windfall for the Wealthy

October 4, 2017

Previous | Next

Last week, the Trump Administration released its tax proposal, titled “Tax Reform: Unified Framework for Fixing Our Broken Tax Code.” Many observers have characterized it as short on reform but long on tax cuts, especially for the wealthy. I agree with them.

Although it is a little more fleshed out than the vague outline the administration released earlier, the proposal still leaves a lot of specific details up to Congress. Although it would reduce the number of personal income tax brackets from seven to three, it does not specify the thresholds for the new brackets; nor does it specify the size of the increased child credit that will replace the personal exemption for dependents. The White House has used the lack of detail to deflect criticism, claiming that the critics don’t know enough yet to assess the impact on taxpayers at different income levels.

However, that hasn’t stopped the President and his supporters from making some sweeping claims of their own about who will benefit most. The stated goals include “tax relief for middle-class families” and “tax relief for businesses, especially small businesses.” They say nothing about benefits for the wealthy. Trump himself claims that the plan will “put more money into the pockets of everyday hardworking people,” and that “I don’t benefit” from the changes. That may be the biggest falsehood he has ever told, and that’s saying a lot.

The proposal would cut taxes for the wealthy in at least five ways.

Personal income tax rates

The current law taxes personal income in seven income brackets, at rates ranging from 10% to 39.6%. The proposed system would have only three rates: 12%, 25% and 35%. Immediately we can see that top incomes get a reduction, although it is less clear than lower incomes do.

Although the thresholds for the new brackets are not definite, the analysis by the Tax Policy Center made the reasonable assumption that they will resemble the thresholds proposed by House Republicans in their 2016 tax plan, which Donald Trump praised when he was running for President. Based on those thresholds and other features of the proposal, the Center estimated how taxpayers in each of the five quintiles of income would be affected. (Quintiles are not the same as tax brackets, but just divisions of the population into fifths.)

In 2018, when the plan is assumed to go into effect, taxpayers in the top quintile would average a tax cut of $8,470, and they would receive 74.5% of all the tax cuts distributed. Taxpayers in the middle quintile would get an average tax cut of only $660. Even more startling, the richest 1% of taxpayers would get an average tax cut of $129,030, and by themselves get 53.3% of all the tax cuts.

It gets worse over time. By 2027, the average cut for the 1% would reach $207,060 while the average cut for the middle quintile would fall to $420. By then 79.7% of all the cuts would be going to the 1%. (Why one group’s tax cut goes down while another’s goes up has to do with how various features of the tax code are indexed for inflation.)

The Trump plan includes a rather vague remedy for this apparent unfairness: “An additional top rate may apply to the highest-income taxpayers to ensure that the reformed tax code is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers.” Given that almost everything in the plan favors the wealthy, translating this pledge into reality will be a very tall order, and one that Congressional Republicans are unlikely to have any enthusiasm for carrying out. (I have been reading Jane Mayer’s Dark Money, which makes a pretty good case that today’s Republican Party pursues an agenda largely dictated by their richest donors.) The leadership is prepared to pass the bill entirely with Republican votes, using the budget reconciliation process to rule out a filibuster by Senate Democrats.

Corporate tax rates

The proposal would lower the corporate tax rate from 35% to 20%. This is also a benefit mainly for the wealthy, for two reasons.

The Congressional Budget Office, US Treasury, and the Tax Policy Center agree that the owners of capital bear most of the burden of corporate taxes, with only an estimated 19-25% falling on workers.

Although many workers own a small amount of corporate stock in their retirement plans, most stock ownership is in the hands of the richest 10% of the population. Less for Uncle Sam means more for the stockholders.

Pass-through business tax rates

Small businesses such as sole proprietorships, partnerships and S-corporations pass through their income to their owners, who pay taxes on it at individual rates as high as 39.6%.

The proposal would tax such pass-through income at a maximum of 25%. However, the great majority of small business owners already pay 25% or less because their income doesn’t exceed the individual threshold of $91,000 or the married threshold of $153,100. According to the New York Times, the effective tax rate for sole proprietors is only 13.6% now. The benefits of this tax cut would go exclusively to owners with higher incomes.

The Trump framework promises “tax relief for businesses, especially small businesses,” but it would more accurately read “especially large businesses.”

Alternative Minimum Tax repeal

The AMT is an alternative tax calculation that high earners with many deductions must complete in order to keep them from avoiding their fair share of taxes. The little bit we know about Trump’s own taxes reveals that he would have paid $31 million less in taxes in just one year (2005) if it weren’t for the AMT. Repealing it is mostly another gift to folks like him.

One can argue that if the new tax law succeeds in its goal of “providing greater fairness for all Americans by closing special interest tax breaks and loopholes,” then the Alternative Minimum Tax will be less necessary. On the other hand, one could argue that it may be more necessary than ever, given all the other tax breaks for the rich in the plan.

Estate tax repeal

The estate tax has already been “reformed” to the point that it only applies to estates valued over $5.49 million. Abolishing the estate tax would benefit only the wealthy, especially people as wealthy as Trump himself, whose estate has been estimated at several billion dollars. Trump has claimed that the repeal would primarily benefit farms and small business owners, but the Tax Policy Center found that less than 1% of the estate tax revenue comes from that group.

And for the rest of us…?

Even without many of the details worked out, the wealthy appear to be the overwhelming beneficiaries of the tax proposals, which are mostly just tax cuts for them. The benefits for the middle class are smaller and more uncertain. I will elaborate on that in the next post.


Another Day, Another Deceptive Health Care Bill

September 26, 2017

Previous | Next

Senate Republicans continue to wrestle with their health care dilemma. Having failed for years to develop an alternative to Obamacare, they remain under great political pressure to repeal it anyway, while somehow pretending they will leave people at least as well insured as they are now. The majority of Americans remain to be convinced.

The latest edition of “repeal and replace” uses block grants to the states as a kind of miracle supplement to compensate for all the nutritional deficiencies of the legislation. The Graham-Cassidy bill would repeal almost all of the specific provisions that have made health insurance affordable for millions of people (while admittedly making it more expensive for some). The bill would also cut health insurance spending at the federal level, giving what’s left to the states in the hope that they can devise something better.

As with previous Republican proposals, Graham-Cassidy would immediately repeal the mandates that require individuals to carry health insurance and large employers to offer group coverage. The year 2020 would see the end of federal tax credits to help offset the costs of premiums, subsidies for out-of-pocket costs, and the expanded Medicaid coverage in which thirty states are participating.

In addition, provisions of the Affordable Care Act that were retained in the last two Senate proposals would now be left up to the states. States could decide whether they wanted to require coverage of medical benefits previously designated as essential, to prohibit lifetime caps on benefits, to require equal treatment of people with pre-existing conditions, or to limit the rates charged to older policyholders.

The Congressional Budget Office, which issued a preliminary analysis yesterday, found all this difficult to evaluate. They said that it would take them several weeks to come up with better estimates of federal expenses and insurance coverage rates. But Senate Republicans are determined to pass the bill this week–although that now looks unlikely–before the deadline for passing it under “reconciliation.” After that, they would need more than 51 votes to avoid a filibuster, and that would require some cooperation from Democrats. As of now, most Republicans are determined to avoid any bipartisan process that might improve Obamacare rather than gut it.

Fiscal implications

The CBO’s preliminary estimate is that the bill would reduce federal deficits by $133 billion over ten years. That’s mainly because the government would give the states less in block grants than it is projected to spend on tax credits, subsidies and expanded Medicaid payments under the current law.

Although the average state would lose federal spending under the proposal, spending would rise in some and fall in others. “By 2026, under the legislation, states that have already expanded Medicaid under the ACA would receive about 30 percent less funding…, and other states would receive about 30 percent more….” This shift would occur gradually over ten years, as allocations came to be based less on what states are spending now and more on the demographic characteristics of their populations (“…their share of residents with income between 50 percent and 138 percent of the federal poverty level (FPL), with adjustments for factors related to the health of those residents and for other factors affecting states’ health care costs”). States would be free to spend their block grants in a variety of ways, such as subsidizing insurance for people with high health care costs, arranging with insurers to reduce premiums, paying health care providers, helping pay out-of-pocket costs, or arranging with private insurers to offer coverage previously provided by Medicaid expansion.

New legislation would be required to continue the block grants beyond ten years.

Insurance implications

As President Trump recently learned to his chagrin, health care is hard. Under this plan, every state would now face the same dilemmas that the architects of the Affordable Care Plan faced. How would the states insure the poor and the sick without placing unreasonable burdens on the affluent and the healthy?

With no federal mandates or tax breaks, what would motivate the healthy to buy insurance so that their premiums could help support health care for the sick? Insurers might avoid insuring the sick, charge them more than they can afford, cover fewer conditions, or leave the market altogether. State-run systems would be vulnerable to the same kind of downward spiral that Republicans have predicted for Obamacare–not enough people in the individual market, insurers raising rates, still more people leaving the market. Each state would have to devise its own system of carrots and sticks to make health insurance affordable, but with a little less money for carrots than we spend now.

The thirty states that expanded Medicaid would have the most acute problem, since they would ultimately lose 30% of their funding. They would either have to dramatically reduce support for the near-poor, or else skimp on the subsidies that keep the healthy in the market and keep coverage affordable for the sick. In either case, the number of uninsured would almost certainly rise.

The CBO predicts that millions now covered by Medicaid would lose coverage, and so would millions in the individual insurance market. The analysis did not try to estimate how many millions in each group. Some of the losses could be offset by voluntary expansion of group coverage, although employers would no longer have a federal mandate to offer it.

The CBO was also concerned about the time it would take for states to develop their own health insurance systems and the confusion that might prevail in the meantime. For example:

To establish its own system of subsidies for coverage in the nongroup market related to people’s income, a state would have to enact legislation and create
a new administrative infrastructure. A state would not be able to rely on any existing system for verifying eligibility or making payments. It would need to establish a new system for enrolling people in nongroup insurance, verify
eligibility for tax credits or other subsidies, certify insurance as eligible for subsidies, and ultimately ensure that the payments were correct. Those steps would be challenging, particularly if the state chose to simultaneously
change insurance market regulations. Insurers would also need time to develop plans under the new system.

Many insurers might leave the market for several years while state policy was up in the air.

In short, the Graham-Cassidy bill is Obamacare overkill. It throws away the system we have and trusts that the states can do better–but with less money. President Trump and his friends could then declare victory and move on to their main agenda–tricking us into another tax cut for the wealthy.