While the broad strokes of the Tax Cuts and Jobs Act were telegraphed weeks, if not months, in advance, it’s now been written up and amended in enough detail that it can actually be debated, scored by the Congressional Budget Office so its cost and effects on the rich and poor are known, and voted upon.
The legislation seeks to dramatically cut taxes on corporations and consolidate benefits like personal exemptions, the standard deduction, and the child credit for individuals. It would eliminate the alternative minimum tax and estate tax, and pare back certain individual deductions. It would also offer a new low tax rate for owners of “pass-through” businesses like LLCs and partnerships, whose income from their businesses is taxed as personal income.
The bill would give disproportionate benefits to wealthy Americans, who tend to benefit from corporate tax cuts more than non-wealthy Americans and who could likely exploit the pass-through rate by setting up dummy corporations. According to the Tax Policy Center, in 2027 the absolute richest Americans, the top 0.1 percent earning at least $5 million a year, would get an average tax cut of 3 percent of their income, or $320,640. The middle fifth of taxpayers, earning $54,700 to $93,200 a year, would get a 0.5 percent income boost, or only $360. Nearly half the cut would go to the top 1 percent.
And while most people (61.4 percent) would get a tax cut by 2027, a whopping 24.2 percent would see their taxes actually go up, by an average of $2,080, TPC finds.
The bill will almost certainly not become law in its current form. As written, it is almost guaranteed to increase the budget deficit by trillions over 10 years, and quite possibly keep increasing the deficit after 10 years are up.
That’s a big problem: Under Senate rules, some legislation can pass with only 51 votes only if it doesn’t increase the long-run deficit. So the current draft of the legislation would probably need 60 votes instead, meaning significant Democratic support, which Republican leaders haven’t been even trying to court. They need legislation that can pass with 51 votes, and for that, they need the bill to not raise the long-run deficit.
The Senate has proposed legislation that meets those requirements, largely by making individual tax cuts expire while making corporate cuts permanent. If the House passes their bill and the Senate passes theirs, they’ll have to hammer out a version in conference committee that satisfies House leaders while not running afoul of the long-run deficit rule.
Who gets tax cuts, and tax hikes, under the bill
Before delving into the bill’s details, it’s worth taking a moment to consider who, all told, comes out ahead and behind.
The nonpartisan Tax Policy Center has modeled the effects of the legislation as reported from the House Ways and Means Committee, and estimated how it affects each income group on average. Here’s the big picture:
The story is very different in 2018 compared to 2027, because two major provisions expire before the end of ten years: a $300 "family credit" for adults, and a provision letting businesses immediately deduct the cost of all their investments. The expiry of those provisions, particularly the family credit, hits low-income families harder than rich ones. So while most groups see a tax cut in 2018, with the biggest gains going to the rich, by 2027 the bottom 95 percent gets very little, with the gains intensely concentrated at the top.
You can see this in more granular detail in the following table. TPC finds that the top 5 percent of taxpayers earn 64.6 percent of the benefits from the cuts by 2027:
But these averages obscure important differences within income groups. Some people earning $200,000 a year will pay less in taxes in 2027. But others will pay more, which can be obscured by a finding that, say, the 80-90th percentiles as a whole will get a $810 tax cut on average.
TPC modeled out for both 2018 and 2027 what share of each group will see taxes go up and down. Here’s 2027:
Overall, 61.4 percent of taxpayers see their taxes cut, with an average cut of $2,410; but 24.2 percent see their taxes go up, by $2,080 on average.
These percentages vary widely between income groups. Within the 90-95th percentiles, people earning between $225,400 and $304,600 a year, 45.1 percent would see their taxes go up. But only about 13 percent of the poorest fifth of Americans would see a tax hike.
The bill would be good for corporations and the wealthy
So who, broadly speaking, wins under the bill?
- Corporations, broadly, are the focus of most of the tax cuts. According to the Joint Committee on Taxation, cutting the corporate tax rate from 35 percent to 20 percent, as the bill does, costs nearly $1.5 trillion over 10 years. They also gain new, more favorable treatment of income earned abroad, which is either not taxed or taxed at an even lower rate than 20 percent.
- Wealthy, particularly ultrawealthy people, who tend to earn a disproportionate share of their income from capital (like stock sales and dividends) and thus benefit from cuts to the corporate tax, which is largely a tax on capital. If the corporate tax also reduces wages, as some conservative economists allege, then corporate cuts still disproportionately help the wealthy, as a huge share of wages go to high earners, not low- or median-wage workers. Additionally, the pass-through cut could enable some wealthy people who either own pass-throughs or create new ones to shelter some of their income from high rates. Both TPC analysis and the Joint Committee on Taxation confirm that the richest Americans get the biggest cuts as a percentage of their income.
- People making mid- to high six-figure incomes, who arguably should count as wealthy or rich too. By raising the threshold for the 39.6 percent rate on individual income to $1 million for couples, up from $470,700 today, people with incomes in the $600,000 to $700,000 range will get a sizable reduction, in addition to the low-end tax cut they get because the new 12 percent bracket will apply to income now taxed at 15 or 25 percent. Sure enough, TPC finds that once you reach the 95th percentile ($304,600 a year) and above, over 70 percent of people get tax cuts in 2027, with the average change amounting to 1.4-3 percent of income.
- Pass-through companies, like the Trump Organization, which get a new very low rate. There are some provisions included meant to prevent rich individuals from using this tax break as a way to shelter income, but they only limit the benefit in many cases. The overwhelmingly rich owners of these companies will still come out way ahead.
- Heirs and heiresses, as the estate tax is first reduced (by increasing the exemption and applying it to an even smaller sliver of the hyperrich) and then eliminated entirely.
But the bill would hurt the poor and increase the deficit
The GOP’s tax reform proposal would leave other groups worse off:
- Blue state residents would pay higher taxes, as the state and local income/sales tax deduction is eliminated and the one for property taxes is somewhat curtailed. That said, wealthy people benefiting from these deductions will likely see this tax hike offset by the other tax cuts in the package.
- The housing sector faces a new limit on the mortgage interest deduction. For individual taxpayers, the rate cuts largely make up for this, but it reduces the incentive to buy and build homes, which could affect lenders, construction companies, real estate firms, etc.
- Poor families were rumored to be getting a tax cut due to a change in the refundability formula for the child tax credit — but that didn’t make it into the bill. The credit only goes to families with $3,000 in earnings or more, and phases in slowly; some in Congress were pushing to lower the threshold to $0, but they didn’t succeed. Instead, a provision denying the child tax credit to American citizen children whose parents are undocumented immigrants is included.
- And it would increase the deficit; the Joint Committee on Taxation has reportedly scored the bill as costing $1.51 trillion over 10 years, about what the House/Senate budget allocated for the bill but still a sizable increase in the public debt.
Here’s the Joint Committee on Taxation’s estimates of what each provision raises and costs in tax revenue:
Individual income tax rates are consolidated and cut
The new tax reform bill (which, again, draws on plans Trump and congressional Republicans have released going back over a year now) would significantly change individual income tax brackets:
- The seven current individual income tax brackets would be consolidated to four: 12 percent (up from the current bottom rate of 10 percent), 25 percent, 35 percent, and 39.6 percent.
- Keeping the 39.6 percent top rate is a huge change from past Republican plans, which have focused heavily on cutting the maximum rate the richest households pay. However, the plan significantly reduces how many people pay the top rate: The threshold for the last bracket would increase from $470,700 for married couples today to $1 million.
- The 35 percent rate would cover some affluent households currently paying a marginal rate of 33 percent, potentially raising their taxes; and the 12 percent bracket would extend into the income range currently covered by the 25 percent bracket, lowering taxes for many middle- and upper-middle-class households.
- The thresholds for brackets will be adjusted according to chained CPI, a slower-growing measure of inflation than normal CPI, which is used currently; this change raises revenue over time by gradually pushing more and more people into higher tax brackets.
- De facto taxes on some corporate executives would go up: Performance pay and commissions above $1 million would no longer be deductible for the purposes of corporate taxes.
The standard deduction is increased, personal exemptions are eliminated, and the child tax credit is mildly boosted
Standard benefits for families are changed significantly, with an eye toward simplifying the vast array of benefits (standard deductions, personal exemptions, child credits, etc.) currently available:
- The standard deduction will be raised to $24,000 for couples and $12,000 for individuals, a near doubling from current levels.
- The child tax credit, currently $1,000, will grow to $1,600, and a new $300 credit for parents and other non-child dependents in the house (the $300 credit expires after five years, presumably to save money).
- Sens. Marco Rubio (R-FL) and Mike Lee (R-UT) have spent months working with Ivanka Trump, and persuaded her to abandon her plan to add a tax deduction for child care in favor of an increased child tax credit. It appears House Speaker Paul Ryan and Ways and Means Chair Kevin Brady (R-TX) have adopted this approach — but have fallen short of the $2,000, more refundable credit Rubio and Lee want.
- The child credit would be available for more wealthy households: It would start to phase out at $230,000 in earnings for married couples, as opposed to $110,000 under current law. It would not be expanded for poor families without a tax liability, as Rubio and Lee had proposed.
- The personal exemption (currently offering households $4,050 per person in deductions) is eliminated, replaced in theory by the higher child credit and standard deduction.
Some deductions are limited, but most remain intact
- The mortgage interest deduction is unchanged for current homeowners, but for all future mortgages, the benefit would be capped at a home value of $500,000, down from $1 million under current law.
- The deduction for state and local income/sales taxes would be eliminated.
- The deduction for state and local property taxes would be capped at $10,000, somewhat curtailing the current tax break.
- A variety of other, much smaller deductions, like the medical expense deduction and the property casualty loss deductions, are repealed.
- Most major tax breaks for individuals — the charitable deduction, retirement incentives like 401(k) and IRA provisions, the tax exclusion for employer-provided health care, the earned income tax credit, and the child and dependent care tax credit — would remain unchanged.
Corporate taxes are slashed dramatically
- The corporate income tax rate will be lowered from 35 percent to 20 percent.
- The corporate tax will be “territorial”: Foreign income by US companies will be tax-free.
- All untaxed income currently held overseas will immediately be taxed at a fixed rate: 12 percent for money held in liquid assets like stocks and bonds, 5 percent for intangibles like buildings and factories.
- Despite the tax being “territorial” in principle, there will be a 10 percent “minimum tax” imposed on profits above a certain threshold from foreign subsidiaries of US companies in the future, to prevent companies from moving income abroad to avoid taxes.
- Additionally, any money that multinational corporations move from the US abroad will be subject to a new 20 percent tax.
- Instead of having companies “depreciate” investments by deducting them over several years, companies could immediately expense all their investments. This benefit expires after five years, presumably to save money, which dampens any positive effect it has on economic growth.
- Companies paying the corporate income tax would face a limit on how much debt they can deduct from their taxable income, a significant change for highly leveraged companies like banks. They could only deduct interest worth up to 30 percent of earnings before interest/taxes/depreciation/amortization. But real estate firms would be exempt from that limit.
- Two big existing credits for corporations — the research and development tax credit and the low-income housing credit — won’t be repealed. But a deduction for domestic manufacturing is gone.
Pass-throughs like the Trump Organization win big
“Pass-through” companies like LLCs, partnerships, sole proprietorships, and S corporations, which are overwhelmingly owned by rich individuals like Donald Trump and currently pay normal income tax rates after their earnings are returned to the companies’ owners, would get a huge number of tax cuts too:
- Taxes on pass-through income would be capped at the 25 percent bracket rather than the top individual rate.
- Pass-through companies would still be able to deduct interest on loans in full, unlike C-corporations.
- The 25 percent bracket creates a huge loophole for rich people, who could incorporate as sole proprietorships and “contract” with their employers so their income is pass-through income rather than wages.
- To partially control that, the law would assume that 100 percent of earnings from professional services firms, like law firms and accounting firms, is wages, not pass-through income. For other businesses, people actively involved in the business as more than passive investors would see 70 percent of their income classified as wages and taxed normally, and 30 percent taxed at the pass-through rate.
Two other significant tax provisions are abolished:
- The alternative minimum tax, which increases taxes for certain affluent or upper-middle-class households, is repealed.
- The exemption for the estate and gift tax, the most progressive component of the federal tax code, only paid by extremely rich estates, is doubled, further limiting who pays it, and the whole tax is then gradually abolished.
And a brand new 1.4 percent tax on university endowment income is added.
The case for the bill
For the public at large, the case for a massive corporate tax cut is sort of hard to grasp. Seventy-three percent of Americans, and 53 percent of Republicans, say they want corporate taxes either kept the same or raised, according to Pew Research Center polling. That the cuts are pared with some tax increases on individuals, like the elimination of the deduction for state and local income taxes and the Social Security Number requirement which kicks some 3 million kids off the child tax credit, makes the choice even more confounding.
But the GOP has a specific economic theory that it claims supports the bill and makes the changes it envisions worthwhile.
The basic idea is that while most economists believe corporate taxes are primarily paid by owners of capital (that is, people who own stock in corporations) in the form of lower profits, a sizable minority, including White House chief economist Kevin Hassett, think that a large share of the tax is paid by workers in the form of lower wages.
In an influential 2006 paper analyzing data in 72 countries across 22 years, he and his American Enterprise Institute colleague Aparna Mathur estimated that a "1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.” A second paper in 2010 found a slightly smaller effect (a 0.5 to 0.6 percent decrease in wage rates per 1 percent increase in corporate tax rates) but still concluded that labor was ultimately paying the tax. More than paying it, in fact — they estimate that labor pays 2,200 percent of the tax’s burden, a really extraordinary estimate.
That suggests that cutting corporate taxes would be a very easy way to raise wages for ordinary workers. Hassett has also gone a step further and, with his AEI colleague Alex Brill, argued that cutting the corporate income tax could raise economic growth enough to actually increase revenue: a Laffer effect. They conclude, based on a data set covering rich developed countries from 1980 to 2005, that the revenue-maximizing corporate tax rate is about 26 percent, significantly below the US rate.
Plenty of economists and tax researchers have argued that Hassett’s results in particular are implausible, and reach some absurd conclusions. Jane Gravelle and Thomas Hungerford at the Congressional Research Service noted that the initial Hassett-Mathur study predicted a $1 increase in the corporate tax would reduce wages by between $22 and $26. Their 2010 follow-up predicted a wage loss of $13 per for every additional dollar paid in corporate taxes. But it's very strange to imagine a corporation responding to an increase in costs like that. The implication is that corporations could have cut wages significantly before the tax hike without negative consequences and simply didn’t.
A more recent survey of the empirical research by Reed College’s Kimberly Clausing found “very little robust evidence linking corporate tax rates and wages.” The consensus in the field remains that most of the tax is paid by capital (as Treasury and the CBO both assume).
But if you believe that corporate tax cuts lead to raises, then corporate taxes should help workers. The biggest beneficiaries will, again, be rich people earning the most wages, but the benefits will trickle down more broadly too.
Other, smaller provisions of the reform package also have reasonable cases for them. The mortgage interest deduction is a huge distortion that leads to fewer people renting than should and hoards benefits among rich homeowners; the bill would reduce that advantage. Opponents of the state and local tax deduction, which the bill would largely eliminate, argue it’s regressive and concentrates benefits on rich states rather than poor ones that actually need the money. The current mix of standard deductions, personal exemptions, and child credit is needlessly duplicative, and the bill simplifies it a bit.
Others are a bit harder to defend. Many economists oppose wealth taxes like the estate tax on the grounds that they penalize savings, but intergenerational transmission of wealth also has huge negative externalities (heirs less willing to work, less equal politics, etc.) that eliminating the estate tax entirely would worsen.
Cutting taxes on pass-through income is particularly hard to defend. Pass-throughs already get a sizable tax advantage relative to other companies. While corporate profits are taxed in two stages — first by the corporate income tax, and then through dividend or capital gains taxes — pass-through income is only taxed once, at the individual level. This change would worsen that advantage.
Pass-throughs will counter that in many cases, people who own stock through 401(k)s and IRAs don’t have to pay capital gains or dividend taxes, and so their profits are only taxed at the corporate rate, which is lower than the top individual rate (and would be much lower under this plan), putting pass-throughs at a potential disadvantage. But analysts who’ve looked at this comparison generally conclude that pass-throughs are taxed less overall, and certainly don’t need another break.
Where the bill goes from here
The Joint Committee on Taxation has scored the bill as costing $1.44 trillion, just under the $1.5 trillion the GOP budget set aside for tax reform.
And because it increases the deficit by $171.1 billion in 2027, and that amount is increasing not decreasing at decade’s end, it’s reasonable to assume it increases the long-run deficit. Some provisions phase out, presumably to lower the long-run deficit effects for scoring purposes, but that’s unlikely to be enough. And so long as the legislation still increases the long-run deficit, it’s a nonstarter in the Senate, which explains why that body has taken a different approach.
The big question, then, isn’t whether or not the bill passes now. It’s whether a Senate rule-compliant bill could pass the House in the future.