By Ryan Ellis
A framework for tax reform was released this week by the “Big Six” who will have a hand in writing the final legislative product: Speaker Paul Ryan, House Ways and Means Committee Chairman Kevin Brady, Senate Majority Leader Mitch McConnell, Senate Finance Committee Chairman Orrin Hatch, Treasury Secretary Steve Mnuchin, and White House NEC Director Gary Cohn.
This framework delicately strikes a balance between two priorities that are absolutely essential to getting tax reform done: making the tax system far more pro-growth and pro-jobs on the one hand, and making tax season simpler and fairer for the middle class on the other.
I’ve written before about how every single GOP tax reform plan that has ever become law has had this mixture. Alloying the priorities of the C-suite and Main Street is not only smart politics, it’s the only way to get a majority for tax reform.
Let’s look at both of these lungs and see how they do in the framework:
Pro-Growth, Pro-Jobs, Get America Moving Again
Business Tax Rates. The centerpiece here is the reduction in business tax rates. Depending on whether they are unincorporated (39.6 percent tax rate) or incorporated (35 percent tax rate), businesses in the United States face the highest marginal income tax rates in the developed world. As a result, companies have every incentive to move jobs and capital overseas where they can live under a far more globally competitive tax regime.
The framework reduces the tax rate on corporations from 35 percent to 20 percent. So-called “pass through” or “flow through” companies like Subchapter-S corporations, partnerships, LLCs, and sole proprietorships see their top rate cut from 39.6 percent to 25 percent. These are tax rates that allow our companies to compete with anyone around the world.
Territoriality. In addition to our companies facing the highest tax rates in the world, they also face a unique double taxation problem. Namely, the IRS seeks a claim not only on the U.S. profits of American companies, but also their overseas profits which already have faced taxation abroad. The framework ends this double taxation of American companies’ overseas operations by moving from the current “worldwide” tax regime to a more modern “territorial” one.
Full expensing. The framework makes a strong move toward full business expensing, at least for the next five years. Under current law, business fixed investment like computers and furniture cannot be deducted as a current expense, like wages or pencils can. Rather, asset purchases must be slowly deducted in pieces, in a tax process known as “depreciation.” How long is set by the Congress. For example, a computer takes five years to depreciate. Why? Because Congress said so. Full expensing is a neutral tax treatment that puts all business cashflow expenditures on the same plane: you spend it, you deduct it.
Death tax repeal. The framework repeals the death tax, a 40 percent tax on assets which have already been taxed when earned. 70 percent of Americans consider this tax grossly unfair, it raises very little revenue, and it is a drag on growth.
How much growth does all of that get you? According to the Tax Foundation, quite a lot:
Rise in Economic New Job Rise in After-Tax
Growth Created Income
Corporate 20% Rate 3.3% 641,000 3.1%
Pass-Through 25% Rate 1.1% 257,000 1.6%
Full Business Expensing 5.4% 1,014,000 5.3%
Death Tax Repeal 0.8% 159,000 1.0%
One cannot simply add all these numbers together due to interactive effects, the temporary status of full expensing, etc. However, it’s clear that millions of new jobs would be created as a result of this tax reform, and the economy would finally begin to approach that magic 3 percent normal real growth rate we need in order to get the country moving again.
Pro-Family, Middle Class Tax Relief
Fewer tax brackets. The current seven bracket tax structure would be collapsed into three: 12 percent, 25 percent, and 35 percent. The top rate would decline from 39.6 percent to 35 percent, and people would have a lot less interest in which tax bracket they were in.
Double the standard deduction. The framework doubles the standard deduction, the amount that taxpayers can claim in lieu of itemized deductions. For a married couple, the standard deduction would increase from about $12,000 today to about $24,000 under the framework. Doing this means that 95 percent of families won’t have to worry about pulling together itemized deductions like mortgage interest and charitable contributions. Tax season gets a lot easier as a result.
Preserve the most important itemized deductions. For the one of out twenty families not using the new standard deduction, the two most important itemized deductions remain available–the mortgage interest deduction and the charitable contribution deduction. However, as noted above this is a moot point for all but the top 5 percent of families.
Increase the child tax credit. The child tax credit is currently $1000 and available in full for families making less than $130,000 per year. Under the framework, both the credit amount and the phase-out window would rise. This obviously helps out middle class families with kids.
Repeal the AMT. The “alternative minimum tax,” or AMT, is a parallel personal income tax system with its own set of deductions and rates. Tens of millions of families have to calculate their taxes both under the regular and AMT rules, and 5 million families have to pay the higher AMT amount. Repealing the AMT removes a big source of middle class complexity.
Preserve and simplify tax benefits for work, retirement savings, education. Translation: expect to see the same or simpler options for 401(k)s, IRAs, and 529 college savings plans. Expect to see the same or a reformed earned income tax credit. Expect to see some consolidation and simplification of the tuition tax credits and deductions.
What does all that simplification and rate cutting result in? You end up with a tax system so easy, most Americans could fill out their own taxes on a simple postcard:
An illustrated tax return postcard after reformHouse Ways and Means Committee
When the main benefits of reform–jobs and raises on the one hand, and simplicity and easier tax seasons on the other–the benefits of this tax reform really come through. Step one is passing a budget resolution to get this started, and then it’s full speed forward until the end of the year.
Learn more here.