Economy & Business

Tax Reform: A Mixed Bag

(Photo: Carroteater/Dreamstime)
The bill will hike the deficit — but there are genuine improvements here, too.

It looks like the Republicans pulled it off: On Friday, a conference committee reached an agreement on tax reform. Both houses of Congress are expected to pass the final bill this week, and the president’s signature will make it law.

The legislation is a mixed bag. It adds to the deficit at a time when we’re already drowning in debt, and it doesn’t simplify the tax code as much as many had hoped it would. Nonetheless, there are some serious reforms here that should endure even if Democrats retake the government soon. Let’s take a tour of the major high and low points.

1. There are about $1.5 trillion in tax cuts over ten years. No, they won’t pay for themselves.

We’re still waiting on the budget wonks to say exactly how much the final bill will widen the deficit. But the GOP’s resolution earlier this year gave them $1.5 trillion to play with, and all the previous versions blew pretty much the whole thing. The handful of tweaks made last week won’t change this, according to a “very preliminary” analysis from the Joint Committee on Taxation.

Economic growth might make up some of the loss, as the government would collect more in taxes in a bigger economy. But no plausible estimate has suggested that any GOP bill this year would fully “pay for itself,” and some credible sources say the economic boost will be small. Though tax cuts can indeed spur growth in various ways, a bigger deficit can counteract this effect by “crowding out” investment, a phenomenon I dug into last month.

It’s also true, as the bill’s defenders say, that the $1.5 trillion estimates come from a “current law” baseline — they represent how much revenue we lose relative to a world where current law plays out as written, with various expensive provisions expiring when they’re scheduled to, when in reality Congress will likely extend them. But the bill itself has the same problem, only more so: All of the individual tax cuts simply expire after 2025, for example, which will similarly force Congress to extend them and increase the revenue hit of the policy change.

Simply put, the bill adds to our debt, which is already massive and on an unsustainable trajectory.

2. The individual tax code is reworked and simplified, to the benefit of most.

A lot of special-interest tax breaks that were supposed to die, didn’t. Deductions for mortgage interest and state taxes were scaled back less than hoped. The credit for electric-car buyers survived too. Someone who works in exchange for a “tuition waiver” worth tens of thousands of dollars still won’t have to pay any taxes on it, and a tax break for higher-ed savings is expanded to cover private K–12 schools too.

But the bill does something huge: It nearly doubles the standard deduction, to $12,000 for individuals and $24,000 for married couples. This dramatically weakens the remaining deductions because relatively few people will itemize anymore. The higher standard deduction isn’t the financial windfall Republicans pretended it was at the beginning of this process, because personal and dependent exemptions are eliminated to make up for it. But it reduces distortions in the tax code and makes taxes easier to file.

What will help many taxpayers financially is that (A) rates are coming down slightly and (B) the child tax credit is doubling to $2,000 (and not starting to phase out until couples hit $400,000 in income, versus $110,000 today). Further, while Senator Marco Rubio didn’t succeed in making the credit refundable against payroll taxes so all low-income workers could take advantage of it, he did manage to modestly expand its refundability in a last-minute deal. This is a major victory for family-oriented conservatives who’ve been clamoring for a bigger child tax credit.

True, some people will see tax hikes from losing their exemptions and deductions. But “the bill would reduce taxes on average for all income groups,” even according to the left-leaning Tax Policy Center. As to the question of who gets the biggest cuts . . . well, that probably depends on how you prefer to do the math.

3. Business taxes get a much-needed overhaul too.

Today, America has the highest statutory corporate tax rate in the developed world at 39 percent (including state-level taxes); thanks to various loopholes and carve-outs, corporations actually pay more like 29 percent, which is still high. Unlike most other countries, the U.S. also taxes companies on income they earn abroad when they bring it home (with a credit for taxes paid to other countries). There’s a bipartisan consensus that it would be good to bring the rate down, maybe to the mid to high 20s, while eliminating loopholes and switching to a “territorial” instead of “worldwide” system for foreign earnings.

That’s mostly what the bill does — except it cuts the rate all the way to 21 percent, a more controversial proposition that will either turbocharge economic growth or bleed revenue to benefit the rich, depending on whose estimates you believe. It further (temporarily) allows businesses to fully deduct certain investments rather than deducting depreciation over a number of years.

Also controversial is the bill’s treatment of “pass-through” businesses, whose income is passed through to their owners and taxed through the individual income-tax system. The final compromise will allow owners to deduct 20 percent of pass-through income, which could encourage people to cheat by characterizing other income this way, though there are rules to prevent this.

Anyhow, even if Democrats will clamor to re-raise the corporate rate and re-revamp pass-throughs when they regain power, they should keep the other improvements the GOP bill makes.

4. No more individual mandate, starting in 2019.

Because fewer people will get health-care subsidies if they’re not forced by buy insurance, this freed up hundreds of billions of dollars, as estimated by the Congressional Budget Office, for the bill to spend on tax cuts — above and beyond the $1.5 trillion in new deficit spending noted above. The true savings will probably be less than that.

It ain’t pretty, but it’s a win all the same.

Either way, this is a risky move. Without the mandate — but with insurers still banned from charging sick people more — some people will abuse the system, going without insurance until they get sick and then signing up for plans. This will certainly raise premiums and might destabilize the individual market as well.

The CBO’s current thinking is that the market will be basically okay even without the mandate; let’s hope they’re right. But let’s also hope Congress can revisit health-care reform before the mandate’s repeal goes into effect.

At any rate, the GOP finally has its big win for the year. It ain’t pretty, but it’s a win all the same.

READ MORE:

The GOP’s Tax Wager Is Worth the Gamble

Delaying the Corporate Rate Cut Won’t Hurt the Economy

Overheated Rhetoric on Tax Reform

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