House Republicans unveiled their plan to update the nation’s tax code on Thursday.
If they are successful at passing the plan—known as the Tax Cuts and Jobs Act—it will mark the first time in more than three decades that Americans will have a chance to experience the benefits of comprehensive, pro-growth tax reform.
Tax reform should provide relief to all Americans, and ultimately help the economy break out of its stagnant economic growth. To achieve this, tax reform should simplify the current tax code, lower tax rates on individuals and businesses, and update the business tax system to make the U.S. competitive again and remove barriers to investment and job creation.
A plan that does this has the potential to unleash higher wages, create more jobs, and spread untold opportunity through a larger and more dynamic economy.
The GOP tax plan scores well on all these fronts.
The proposed plan would vastly simplify the tax code by eliminating a host of unnecessary and inefficient provisions designed to benefit special interests.
It would also simplify the process of tax filing by doubling the size of the standard deduction, which would cut in half the number of taxpayers who need to itemize their deductions. In addition, the condensed rate structure—which collapses seven rates into four—also simplifies the tax code.
2. Lower Rates
The proposed plan would drastically lower tax rates for corporations, small businesses, and lower- to moderate-income individuals and families.
The new 20 percent corporate tax rate would help make the U.S. competitive with the rest of the world, and the top 25 percent small business or pass-through tax rate would go a long way toward stimulating entrepreneurship, job creation, and income growth across all income groups in America.
By maintaining the top marginal tax rate on individuals, however, the plan would fail to achieve optimal economic growth, as it leaves a significant portion of economic activity subject to a 39.6 percent federal tax rate (43.4 percent including the Obamacare surtax).
3. Business Taxes
The combination of business tax reforms—including a top 20 percent corporate tax rate, five years’ worth of full expensing, and a modernized international tax system—would provide a huge boost to the U.S. economy and its workers.
These business changes have the potential to bring trillions of dollars back into the United States and to significantly boost economic output, jobs, and incomes within the U.S.
This tax proposal marks a huge improvement over the status quo. It would go a long way toward making America more competitive and toward improving the lives and financial well-being of all Americans.
Heritage Foundation experts are providing their assessment of the GOP tax plan. This page will be updated throughout the day with their analysis.
Tax Plan Details
Lowers and Simplifies Bottom Rates, but Keeps Top Marginal Rate
The tax reform package would simplify and lower the current tax rate structure, from seven different rates ranging from 10 percent to 39.6 percent, to four rates: 12 percent, 25 percent, 35 percent, and 39.6 percent.
Most low- to middle-income earners would face lower marginal tax rates, which would help encourage more work and also put more money back into taxpayers’ pockets to spend more productively than the federal government.
Unfortunately, the plan maintains the top marginal rate of 39.6 percent (which reaches 43.4 percent when factoring in the Obamacare surtax).
While only 1 of every 150 taxpayers actually pays the top rate, more than 1 of every $5 of taxable income is subject to that tax rate. That means a lot of economic activity is affected by the top rate, and lowering it would have a significant and positive impact on investment, productivity, incomes, and job growth in the U.S.
Maintaining a high top rate for wealthy Americans may make the plan more politically palatable, more appealing to average Americans, and help reduce the alleged “costs” of the tax reform plan. In reality, though, it would not result in nearly as much revenue as static estimates project, and it would limit the plan’s ability to maximize job growth and boost incomes for everyday Americans.
New Income Brackets: Lower Marginal Rates for Many, Higher Rates for Top Earners
The new and higher income brackets would mean lower marginal tax rates and significant tax cuts for most Americans making below about $250,000. A significant portion of upper-income earners, however, would face higher marginal tax rates and higher tax bills.
On the bottom end of the income scale, single workers who previously paid a tax rate of 10 percent on incomes up to about $9,000, and 15 percent on income between $9,000 and $38,000, would now be taxed at a flat rate of 12 percent on all income under $45,000.
When adding on the newly doubled standard deduction of $12,000, that means the first $57,000 of an individual’s earnings are taxed at no more than 12 percent.
Married couples who previously faced marginal rates of 10 percent up to the first roughly $19,000 of income, and 15 percent up to about $76,000 in income, would now face a 12 percent rate on the first $90,000 of income.
Factoring in the newly doubled standard deduction of $24,000 means the first $114,000 of a married couple’s earnings would be taxed at no more than 12 percent.
The new middle bracket of 25 percent is also set at more than twice the level of the current 25 percent bracket (and above even the current 28 percent bracket). This would translate into significant tax cuts for any individual making below $200,000 and any married couple making below $260,000.
On the upper end, the new 35 percent bracket kicks in much sooner than before, at about half its current income level. Currently, the 35 percent bracket begins at about $417,000 in income for both single and married taxpayers. Under the new plan, the 35 percent bracket kicks in at $200,000 for individuals and $260,000 for married couples.
This would result in significant tax increases for many upper-income taxpayers.
While individuals who make just over the new 35 percent bracket level ($200,000 for individuals and $260,000 for married couples) would still benefit overall from the lower limits on the 12 percent and 25 percent brackets, taxpayers who make significantly above the new 35 percent bracket could pay significantly higher taxes.
Finally, the income limit for the top marginal tax rate of 39.6 percent would increase slightly for individuals in the proposed plan, from about $418,000 to $500,000.
For married taxpayers, the increase is more significant, as the plan effectively does away with the marriage penalty by setting the income level for married couples at twice that of individuals. This is an increase in the top income tax threshold from about $470,000 to $1,000,000 for married couples.
Getting rid of the marriage penalty is a positive step, and subjecting less of married couples’ incomes to the top rate is helpful—but the top marginal tax rate would still affect a significant portion of economic activity, and thus limit the plan’s potential to grow the economy.
Doubled Standard Deduction Would Simplify Taxes for Tens of Millions
The GOP plan roughly doubles the standard deductions from $6,350 to $12,000 for individuals, and from $12,700 to $24,000 for married couples. This would go a long way toward helping Americans keep more of their hard-earned dollars.
Doubling the standard deduction would also vastly simplify tax filing for tens of millions of Americans who would no longer need to itemize their deductions. This would make tax filing easier and would make postcard-sized tax returns a reality for certain taxpayers.
We estimate that doubling the standard deduction would roughly cut the percentage of taxpayers who itemize their deductions in half—from 30 percent to 15.5 percent—saving about 22 million taxpayers from the headache of keeping track of all their itemized deductions.
When combined with the plan’s elimination of state and local income and sales taxes, the percentage of taxpayers who itemize their deductions would drop even further.
State and Local Deductions Partially Eliminated
The proposed tax plan would partially eliminate state and local tax deductions by getting rid of the deduction for income or sales taxes, and by capping the deduction for property taxes at $10,000.
State and local tax deductions provide no economic benefit. In fact, they are outright detrimental to the economy.
By allowing those who itemize their taxes to deduct property taxes as well as income or sales taxes they pay to state and local governments, these deductions shift the burden of high-tax states onto low-tax states, and spread a portion of high-income earners’ taxes onto lower- and middle-earners’ tax bills.
For example, just seven states (California, New York, New Jersey, Illinois, Massachusetts, Maryland, and Connecticut) receive more than 50 percent of the value of the state and local tax deductions.
And on net, the average millionaire receives 102 times as much benefit from the state and local tax deductions as a typical household that makes between $75,000 and $100,000.
Eliminating the sales and income tax deductions would be a huge benefit to at least 85 percent of Americans.
Currently, 70 percent of taxpayers do not itemize their deductions and therefore receive no benefit from the state and local tax deductions. We estimate that doubling the standard deduction as proposed in the tax plan would reduce the percent of taxpayers that itemize to just over 15 percent.
Eliminating these deductions would also provide a huge boost in federal tax revenues to help accommodate the plan’s lower marginal tax rates, which benefit all taxpayers (even those who lose their state and local income or sales tax deductions).
Maintaining the property tax deduction could have unintended consequences that would adversely impact lower- and middle-income families. That’s because eliminating the income and sales deductions but keeping the property tax deduction would encourage states to concentrate their tax burden on property taxes, which could make homeownership less affordable—particularly for low- and middle-income families.
The plan’s $10,000 cap on property tax deductions would help limit the subsidy to very wealthy homeowners in high-tax states, but the cap should be even lower if the goal is to maintain the deduction primarily for middle-class families.
According to IRS data, the only taxpayers who would be affected by this cap are those who make well over half a million dollars a year.
While this partial elimination would be a big step in the right direction, full elimination—including the property tax—or at least a lower cap, would be far more efficient and would provide additional revenue to further reduce marginal tax rates.
Eliminating Personal Exemptions, Increasing Child Tax Credit Would Better Target Families
As a general principle, Congress should refrain from implementing social policy through the tax code. But if lawmakers do want to provide child-related financial assistance to households through the tax code, the child tax credit is a more efficient way to give targeted relief than the personal exemption.
The proposed tax plan would eliminate the existing $3,400 personal exemption. When combined with the new double-sized standard deduction and $600 increase in the child tax credit (from $1,000 to $1,600), virtually all taxpayers—including families with children—would face lower tax bills, even excluding the current personal exemption.
But as mentioned, the personal exemption is not the most efficient way to provide relief to taxpayers based on their family size, as the progressive nature of the tax code means that wealthier families receive more value per person from the exemption than lower- and middle-income families.
The child tax credit is a better way to provide child-related financial relief to families who need it most.
Unlike the personal exemption, the value of the child tax credit is not smaller for lower-income families. In fact, it is lower and even nonexistent for upper-income families, as the credit phases out rather quickly between income levels of $110,000 and $160,000.
So while the enhanced child tax credit would not contribute much to economic growth, it would help provide additional tax relief to low- and middle-income families with children.
Cutting Corporate Tax Rate Would Raise Workers’ Wages
Permanently lowering the corporate tax to 20 percent is the single most important pro-growth change included in the Tax Cuts and Jobs Act.
U.S. businesses currently face the highest statutory corporate tax rates in the developed world. The United States ranks consistently as one of the worst in business tax environments in the world.
Over the past few decades, countries around the world have steadily lowered their corporate tax rates, leaving American businesses behind.
The Tax Cuts and Jobs Act takes a bold step to move the U.S. corporate tax rate into line with those around the world. The plan calls for a permanent 20 percent corporate tax rate, down from the current federal rate of 35 percent.
A 20 percent corporate tax rate would encourage significant new investment in the U.S., which would primarily benefit workers through higher wages and more jobs.
The permanence of the tax cut is especially important. A temporary rate cut would have left significant potential economic growth on the table. A permanent tax cut, as proposed Thursday, would drive growth in business investment, which would lead to greater worker productivity, more hiring, and significant wage increases.
The benefit to workers of a corporate tax cut are well established. The president’s Council of Economic Advisers recently released a report showing that a lower corporate tax rate could boost workers’ wages by $4,000, and as much as $9,000 a year.
According to research from Boston University, updating the tax code would result in a roughly $3,500 wage increase for every working American family. Similar reforms have been modeled by the Tax Foundation, finding an increase in wages for an average household of around $4,000 a year.
And analysis from Marquette University shows that tax reform could increase wages for an average family by as much as $14,000 a year.
Tax reform resulting in wage increases is exactly what happened over the past decade and half in Canada. In 2007, Canadians began lowering their corporate tax rate, and wages grew significantly faster in Canada than in other comparable countries as a result.
It is due time for the U.S. to reposition itself as a top global destination for business, and lowering the U.S. corporate rate is the single most important change to get us there.
Lower Tax Rates on Pass-Through Businesses
Most businesses, including the vast majority of small businesses, are taxed as S corporations or partnerships. Rather than pay taxes at the business level, the income they earn is “passed-through” to the individual owners who pay taxes on their individual tax returns.
Pass-through businesses account for about two-fifths of payroll.
The GOP tax proposal would reduce the tax rate these businesses pay to 25 percent from as high as 40 percent. This aspect of the proposal will help small firms grow and have a positive impact on job creation and wage growth.
The proposal also contains rules to prevent higher-income salaries from being re-characterized as pass-through income. Although such rules are needed if pass-through income is to be taxed at a lower rate than high-salary income, they introduce substantial complexity to the law.
There is no simple way to address the problem in a fair and economically constructive manner.
The GOP tax bill would do the following:
- Investors who do not work for the business get the 25 percent rate.
- For those that work for the business, there are rules determining how much is salary (subject to higher rates) and how much is “pass-through” or “capital” income subject to the lower rate. These rules are as follows:
- In general, 70 percent is treated as salary and 30 percent as pass-through or capital income
- Taxpayers can elect to use an alternative “facts and circumstances” test, which would determine the capital income by looking at the investment in the company and multiplying that by the sum of the federal short-term rate, plus 7 percent (i.e. about 8 percent).
- There are, in addition, rules saying that specified service companies are not eligible for the 25 percent rate. These include “any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.”
- There are, in addition, specific anti-recharacterization rules to prevent salary income from being recharacterized that are not caught by these rules.
- There are also rules allowing certain tax attributes (notably capital gains) to survive these provisions.
So, many personal service pass-through entities would not get any benefit from the 25 percent lower rate for pass-throughs, and many owner-operators in effect would get about a 3-point rate reduction to 32 percent (because 30 percent of the 10-point differential, if they are in the 35 percent bracket, is 3 percentage points).
Lets Families Save for Private K-12 Education Expenses, and Advances School Choice
The GOP tax plan would take the long-overdue step of allowing parents to use elementary and secondary education expenses under 529 savings plans. This could help parents across the country access more education options for their children.
The plan would effectively eliminate the existing Coverdell savings account program (which allows families to save for their children’s K-12 expenses) by enabling families to put post-tax earnings into an account, with any interest that accrues growing tax-free if put toward K-12 expenses.
The tax plan would replace the Coverdell system of K-12 savings, which was limited in scope at just $2,000 annually, and would combine it with the current 529 college savings plan, providing a much more robust K-12 savings vehicle for families.
As the tax plan reads:
Under the provision, new contributions to Coverdell education savings accounts after 2017 (except rollover contributions) would be prohibited, but tax-free rollovers from Coverdell accounts into section 529 plans would be allowed. Elementary and high school expenses of up to $10,000 per year would be qualified expenses for section 529 plans.
Families could also leverage their 529 savings to pay for expenses associated with apprenticeship programs.
As The Heritage Foundation has previously written, allowing K-12 expenses to be 529-eligible is smart policy. In a 2012 report, we explain:
Existing ‘529’ college savings accounts should be expanded to allow families to save for K-12 education expenses. … [This]would allow parents to use more of their money for a child’s private school tuition or other education expenses. Since most states offer either tax credits or deductions to encourage saving in a 529 plan, expanding it to make K-12 expenses allowable would effectively create opportunities for millions of American families to open [education savings accounts].
We also explain how 529 accounts have become extremely popular among families. Investments in the accounts have increased significantly in recent years.
In 2000, there were $2.6 billion in total investments in 529 plans. By 2006, that figure had increased to $92 billion, and by 2011 it had reached $135 billion.
The biggest advantage to investing in a 529 plan is that withdrawals from the accounts are free from any federal income tax. Funds spent from 529s are tax-free, as long as disbursements are used to cover qualified educational expenses.
Moreover, of the 44 states that levy an income tax on earnings, 35 states offer credits or deductions for contributions to 529.
Expanding section 529 of the Internal Revenue Code to allow families to contribute money to 529 plans for K-12 educational expenses would enable families to save for K-12 education-related expenses while increasing their ability to pay for education options outside the public school system.
Moving Closer to Free Market Energy Policy
The Tax Cuts and Jobs Act makes a profound policy statement that is to be commended: The goal of the bill’s energy measures is “to move closer to a free-market energy agenda.”
Free markets supply affordable energy, innovation, and a clean environment better than any heavy-handed regulatory approach to manipulate how people produce and use energy.
In getting to that goal, The Tax Cuts and Jobs Act would repeal and sunset targeted tax credits for specific energy sources, technologies, and extraction methods. Regrettably, though, the bill extends and phases out several energy tax credits that expired in 2016 and 2017.
Eliminating the preferential treatment in the tax code would drive energy innovation, competition, and job creation, resulting in a healthier, robust energy sector that isn’t dependent on Washington.
Targeted tax credits have become a popular and prevalent method for the government to award preferential treatment to certain energy industries. Tax credits initially intended to last only a few years continue to get additional lifelines from politicians who benefit from industries taking advantage of the credits in their respective districts and states.
Congress does no service to these energy technologies and companies by subsidizing them.
Rather than increase competition in energy markets, tax credits to specific energy technologies and sources distort energy investments. They artificially attract private-sector interest to the energy sources that Washington politicians think should be in America’s energy portfolio.
On the issue of energy tax credits, The Tax Cuts and Jobs Act is a mixed bag.
Cutting oil and natural gas subsidies.
Proponents of renewable subsidies often argue that oil companies receive subsidies, so wind and solar should get some, too.
Yet the left often overstates its case on what truly counts as a subsidy for oil (e.g. broadly available tax credits) and ignores the fact that the government does far more to harm natural resource development than to help it.
The Tax Cuts and Jobs Act would eliminate bona fide subsidies targeted to the oil industry. It ends the enhanced oil recovery credit, which gives oil producers a 15 percent tax credit for costlier methods and technologies, such as injecting liquids and carbon dioxide into the earth.
Many enhanced oil recovery processes are no longer in use. The U.S. is now awash in oil resources, with new, innovative fracking technology to access it.
“The bill would also repeal the credit for marginal well production. Marginal wells are wells that produce heavy oil or minimal mounts of oil on the order of 15 to 25 barrels of oil per day. The credit for these wells is another safety-net tax provision that needs to go.”
Green energy subsidies: a mixed bag.
The Tax Cuts and Jobs Act is a mixed bag on green energy policy, but if Congress can keep its promises, will be good policy in the long run.
The House does well in not using tax reform as an opportunity to extend wind and solar tax credits, as it has often done in the past. The omnibus spending bill in December 2015 was the last time Congress did this, constituting the current tax treatment of wind and solar to begin sunsetting those credits in 2022.
That decision diverted over $14 billion to the green energy industry over 10 years, which American taxpayers had to make up for. However, if Congress can keep its promise to sunset these wind and solar subsidies (as The Tax Cuts and Jobs Act does), it will be a victory in the long term for the taxpayer and the competitiveness of the energy sector at large.
Mixed with this, though, is how the bill approaches a slew of tax credits to other technologies—tax credits that had already expired.
The House should have let sleeping bears lie and not reopened these credits. Instead, the Tax Cuts and Jobs Act renews these credits and sets them on the same sunsetting track as wind and solar. The technologies include: hybrid solar lighting systems, fuel cells, small wind turbines, biomass, and geothermal energy.
This is poor policy. But if Congress can keep its promise to actually sunset these tax credits, it will be a victory in the long term.
The House also wisely clarifies which projects are eligible. In the past, subsidized projects had to have begun construction by the credit expiration date. This opened the door for fraud, where a company could stockpile solar panels or pour some concrete for “future projects” and still get the tax write off.
The Tax Cuts and Jobs Act requires “a continuous program of construction” for a company to be eligible.
Nuclear tax credits.
The Energy Policy Act of 2005 created a tax credit for new nuclear power reactors up to the first 6,000 megawatts of capacity brought online by 2020. The Tax Cuts and Jobs Act extends that tax credit beyond 2020.
Of course, there is a reason for this: Several nuclear power reactors have struggled mid-stream to complete construction and will not make the 2020 deadline as planned.
If the nuclear industry was not able to get a few power plants permitted and built in 15 years, Congress should perhaps delve more into why. The way for Congress to help the nuclear industry compete is not with handouts and bailouts, but by addressing the government-imposed regulatory barriers that are stifling investment and technological innovation.
The best way to level the playing field is not to press more thumbs on the scale, but instead to remove all targeted tax credits for the production and consumption of energy.
The Heritage Foundation has consistently called for the elimination of all energy subsidies, including targeted tax credits for natural resource extraction, nuclear, renewables, biofuels, electric vehicles, and more. The federal government should stop using the tax code, loan guarantees, mandates, and grants to pick winners and losers in the energy space.
The Tax Cuts and Jobs Act is an important and necessary step in the right direction, but it should not extend and phase out credits that have already expired.
This piece originally appeared in The Daily Signal