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Tax Reform Simplifies the Code for Middle Class but Future Reforms Should Kill Crony Capitalism

By Ryan Ellis

The Senate Finance Committee this week held a hearing on the initial impacts of the Tax Cuts and Jobs Act of 2017. Helpfully, Congress’ non-partisan Joint Committee on Taxation provided some tables to show the effects the new tax reform law will have on the tax landscape.

In particular, JCT’s analysis of itemized deductions stands out. Taxpayers can choose between taking a “standard deduction” ($12,000 for singles and $24,000 for married couples under the new tax law) and totaling together “itemized deductions” (mostly mortgage interest, charitable contributions, and up to $10,000 of state and local taxes).

The tax law doubled the standard deduction to these current levels, and curtailed greatly the formerly-unlimited state and local tax deduction. As a result, the middle class will abandon itemizing in droves:

As seen above, families making between $50,000 and $200,000 (a pretty good proxy for the middle class) sees a sharp dropoff in itemized deduction incidence. 31.3 million such families itemized under the old tax rules, but that number plummets to 11.1 million this year–a one year drop of 20.2 million families. That’s a two-thirds reduction in middle class family dependence on their mortgage interest statement, their state and local tax write offs, and their charitable donations. They will simply take the standard deduction instead and be done with it.

They aren’t alone. According to JCT, the total number of itemized deduction families will fall from 46.5 million households before tax reform to 18 million after it. That means the percentage of families that itemize deductions instead of claiming the simple standard deduction will fall from one-third to one-eighth of all taxpayers, the lowest level in living memory.

Those 18 million families are overwhelmingly on the high end of the income spectrum. Two-thirds of them make more than $100,000 per year. Fully a third of them make more than $200,000 per year. Tax reform has resulted in a system where itemizing deductions is a preoccupation of the mass affluent and the very high income.

This is all to the good. Our tax system is not meant to subsidize behavior, but rather to collect revenue for the federal government. To the extent possible both practically and politically, the tax code should be neutral on questions like whether you own or rent your home, whether or not you choose to live in a high cost area, and how much you choose to give to charity. We’re already seeing real world impacts here when it comes to the new $10,000 limit on the state and local tax deduction and the diminished political power of the mortgage interest deduction.

There’s no reason Congress should stop there. There’s been a lot of talk about building on the tax cut’s success in a “phase two” of tax reform. There are no shortage of places in the tax code to start.

Believe it or not, there’s a tax credit of $7500 for purchasing an electric car. There’s a hitch–once a manufacturer sells 200,000 such cars, the tax break goes away. That a very specific tax benefit that borders on the absurd in its precision. There’s no reason why a neutral tax code should be that geared toward engineering an outcome. Tax experts left, right, and center would all agree that this is bad tax policy. Given the price of these vehicles (the cheapest one costs $35,000 even stripped down), this is almost certainly a tax benefit for very high income people, the same as the remaining itemized deductions.

One of the biggest beneficiaries of this electric car tax credit is Tesla, which has ties to the same ownership as SpaceX, a contractor which launches rockets for NASA, among other activities. Earlier this year, there was yet another in string of launchpad accidents by SpaceX which was very costly to taxpayers.

It’s a fair question to ask: does the $7500 electric car credit sell so many Tesla vehicles (above and beyond market demand) that this has created the financial cushion for SpaceX to survive? When combined with the $3 million in state and local subsidies and over $100 million in federal grants, does the tax credit simply add to a web of companies propped up by the government? Would these companies survive without the tax credits, the state and local tax breaks, and all the other subsidies? If not, it’s a fair question to ask why they exist at all.

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