GOP tax bill: Good for business, bad for debt, meh for middle class

The Republican-controlled House and Senate are working on what could be the largest change in tax policy since the Reagan-era tax cuts of 1986.

The current bill will make significant reductions in corporate taxes, makes a change in the taxation of small business that have chosen to avoid the corporate tax, eliminates or reduces some familiar tax deductions and almost doubles the standard deduction.

The middle class: Who fits in the middle class varies by income, the cost of living and local tax policy. Living in New York will cost more than living in Texas, for example. Most analyses show the middle class receiving a modest tax cut.

{mosads}But the modifications of the various deductions will make a difference. The proposed bill eliminated the deduction for state and local income taxes and caps the deduction of property taxes at $10,000.

In addition, the deduction for mortgage interest is limited to mortgages of $500,000 or less, although existing mortgages are expected to be grandfathered. Home builders are concerned; high-end houses are a lucrative part of the builders market. Deduction for medical expenses are also eliminated, raising a question about the fate of future medical legislation.  

Tax specialists report that by doubling the standard deduction, the percentage of taxpayers who itemize their deduction will fall from 30 percent to 5 percent. Some charities fear that charitable contributions may suffer.

Why eliminate the deduction of state and local income taxes? Lower-tax states argue that they should not be paying more in federal taxes by, in effect, subsidizing the higher-tax states. So far, omitted from the discussion is that in reality, many of the higher-tax states also receive less, sometimes much less, back from federal spending than do the lower-tax states.

Upper income: As major owners of capital, the upper-income will benefit from the corporate tax cuts. Some will also benefit from an elimination of the inheritance tax.

Lower income: Lower-income individuals are largely unaffected by the tax changes. They would continue to receive the Earned Income Tax Credit, but there would be no increase in it. Increasing the credit could be a response to the growing movement pressing for a higher minimum wage or a living wage.

Business: Under the proposed bill, the corporate tax rate will fall from the current 35 percent to 20 percent, and companies could bring overseas earnings back at a 12-percent rate. Corporations will also be able to expense or immediately deduct the cost of investment in plants and equipment.

Perhaps as much 60 percent of business income is not subject to the corporate tax. Many smaller businesses chose to avoid the corporate tax and, instead, be taxed on all their earnings at the personal rate. The proposed bill would apply a 25-percent rate on their business earnings but subject other earnings to the personal rate that could be as high as 39.6 percent.

Territorial tax: Virtually alone, the United States levies taxes on an individual’s or a corporation’s worldwide income. Under current law, overseas income is not, however, taxed until the funds are actually brought back to the United States, or repatriated. Taxes paid overseas are taken as a credit against any U.S. tax liability.

Proponents argue that taking a territorial approach will lead to American companies invest more of their overseas earnings at home. The change would also be part of a move to harmonize American taxes with tax policies overseas.

Skeptics make three points: First, there was an earlier tax holiday for overseas earnings that did not lead to investment but, for the most part, was used to increase dividends and fund stock buybacks.

Second, domestic corporations have significant domestic tax reserves, but despite tight labor markets and recovered consumer demand, they have not sharply increased corporate investment.

Third, moving to a territorial tax might actually encourage more companies to shift investment overseas to countries with even lower tax rates.

Deficit and growth: Current estimates suggest that the proposed tax bill will add $1.5 trillion to national debt that is already at a peacetime peak. The bill’s proponents argue that current estimates do not recognize how much the economy will grow in response to the individual, and particularly, the corporate tax cuts.

Some proponents argue dynamic scoring would show growth that would either pay for the tax cuts or significantly reduce their impact on the deficit. Most economists are highly skeptical of the claims for dynamic scoring. Other proponents put the tax cuts in context of broader administration policy.

They argue the combination of tax cuts, repatriated capital from overseas, pro-growth regulatory changes and a major infrastructure bill will supercharge domestic growth.

Republicans are intent on using the reconciliation process that will allow them to pass tax legislation with only 50 votes (counting the vice president as breaking a tie if needed). However, if the bill will add to the deficit beyond the time of the budget resolution, the tax cuts would expire at the end of the 10-year period.

Would the 10-year cuts have the same impact as a permanent cut? Proponents will point to the fate of the President George W. Bush’s tax cuts that also were due to expire at the end of 10 years but were, with the exception of the highest individual rate, made permanent in an agreement between President Obama and the Republican Congress.

In sum: There are modest tax cuts for the middle class, no change for the lower income workers, significant tax cuts for corporations, major change from global to territorial tax, some cuts for small business, major changes in treatment of deductions and an addition to the national debt.

Kent Hughes is a public policy fellow and former director of the Program on America and the Global Economy (PAGE) at the Woodrow Wilson International Center for Scholars.