Trump Tax Cuts–Meager for the Middle Class

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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.

Continued

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