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Congressional Republicans, with no support from Democrats, have used their majority control of both houses to pass the tax bill that emerged from the conference committee. It is fairly close to the one passed by the Senate, the one I’ve referred to previously as the “Magical Disappearing Tax Cut.” Unlike the corporate tax cuts, the individual cuts in the bill are scheduled to expire after 2025.
The final bill differs in a few ways from the earlier Senate version:
- The top tax rate for wealthy taxpayers is lowered from 39.6% to 37%, instead of only to 38.5%
- The corporate rate is cut from 35% to 21% instead of to 20%
- Taxpayers with income from “pass-through” businesses such as partnerships and S-corporations still have to pay taxes at individual rates, but they can deduct 20% of the income before applying those rates
- The deduction for state and local taxes is not repealed, but is now limited to $10,000
- The Alternative Minimum tax, which is designed to keep rich individuals and businesses from reducing their taxes too much with deductions, is repealed only for corporations, but individuals can exempt more income before paying it
Who gets a tax cut? The short, but somewhat misleading answer is almost everybody who pays income taxes now. However, the big winners are corporations and the wealthy, despite the assurances from the White House to the contrary. The benefits for the rest of us are a little harder to sort out, but they fall into a range from small (for the middle class) to almost nonexistent (for low-income households).
The richest fifth
I will once again draw on an analysis by the Tax Policy Center, which considered the effects of the bill on each quintile of the population by income. They estimated that in the top quintile in 2018, the average tax filer will see a $7,640 reduction in taxes and an increase of 2.9% in after-tax income. The percentage of filers getting a tax cut will be about 94%.
The bill includes many benefits that go disproportionately to the wealthiest Americans:
- The lower corporate rate that primarily benefits the wealthy because they own most of the corporate stock
- The lower individual rates, especially the reduction in the top rate from 39.6% to 37%
- The exemption of 20% of income from “pass-through” businesses, especially beneficial to real-estate partnerships such as Donald Trump’s
- The exemption of more income from the Alternative Minimum Tax
- The doubling of the estate tax exemption, so that heirs can inherit twice as much money tax-free
One provision of the new law that will impact negatively on some wealthy families is the reduced reduction for mortgage interest from $1.1 million to $750,000.
The Tax Policy Center estimates that in 2018, 65% of all the tax cuts will go to the richest fifth of the population. That does not include benefits that may trickle down from corporations to their workers, but most economists expect those benefits to be pretty small.
The middle fifth
In the middle quintile (neither in the upper 40% nor lower 40%), the percentage of filers getting a tax cut will also be very high, 91%. The average change in taxes will be much smaller, $930, and so would the increase in after-tax income, only 1.6%. The tax brackets that most affect the middle class have rate reductions of only 3 or 4 points. Contrast that with the 14-point reduction in corporate taxes and the new 20% exemption for pass-through business income.
Although the standard deduction increases by $5,500 for individuals and $11,000 for married couples, that is largely offset by the repeal of the personal exemption, currently $4,050 per person. Similarly, the child tax credit increases from $1,000 to $2,000, but families need that to make up for the lost tax exemption for children. Taxable income will remain just as high as now for many filers, and for some it will increase. Those who want to itemize because their deductions for mortgage interest, property taxes, state taxes, charitable donations, etc., exceed the standard deduction may not get much under the new system. They will gain nothing from the increased standard deduction, but they will still lose their personal exemptions. Those in high-tax states will also lose from the new limitation on state and local tax deductions.
The bottom line for the middle-class is a modest and temporary tax cut. The rhetoric on both sides has been a little excessive about this. The new law isn’t a huge cut for the middle class, but it’s not a transfer of wealth from the middle class to the rich either. It is a small tax cut whose full impact depends on who ultimately pays for it and how.
The lower two-fifths
In the lowest 40% of the population, the immediate effects are even smaller. In the Tax Policy Center analysis, only 54% of the lowest quintile and 87% of the next quintile even get a tax cut. The average change in taxes is only $60 for the lowest quintile and $380 for the next. The average increases in after-tax income are 0.4% and 1.2% respectively.
The main reason why the impact is so small is that people with low incomes are not paying much federal income tax to begin with. They are often paying more in payroll taxes, and the bill provides no relief there. Consider a married couple with two children and an income of $45,000. Under the system in effect for 2017, they reduce their taxable income by taking a $4,050 personal exemption for each member of the household and a standard deduction of $12,700. That makes their taxable income low enough to put them in the 10% bracket, and their calculated tax low enough to be wiped out by their child tax credit of $1,000 per child. Cutting taxes for people who don’t pay much in taxes isn’t easy. Many families will experience what changes there are not as a cut in what they pay, but as a small increase in what the government pays them in refundable child tax credits.
That does not mean that low-income households have no stake in tax policy. Defenders of the legislation argue that it cuts taxes for the people who pay most of the taxes. That would be all well and good if the government were running a surplus, and could afford to send some tax revenue back where it came from. But when the government is running a deficit and having trouble paying for important things that need to be done, like rebuilding infrastructure and keeping Social Security solvent, borrowing more money in order to finance tax breaks for corporations and the wealthy makes less sense. Because the tax cuts for corporations and higher-income households will drive up the federal deficit by an estimated $1.45 trillion over ten years*, Republicans can be expected to drop the other shoe, calling for offsetting spending cuts. And since low-income households depend more on federal programs like Medicaid, Medicare and food stamps, they have the most to lose. In addition, the Congressional Budget Office projects that the repeal of the Obamacare insurance mandate will force health insurers to raise premiums 10% per year because they will have fewer healthy customers. That would make subsidized health insurance less affordable for low-income families. So the tax bill is a big deal for the rich, a small deal for the middle class, and a bad deal for the lower classes.
The Tax Policy Center projects that in 2027, after most of the individual tax cuts have expired, only 25% of taxpayers will still be getting a cut, while 53% will be paying 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. For most people, however, any tax increases will be extremely small. The more important part of the story is that the top quintile will still see an average tax cut of $1,260 while people at other income levels get virtually nothing. That’s probably because the wealthy continue to benefit from the permanent cut in corporate taxes.
Instead of exaggerating any harm that will be done to the middle class after the individual tax cuts expire, we should instead be focusing on the potential harm to society in general if our government is deprived of the revenue it needs to address pressing social needs. The tax cut makes perfect sense to those who believe that government should sit back and wait for free markets to solve our problems. The number of people who believe that government has waited too long already seems to be growing, which may explain why this tax cut is the least popular one in modern American history. Republicans say that we will learn to love it. We’ll see.
*In the time available, the CBO was not able to factor in the possibility that additional growth in the economy generated by the tax cut might produce some offsetting revenue. Most economists expect such effects to be small. Although they have made extravagant claims about these effects, Republicans quickly passed the bill without giving the CBO time to estimate them. Secretary Mnuchin claimed that the Treasury Department had its own analysis of this question, but he has not produced it.