November 2 saw the unveiling of the new tax reform bill, entitled ‘Tax Cuts and jobs Act of 2017,’ in the Congress (House of Representatives). The New York Times did a great round up of the bill and what it entails, if it were to pass through the Congress and signed into law.
In a move to streamline the tax brackets in individual income tax, the new bill sets out four easy brackets, some of which involve merger of existing brackets. The bill also revises the income ranges for the brackets. Under the new bill, the top tax rate will be applied to households making $1 million and above as compared to $480,050 under the existing structure, thus relieving the burden on six digit earners. While low income earners ($0 - $19,000) will be taxed at 12%, up 2 percentage points from the existing 10%, a larger child tax credit for low income families might make up for the earnings lost in the mark-up.
Repealing the estate tax, which might double the amount of tax exempted inherited wealth to $11 million, seems like a huge windfall for the rich. Critics of the tax reform bill will and have certainly used this giveaway to label the bill as ‘tax cuts for the rich.’
But the real bonanza lies in the bill’s proposal to double the standard deduction – fraction of income immune from taxation. This is applicable to all but married couples with multiple children.
On the other hand, the bill proposes to eliminate local and state tax deductions – a move touted to negatively affect blue state residents more than red state residents, as the former have higher taxes. Could this be an attempt to pressure blue states into reducing their state and local taxes? The next few weeks might answer this question.
Pass-through businesses (sole proprietorships, partnerships, and S corporations) will be taxed at a new single tax rate – 25%. Although a fine streamlining measure, the flat tax rate seems high given the fact that most of pass-through businesses are small and medium enterprises that operate domestically and contribute a lion’s share to the economy. Taxing them lower than the proposed flat tax rate for corporations might make it reasonable and might win over at least one Senate Republican – Sen. Ron Johnson (R-Wis). Winning Senate Republicans over is critical for the passage of the bill, as we shall see later.
The corporate tax rate, under the bill, will be slashed to 20% from the current 35% - one of the highest in the world. The 35% tax rate doesn’t include taxes imposed by the state and local councils. The existing tax burden means more and more US corporations park their money abroad in ‘tax havens.’ The only way to lure that money back and earn taxes on it is to become competitive and incentivize firms to hold their money in the US. The change will have to be coupled with closure of all possible tax loopholes to make sure that the new policy delivers the proposed goodies.
The connection between tax relief to corporations and job creation and better wages is tenuous, yet widely leveraged. But it sounds sanguine and gets the masses to rally around such proposals – an indirect measure to influence the voting patterns of the elected representatives.
On the other hand, there might be some wisdom in cutting taxes for small businesses in a bid to create jobs, as these businesses hire locally and cannot replace human labor with automation due to the high costs of the latter. That’s one more reason to lower the tax rate for pass-through businesses.
The Senate has its own version of tax reform, which if passed, will need to be reconciled with the House version. The Senate version agrees with the House version on most of the key elements. Notable differences include further lowering taxes on overseas profits, an unreasonable tax to begin with, as the profits were made elsewhere and probably have been taxed locally.
The Senate has also added a repeal of Obamacare’s individual mandate that requires everyone to get health insurance or else pay a tax penalty. This is a huge boon for those who don’t want to buy health insurance or can’t afford the ever-increasing costs of O-care. This might also save the government some money, as there will be fewer people requiring health subsidies. The Congressional Budget Office (CBO) estimates that repealing the individual mandate will earn the federal government $338 billion in revenue, which it would otherwise spend on health subsidies.
On a conspiratorial note, the Senate’s repeal of the mandate might be a cloaked attempt to gradually chip away at Obamacare.
The tax bill has passed the House and is awaiting the Senate’s consensus over its own version, following which the complicated ‘reconciliation’ process will begin. Although the tax bill made it through the House without breaking a sweat, its Senate counterpart might have to struggle, given the fact that the Democrats are unanimously opposed to it and only three Republicans need to vote ‘nay’ for the Senate version to fizzle out. Given the current mood, the Senate version seems to be hanging by a thin thread.
(The story is developing and so will the commentary. Check back periodically for updates.)