By Dr. Elizabeth Keavney
Faculty Member, Intelligence Studies, AMU

The U.S. Senate returned to work last week; the House began work on Monday, January 8. Among their main tasks this session will be to hammer out a budget agreement to fund the government – including the Department of Defense and the intelligence community – for the next fiscal year.

The Republican-led Congress passed a sweeping tax cut bill at the end of 2017. Now, the GOP legislators also must decide whether to pursue one of their other priorities – the overhaul of welfare and entitlements in an election year.

Entitlements have always “been the third rail of politics,” especially in a mid-term election year when the party in power traditionally loses seats. Congressional Democrats are sure to oppose any attempts to reduce social services, such as Medicare and Medicaid.

How all this plays out is anybody’s guess. All we know at this juncture is that the Tax Cuts and Jobs Act of 2017, like all new laws, comes with good and bad elements.

As always, some taxpayers will benefit more than others. But only time will tell exactly how much the law helps or harms the American public.

Tax Law Remains Complex Despite Attempts to Simplify It

One of the Trump administration’s goals was to simplify the tax code. But despite some movements toward simplification, the new law is still very complicated. It contains special rules for specified service businesses, such as accounting, law and financial services.

There are seven income tax brackets and rates for the 2018 tax year. Income requirements for each of those seven brackets is different for single, married filing jointly, and head of household filers. Additionally, there will be an increased tax credit for families with children.

Now that President Trump has signed the bill into law, most of the brackets will have lower tax rates, except for one of the top brackets. The standard deduction has been increased to make up for the elimination of many of the deductions in the old tax code. Personal exemptions were repealed.

Some economists and tax authorities say the very wealthy will benefit the most from the new law. While this may be true in absolute dollars in percentages, it is not true. (See Figures 1 and 2.)  It also seems to help families with children and harm those who live in states with high state and local taxes as well as states where housing costs are high.

Figures 1 and 2 show the federal income tax rates (percent of taxable income due to the federal government) under the tax rates effective in 2017 and 2018. Note that they do not capture the reduction in taxable income for those who do not itemize deductions (or whose itemized deductions plus personal exemptions would be less than the new standard deduction) caused by the increased standard deductions or the increase in taxable income for those who are negatively affected by the elimination of or limits on some deductions. The former will benefit taxpayers who do not itemize (a majority do not), and the latter is likely to mainly reduce the tax benefits for people with high incomes and people who live in states with high income taxes.

Figure 1. Federal income tax rate comparison for unmarried filers. Information is from Tax Foundation and U.S. Congress

Figure 2. Federal income tax rate comparison for joint filers. Information is from Tax Foundation and U.S. Congress

As is evident from the figures above, the people who pay very low taxes get relatively little benefit from rate reduction. The increased standard deduction will provide a greater benefit to these people in percentage terms. The greatest reductions in taxes (in percentage terms) occur below $50,000 taxable income for single filers and below $100,000 for joint filers. Of course, the greatest reductions in absolute dollars will be for those with very high incomes, since they are paying higher tax percentages and much higher taxes in absolute dollars than those with lower incomes are.

Taxpayers will be able to deduct a maximum of $10,000 in state and local income taxes or property taxes. This change mostly affects taxpayers who live in states with high income taxes, such as California (13.3%), Oregon (9.9%) and Minnesota (9.86%).

According to the Tax Foundation’s Lori Robertson, “Just six states (California, New York, New Jersey, Texas, Illinois and Florida) claim more than 50 percent of the property tax deduction.”

Other Changes Resulting from the New Tax Law

The new law retains the deduction for charities. However, people who live in high-tax states where homes cost more, probably will not see lower federal income taxes in 2018.

The mortgage interest deduction on new homes drops to $750,000 on primary residences. The deduction remains at $1 million for homes purchased before December 15, 2017. Also, interest paid on loans for vacation homes is no longer deductible. Taxpayers who live in areas where homes are the most expensive and anyone buying a second home in 2018 will be hurt the most by these changes.

In addition, there is no longer a requirement to purchase health insurance under the Affordable Care Act (ACA). This does not mean anyone will lose their health insurance. If taxpayers prefer, they can decide not to have any insurance, but the new tax law sets the ACA-mandated financial penalty for being uninsured to zero.

The lower business tax rate has already begun to have an impact. According to National Review, a number of companies have decided to invest in the U.S. and share their corporate savings from the new law with their employees:

• Fifth-Third Bancorp will raise hourly wages and pay one-time bonuses.
• AT&T is giving employee bonuses and making a $1 billion investment in the United States.
• Boeing will invest in employee-related and charitable organizations.
• Comcast-NBC Universal will award bonuses and invest in infrastructure.
• Wells Fargo will match Fifth-Third’s wage increase and make donations of up to $400 million to the new home of the Los Angeles Philharmonic.
• Target will raise hourly wages to $11 per hour and later to $15 per hour over a period of two years.

Each company explicitly stated that its action was the result of the Tax Cuts and Jobs Act.

Final Version of Bill Did Not Offer Sweeping Reforms

The final bill did not simplify the tax code as much as it might have and it did not make the promised “sweeping reforms.” But the 70% of American taxpayers who do not itemize their deductions should pay less in federal income tax next year due to lower tax rates and the doubling of the standard deduction.

Taxpayers who do not itemize and have children will also pay less in federal income tax for the same reasons. In addition, families will benefit because the new law doubles the tax credit for children.

Although this new law did not achieve all of the Trump administration’s stated goals, it will at least reduce income taxes until the end of 2025 (unless Congress changes it before then) for most taxpayers. In addition, the corporate tax rate reduction should cause companies to raise employee wages and increase investment in the U.S., which will benefit the economy.

It’s not clear yet whether the new law will produce the expected increase in tax revenue to offset the lower tax rates. However, since total federal tax receipts generally account for 15% to 20% of the nation’s Gross Domestic Product (GDP), increasing the GDP should increase the federal government’s tax revenue.

About the Author

Elizabeth Keavney, Ph.D., is a full-time associate professor in the School of Security and Global Studies at American Military University. She holds a bachelor’s degree in communications from Quincy University, an M.P.A. in public administration from California State University, Long Beach, and a Ph.D. in public policy and administration from Walden University.