By: Avi Yishai and Yaakov Kornreich
The major feature of the initial tax proposal announced by the House Ways and Means Committee slashes corporate tax rates from 35 percent to 20 percent. Even most liberals agree that the current corporate tax code is obsolete and the rate cuts and other changes proposed in the tax bill will stimulate the U.S. economy, making it more competitive. But serious challenges are being raised to claims by Republicans and President Trump that the proposal should also be viewed as a tax cut for middle income Americans. Its individual tax provisions hurt and help different segments of the middle class, and seem to have been designed more for their political effect rather than the country’s overall economic benefit.
While it is true that most lower middle-income families are likely to benefit from the proposed doubling of the standard deduction for families from $12,000 to $24,000, the bill’s impact on families earning more than $100,000 a year will vary considerably. Whether they will pay more or less in federal income taxes will depend on where they live, whether they own their own home and which itemized deductions, if any, they are taking now.
While the new plan has only four tax brackets rather than the current seven, the actual rate most people will pay on their taxable income will not vary much from where it is now. Many higher middle-income families (earning more than $200,00) will benefit from the elimination of the Alternate Minimum Tax (AMT), and provisions that will allow them to pay a lower tax rate on passthrough income from their businesses. But those living in high tax areas, such as New York, New Jersey and California, and many suburban homeowners who pay much more than $10,000 each year in real estate taxes, will have to pay the IRS significantly more if this proposal, which eliminates most deductions for state and local taxes (SALT), becomes law. Others who will have to pay more include those now taking deductions for large medical bills or interest on student loans, which would also be eliminated.
A TOUGH BOTTOM LINE FOR LARGE FAMILIES
Families with more than three children under age 17 will also pay more in taxes because it eliminates the personal exemption of $4,050 for each dependent. The impact is cushioned somewhat by the doubling of the standard deduction (which helps only those who don’t itemize) and a boost in the child tax credit by $600 to a total of $1,600, the first $1000 of which is refundable. But big families will face a net tax increase. The more children a family has, the more taxes they will pay, due to the elimination of the personal deduction.
For a typical family of four earning $59,000 and taking the standard deduction, the proposal would lead to a net annual tax cut of $1,182, leaving them with a total tax bill of $400. No doubt, that example was carefully selected by the plan’s sponsors for maximum political effect. But if that same family owns their own home and claims the itemized deduction for state and local taxes which the bill eliminates, the story changes significantly. They will likely have to pay a significantly higher tax than they do now.
On the plus side, the bill establishes a $300 family credit for each parent and non-child dependent, such as an adult child with a disability or a family member living under your care. Big deal.
REPUBLICANS BETRAYING THEIR OWN PRINCIPLES
In crafting the current proposal, the Republicans have sacrificed the interests of larger middle-income families, especially those who live in areas with high state and local taxes, to help pay for a necessary but large tax cut for businesses. In doing so, they have abandoned one of the GOP’s core political principles.
Republicans have always argued that taxes should be kept low so that people can keep as much of their own money as possible. They believe people will spend their own money more wisely and efficiently than government would. That would generate more retail demand and capital for investment that would grow the economy, creating more good jobs and ultimately raising the standard of living.
THE ECONOMIC CLASS-WARFARE ARGUMENT
Instead, Republicans and President Trump have let themselves be intimidated by the class-warfare rhetoric of former President Obama and other liberal Democrats. They seek to demonize the rich, accusing them of selfishly exploiting the working class, instead of recognizing successful entrepreneurs and investors as the main engine for job creation, innovation and growth in the economy.
Progressive Democrats like Senator Elizabeth Warren argue that it is unfair for the rich to get any benefit from tax cuts. They want all the tax cuts to go to the least productive segments of the population.
They ignore the fact that the wealthy pay a disproportionately large fraction of federal income taxes. The top 10% of Americans by income pay 70% of all individual tax revenues. By contrast, almost 50% of all Americans, those who are at the bottom of the income scale, pay no income taxes at all.
Aside from the fact that most of the taxes are collected from them, the wealthy are far more likely to spend their tax savings productively, in ways that will stimulate the economy more than poorer people would.
Giving the lion’s share of tax savings to lower income people is contrary to the basic Republican rationale for tax cuts. Their purpose is not, as some Democrats believe, forced income redistribution. Tax cuts are justified by generating enough added economic activity to pay for themselves and create new opportunities for American workers.
WEALTHY STILL PAYING HIGH RATES
Instead, many of the wealthiest Americans will pay more in taxes under the House proposal than they do now. The top 39.6% rate remains unchanged for those earning $1 million or more, and new provisions in the proposal would force them to surrender some of their existing tax breaks. While higher income people will benefit from other provisions in the new proposal, such as the passthrough for business income and the end of the AMT and the estate tax, the proposal would have been more effective at stimulating the economy if the wealthy had been permitted to benefit from the a tax rate break as well.
One must ask why Trump and the Republicans in the House would fashion a tax cut proposal that shortchanges the most productive segment of the population. The answer has to do with the polarized political reality in Washington, D.C., one year after Donald Trump’s unexpected election victory.
RECONCILIATION RULES FORCE DIFFICULT TRADEOFFS
Unable to count on any support from the Democrats, Trump and the Republicans have been forced to follow the arcane rules of a legislative process known as reconciliation to keep their tax proposal from being blocked by Democrats with a Senate filibuster. To qualify, the rules require that any tax cut proposal not increase the national debt calculated over the next decade.
Last month, Republicans passed a budget plan which, according to Congress’ Joint Committee on Taxation (JCT), would result in $1.5 trillion in reduced federal spending over the next decade. That meant that if Republicans wanted to use reconciliation rules to avoid a filibuster by Senate Democrats, they could pass no more than $1.5 trillion worth of tax cuts over the same period.
Unfortunately, $1.5 trillion is not enough to pay for the business tax rate reduction all the way down to 15%, which President Trump had promised when he campaigned last year. Trump and the Republicans had to scale back their corporate tax rate cut to 20%, and 25% for the business passthrough rate. Even at these levels, the business tax cuts will cost $850 billion, leaving little financial room to pay for the large “middle class” tax cut Trump and the Republicans had promised to pass alongside the business tax reductions.
DUBIOUS CLAIMS OF MIDDLE CLASS TAX RELIEF
Trump claimed, “It’s a tax bill for middle class; it’s a tax bill for jobs, it’s going to bring a lot of companies in, and it’s a tax bill for business, which is going to create the jobs.”
House Speaker Paul Ryan was pushing the same message. The same day the tax proposal was announced, Ryan said, “The focus is on middle-class tax relief. The focus is on directing that tax relief to the people in the middle and the people who are trying to get there. And that is why we put our emphasis on that tax relief for those people who are in the middle.”
But other Republicans were disappointed that the proposal does not bring down taxes for everyone, as Trump had promised.
Senator Paul argued, “we should bring all rates down.” He rejected the argument that the rate cuts should be targeted to benefit lower income individuals. Noting that high income people pay the lion’s share of income taxes, Paul said, “If you really want to return money to the private economy, you have to be less focused on who gets what money.”
Some Trump voters said they were deeply disappointed in the president for supporting a tax plan that works against them by putting certain classes of innocent people at a special tax disadvantage. They include families with many children and homeowners in high tax areas.
THE SALT DEDUCTION ALMOST DISAPPEARS
Republicans propose to finance the tax rate cut, the standard deduction increase and other benefits for individuals by doing away with the state and local tax (SALT) deduction, which mostly benefits upper income families living in high tax areas. Eliminating SALT deductions will generate about $1 trillion in tax revenue over the next decade. The main feature in the tax cut bill to compensate upper income people for the loss of the SALT deduction is the elimination of the AMT and, for the wealthiest families, the phasing out of the estate taxe. The only part of the SALT deduction that survives in the original tax cut proposal is a property tax deduction which is capped at $10,000. However, that amount is far less than the real estate taxes on many middle class homes in nicer suburban communities across the country.
Another provision in the House proposal which trimmed a popular homeowner tax break was the halving of the cap on the home mortgage interest deduction from the current $1 million mortgage limit. To avoid a further outcry from homeowners, the lowered cap will only apply to new mortgages. Going forward, lowering the cap will tend to reduce the market value of more expensive homes. This has already caused home builders to complain to Republican leaders.
The National Federation for Independent Business, usually a reliable ally of Republicans, has also come out against the proposal. They are disappointed that the passthrough business tax rate will only be lowered to 25 percent, compared to the reduction of the corporate tax rate to 20%.
Democrats dispute the Republican claim that their proposal is a middle-class tax cut. They insist that for the wealthiest individuals, the other provisions in the GOP proposal, including the business passthrough, the elimination of the AMT and the phasing out of the estate tax, will more than offset the loss of the SALT tax deduction and maintaining the top 39.6% tax rate.
“The bill’s like a dead fish: The more it hangs out in the sunlight, the stinkier it gets,” Senate Minority Leader Chuck Schumer said. “The more people learn about this bill, the less they’re going to like it.”
House Minority Leader Nancy Pelosi blasted the House Republican tax bill as “a terrible assault on opportunity for the middle class.”
“Get real. Don’t tell the middle class this is for them,” Pelosi lectured Republicans at a press conference. “You’ve set a banquet for the wealthy and corporate America and thrown a few crumbs” to the middle class.
SOME REPUBLICANS COMPLAIN
Even though Trump and Ryan emphasized the importance of the middle-class rate cuts in the proposal, Senator Rand Paul complained that the reductions were inadequate. “I still think we need to work the brackets and the rates a little lower for those in the middle,” Paul said. He also noted that people earning up to $416,700 in the current 33 percent tax bracket will actually face an increase to the 35 percent bracket under the House proposal.
Republican senators Marco Rubio and Mike Lee said the bill doesn’t go far enough to compensate working families raising children for the loss of the personal deduction. They want the child tax credit raised to $2,000.
The proposal has also been accused of hurting families by calling for the repeal of a credit for child adoption expenses and the elimination of tax-free accounts of up to $5,000 to help pay for dependent care assistance.
Another provision in the tax proposal would place a limited surcharge on the 39.6% top rate for those earning more than $1 million. This led several conservatives to complain that the consumer side of this plan was designed more in line with the Democrat tax-the-rich rhetoric than Republican free market principles.
Some Republicans were also disappointed that the proposal would not immediately eliminate the estate tax. Instead, it settles for a doubling of the current $5.5 million estate tax exemption and delaying full cancellation of the tax for six years.
HIGH TAX STATE REPUBLICANS IN PERIL
There has been a fierce outcry against the elimination of the SALT deduction from House Republicans from high tax states who fear it could cost them re-election next November.
The relatively thin GOP majority in the House is at risk in the 2018 midterm election. GOP leaders are concerned Democrats will take advantage of the hostile voter reaction to the proposal in high tax Democratic states, whose taxpayers, between them, claim more than 30% of all the SALT deductions for the entire country.
About a third of all taxpayers, the vast majority of them making more than $50,000 a year, use the itemized deduction for state and local taxes rather than claiming the standard deduction in filing their tax returns. The state with the highest rate for the SALT deduction, 46%, is Maryland. The reductions averaged almost $13,000 each in 2015.
GOP leaders fear that a backlash in those states might lead to their loss of majority control of the House next year. But if they want to restore some of the canceled SALT deduction, they will have to find a way to make up for the lost tax revenue.
GOP TAX WRITERS LOOKING FOR MORE MONEY
The day after the release of the bill, House Ways and Means Committee chairman Kevin Brady leaders quietly announced a technical change that would generate $89 billion in extra tax revenue by tinkering with the inflation adjustment for the tax brackets. There will almost certainly be other adjustments as the bill works its way through Congress.
Some Republicans chafe at the $1.5 trillion limit imposed by the JCT, and its prediction that those in the upper middle class, earning between $200,000 and $500,000, will wind up paying more taxes when some of the temporary provisions in the proposal expire in 2023. They argue that the JCT criteria do not sufficiently account for the added economic activity and government revenue that the proposed tax cuts will generate.
Conservative Congressman Mark Meadows suggests that the tax cut proposal be expanded to include a repeal of the Obamacare individual mandate. That would save an estimated $300 billion or more in government spending over the next decade, which Republicans could use to finance deeper tax cuts. The suggestion was endorsed by President Trump, who tweeted: “Wouldn’t it be great to repeal the very unfair and unpopular individual mandate in Obamacare and use those savings for further tax cuts for the middle class.” Senator Paul also supports the proposal, in part because he opposes the individual mandate in principle.
Republican Congressman Tom Cole warned against such a move. “I think the attitude is let’s not mix up health care with this,” he said.
A REPUBLICAN JUGGLING ACT
Congressional Republicans are still smarting from their embarrassing failure to pass any legislation to keep their promises to repeal and replace Obamacare.
Those standing for re-election next November fear a backlash at the polls by the voters who put them into office. They desperately want to put in place the foundation of Trump’s promise to “Make America Great Again” by jump-starting the economy through aggressive tax cuts, yet they do not want to endanger their GOP colleagues running as incumbents in high tax districts in New York, New Jersey, Massachusetts and California, whose voters will be hard hit and angered by the cancellation of the SALT tax deduction.
This has forced Republican leaders into a delicate political juggling act. They are trying to downplay the cost of the proposal to large families and homeowners in high tax areas while emphasizing the broader financial benefits expected from the increase in economic activity stimulated by the business tax cuts. President Trump has predicted that the average family income will rise by $4,000 a year due to the tax stimulus, but Democrats argue that the large tax cuts put through by President George W. Bush failed to live up to the expectations of their Republican supporters.
A GATEWAY TO RESTORING THE AMERICAN DREAM
Former House Speaker Newt Gingrich told Fox News that the GOP tax proposal, “represents a tremendous opportunity for the Congress and the president to take the U.S. economy to a new level of prosperity and improve the lives of hundreds of millions of Americans.”
Gingrich puts it in the context of Trump’s success in boosting U.S. economic growth, up to 3 percent for two straight quarters, which so-called experts insisted for months was nearly impossible.
“At the same time, Pew Research Center reported that 82 percent of Americans now say they have either achieved their definition of the American Dream or are on their way to achieving it. “
Gingrich also notes that only three years ago, a CNN poll “found that 60 percent of Americans thought the American Dream was unattainable.”
Ignoring the short-term cost of the tax proposal to millions of middle class families, Gingrich declares, “the passage of this bill will be a defining moment for our country. It will cut through all the noise of Washington and show Americans they were right to elect Republicans to lead in the White House and Congress.
“Over the next few weeks, the Democrats and the left-wing media will undoubtedly try to oppose this bill. They will come up with all sorts of reasons why they don’t support the bill, but what they are truly arguing against is lower taxes, more jobs, higher wages, and a simpler, fairer system. The American people will see that once again, the left is trying to stand in the way of our country’s working class, who are finally starting to see their American dreams become a reality.
“That’s why we’ll win,” the former House Speaker concludes.
A FIRST STEP TOWARD MORE TAX CUTS
Tax reduction advocate Grover Norquist, who is famous for having demanded that every Republican candidate take a “no tax increase” pledge, acknowledged that the tax proposal is imperfect, but insisted that it must be passed. He openly described it as an interim measure designed to help the GOP win next year’s midterm election, thereby strengthening its ability to pass more comprehensive conservative economic legislation.
“Every year the GOP holds Congress and White House there will be another tax cut. Four tax cuts in the next four years. So this bill is just a start. A very good start,” Norquist predicted confidently.
Even Republicans who share the long term economic goals of the proposal are concerned about the potential political cost. Losing control of the House to Democrats in the midterm election due to a taxpayer backlash would be a catastrophe for Trump’s agenda.
SOME TRUMP SUPPORTERS FEEL BETRAYED
That is the risk Republican leaders and the president would be running. They need to come up with an effective response for their voters who are justifiably alarmed at the consequences of the repeal of the SALT tax deductions.
Homeowners with high property taxes and large families, who are struggling financially to raise their children had been looking to Republicans and Trump for help rather than an increase in their taxes.
Many voters hoped that by voting for Trump and Republicans, they would be getting long-sought relief for high taxes and leaders who really cared about their welfare. But the crueler, family-unfriendly provisions of the GOP tax proposal which Trump has endorsed are causing some of his former supporters to have second thoughts.
The Washington Post and the Associated Press contributed to this story