The Republicans are finally at the finish line of a massive tax cut bill, the first major legislative accomplishment of Donald Trump’s Presidency and the biggest overhaul of the tax code in three decades. But, tax policy is mindbogglingly complex. Sorting through all the hot takes and rhetoric can leave your head spinning. Here are five things people most commonly misunderstand about the tax bill explained.

1.

Does it pay for itself?

The tax cut bill will pay for itself in terms of greater economic growth, but not enough to offset the reduction in government revenues. It will reduce federal revenues by about $1.47 billion dollars on a static basis. But, that’s only if everything stays the same. Lower taxes will also result in stronger economic growth. However, there’s debate about exactly how much. The Tax Foundation, a non-partisan but conservative-leaning think tank, estimates that the U.S. economy will be about $4 trillion dollars larger over the next decade than it would otherwise have been without the tax cut — in this sense, it does pay for itself. Other models suggest more modest growth, but most agree that the bill will boost tax revenues which, at least to some extent, will offset the static cost of the bill. On a dynamic basis, which takes this economic growth into account, the price tag is considerably less — only $448 billion according to the Tax Foundation.

SOURCE: Tax Foundation

2. Why do the wealthy and big corporations benefit most?

The centerpiece of the tax cut bill is a reduction in the corporate tax rate from 35% down to 21%. In dollar terms, this is the largest tax reduction. But, it is also the most important provision in terms of creating economic growth.

The U.S. has among the highest corporate tax rates in the world.

Source: Tax Foundation

Even taking into account various deductions and credits, the tax burden on U.S. businesses is still quite high relative to its peers. Reducing the corporate tax rate brings U.S. business taxes in line with other countries, giving businesses less reason to move overseas where taxes are lower. This will mean more jobs in the U.S. and stronger economic growth that raises wages for ordinary Americans. Pretty much all of the economic growth the tax bill creates comes from this provision.

It is true that the largest share of the tax cuts go to wealthier individuals. But, it’s important to remember that wealthier people pay the largest share of taxes already. This doesn’t  change under the tax bill.

Source: Pete Peterson Foundation

3. Is eliminating tax deductions bad?

The tax code is such a maddening mess because it’s not just about taxes. For years politicians have used it as a way to subsidize things they like without actually calling it a subsidy.

The result is dozens of tax deductions and tax credits that taxpayers must wade through to figure out how much they actually owe. To make the tax code simpler, you need to eliminate many of these deductions, all of which are popular with somebody.

The bill does eliminate most individual tax deductions and limits others. But, it also increases the standard deduction. This will allow most people to file their taxes without having to itemize deductions, vastly simplifying the process of filing taxes:

Increases the standard deduction from:

  • $6,500 to $12,000 for single filers;
  • $9,550 to $18,000 for heads of household, and;
  • $13,000 to $24,000 for joint filers.

For most taxpayers, the higher standard deduction will make up for any lost tax benefits of deductions being eliminated. Also, it does maintain three of the most common deductions.

Tax Deductions Maintained

  • Deductions for charitable giving;
  • mortgage interest, up to $750,000; and,
  • state and local income and property tax up to $10,000.

The bill also doubles the child tax credit from $1,000 to $2,000. Unlike a deduction, which reduces the amount of income on which you pay taxes, a tax credit directly reduces your tax bill.  So, if you owe $10,000 in taxes and have one child, you can subtract $2,000 from what you owe, reducing your tax bill to only $8,000. It also makes up to $1,400 of this tax credit refundable. This means if you owe no taxes, you get a $1,400 tax refund anyway.

How much you will benefit will depend on the tax deductions you take. Limits on state and local tax deductions, for example, will mean that if you live in a high tax state and pay a lot of state taxes, you may not see as big a benefit as those in low tax states. Likewise, if you take an unusually large number of deductions, you might not benefit as much. But, between reduced rates and the larger standard deduction, the vast majority of people will come out ahead.

4. Will it really help the economy?

There’s no question that tax cuts create economic growth, although there’s room for debate about how much. The Tax Foundation estimates that the bill will create 339,000 jobs over the next decade, increase wages by 1.5% and increase GDP by 1.7%. Other models may predict more modest growth effects, but none suggest that there will be no growth at all.

SOURCE: Tax Foundation

5. Will regular  Americans  benefit?

Most taxpayers would see their taxes reduced. All tax brackets receive a cut, and middle-class families with children make out especially well, mostly due to the doubling of the child tax credit, which is used by 22 million taxpayers. Exactly how much any individual person benefits depends a lot on your particular situation. The Tax Foundation provides a good breakdown of the impact on various hypothetical taxpayers. 

However, to reduce the cost of the bill over the ten-year budget window, Congress decided to make most of the individual tax cuts temporary. If the tax cuts aren’t restored before they expire in a few years, then it is true that a lot of people would see their taxes go up. This is a budget gimmick necessary to get the bill through the Senate without requiring 60 votes. But, Congress may correct this down the road. So, in the short term, the tax bill will benefit most people; in the long term, it may not depending on how confident you are that Congress will go back and fix it.

Bottom line

The tax bill isn’t the apocalypse its detractors claim, but it isn’t perfect either. Like most legislation, it is the product of political compromises that will thrill some and infuriate others. It will simplify individual taxes and make U.S. businesses more competitive. Most taxpayers will see their bill to Uncle Sam reduced and all Americans will benefit from stronger economic growth.

It does create a revenue hole that Congress will eventually have to fill by future reductions in spending and Congress will also have to revisit tax reform in a few years to extend expiring temporary provisions if it is to avoid tax hikes. Also, it arguably could have gone further in tax simplification.

But, if it works as hoped, and the economy grows at a brisk pace, the flaws in the bill may not seem so worrisome. Ultimately, whether you’ll think this bill is good or bad boils down to whether you believe that America will benefit more from putting additional money in the hands of the private sector or keeping it in the hands of the federal government.

Comments

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5 COMMENTS

  1. I have to disagree with a number of suppositions in this article. It relies on The Tax Foundation, while disregarding estimates from bipartisan groups. “Will most americans benefit?” While the idea that tax cuts will spur enough economic growth is up for debate and, I believe, doubtful, the idea that health care premiums will rise with fewer, younger, healthier people signing up, is proven, and those costs will drastically offset any temporary gains for the middle class. That I, with higher income, will be able to form a company, and lower my actual, EFFECTIVE tax rate, than the remaining coal miners so desperate for some form of relief, is absurd.

    • Thomas, thanks for your feedback. As of publication, the Tax Foundation was the only outfit that had produced a dynamic score on the final bill. Readers should know that we try not to disregard anything. This was what was available. We do note that other models may show more modest growth effects. However, I did add a reference that notes that Tax Foundation leans conservative in response to your concern.

      You make a valid point about the individual mandate and premium rises. It’s a topic that we’ve discussed in several previous posts and has been thoroughly debated so did not feel compelled to revisit here. But, I might add a note mentioning it.

    • My general bias is that CBO tends to overstate the effectiveness of the of the individual mandate in compelling coverage. CBO has repeatedly revised it’s modeling on this point but continues to overshoot take-up rates. I believe that adverse effects of repealing the individual mandate on risk pools are likely already baked into current premium rates, and potential reinstatement of CSR payments may offset them regardless. More discussion of this in our article on the CBO cost estimates.

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