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IntelDigest
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
FEBRUARY 7 , 2018
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We did not publish IntelDigest last week because of travel. In this issue, we review analyses of major provisions of the Tax Cuts and Jobs Act of 2017 (TCJA). Will the legislation attain the advertised benefits for American taxpayers and the economy? Or, have the benefits been reserved for the special few?
Initial Impressions of The New Tax Law
We discussed Tax Reform proposals in IntelDigest on several occasions last year, including the December 20 issue:
“… we supported changes which would facilitate American business putting more private money into growing the American economy. We still believe that lowering tax rates on businesses … large and small … has the potential to increase the competitiveness of U.S. corporations in world markets, and allow smaller businesses to employ more Americans …
“… IF these tax cuts prove to be stimulative to the economy, and IF business owners truly plow their new-found tax savings into business expansion and hiring thousands of workers, then we will have taken a large step toward attaining 3-4% growth in the American economy in the coming years.
“… However, we also believe that massive changes in individual taxation are not warranted at this time, most especially because of the likelihood that this wholesale Tax Cut package will add another Two Trillion Dollars to the national debt in the next few years …
“The fear is that these tax changes will:
* amount to nothing less than a redistribution of resources from the Middle Class to multinational corporations, millionaires and billionaires, and the same banks which were responsible for the 2008 Financial Crisis; and
* drive up the cost of premiums in the health insurance exchanges.”
In our last issue, on January 24, we reviewed technical aspects of the Tax Cuts and Jobs Act of 2017 (TCJA). Herein, we’ll look at the probable outcome of some provisions of the TCJA, which applies for the 2018 tax year and later years.
All That Debt
Unfortunately, Congressional Republicans have created new problems by passing massive tax cuts without coming up with new revenue to offset the cost.
In the news today, the U.S. Senate is touting a two-year spending deal which will increase federal spending and the National Debt. The TCJA will add an additional Two Trillion Dollars to the Debt.
What happens when the next serious recession hits this economy? There will be pressure to expand unemployment benefits, lower interest rates again, and enact other traditional types of fiscal stimulus. Such measures become more difficult and less effective as the Debt grows ever larger.
Just a few years ago, Congressional Republicans portrayed themselves as “budget-conscious.” The GOP fought hard to pass sequestration, a measure to cut federal government spending. In 2011, some members even threatened to default on the federal Debt rather than to add to it.
Today, they say that the tax cuts will boost the economy so much that the additional revenues would offset the tax cuts. Basic Arithmetic differs. The Debt will continue to grow; and, a future Congress will likely extend the tax cuts past 2025.
Worsening Income Inequality
Income inequality drives American workers, providing motivation for working hard and getting ahead. However, wealth is increasingly loaded at the top of the income chain today, while the middle is hollowing out. Income inequality is winning the battle versus the American worker.
Intelligent tax policy would be designed to push income inequality back toward historical norms. Unfortunately, the new tax law will make the rich richer still, and the rest more resentful.
The current Republican-led government has turned back to “supply-side economics,” which had a modicum of success during the Reagan Administration when the highest tax rate was 70 percent. Tax cuts were effective at such high levels; they could boost growth enough to offset federal losses of revenues.
However, “trickle-down economics” does not work as well today, when tax rates are half what they were in the 1980s.
Tax cuts for the wealthy are much larger than tax cuts for lower-income workers, in both dollar and percentage terms. It is true that upper-income taxpayers pay more taxes, so they should save more when tax rates decline. However, their tax payments will also drop more in percentage terms than lower- or middle-income taxpayers.
Wealthy taxpayers tend to use tax cuts for savings/investment. This will help buoy the stock markets, but will not drive demand or create jobs. Upper-income taxpayers will also benefit most from cuts in the corporate tax, which will inflate stock prices and returns for those who can afford to own stocks.
A greater tax cut for the Middle Class could drive demand and create more jobs.
Taxes on Businesses
The maximum corporate tax rate is cut to 21% (previously 35%), which brings the U.S. tax rate more in line with other developed nations.
Also, a major feature of TCJA is allowing multinational companies to repatriate large cash stockpiles which had been kept outside the U.S. The total amount held by American companies overseas has been estimated at $2.6 Trillion! Under the repatriation provision, companies will have a limited time to bring those assets home and pay a tax rate of 15.50% on cash (8% on equipment).
Many large corporations have already stated that they will NOT use the tax cuts to create jobs. The chief executives of Cisco, Pfizer, and Coca-Cola would instead use the extra cash to pay dividends to shareholders. The CEO of Amgen will use the proceeds to buy back shares of stock.
The corporate tax cuts will boost stock prices, but only a small number of companies (e.g., Amazon, Apple) propose to create new jobs.
Business Tax Games
Many private business owners get a new tax break which allows them to deduct 20% of their income, effectively lowering their tax bill well below what they’d pay if their income were taxed as regular wages. So, more people are likely to change their reporting status, stretching the definition of a “business.”
This comes as funding and staffing at the I.R.S. are both down, because of hostility toward the agency from Congressional Republicans. The inevitable outcome will be a surge in tax cheating, resulting in a growing sense among honest taxpayers that the system is “rigged.”
True ‘tax reform’ would have made the system more fair; our shiny new tax laws are arguably less fair.
Taxes on Individuals
TCJA generally helps businesses more than individuals. Business tax cuts are permanent, while the individual cuts expire in 2025. This creates a Fiscal Cliff to come in 2025, which Congress could have avoided if it had had a smidgen of fiscal discipline in 2017.
On the positive side, the tax rates have been lowered in most tax brackets, and exemption amounts have been increased for the Alternative Minimum Tax (AMT) on individuals.
The Tax Policy Center breaks down the individual tax benefits as follows:
Those in the lowest-earning one-fifth of the population would see their income increase by 0.4 percent; the next highest one-fifth would receive a 1.2 percent boost; the next two quintiles would see their income increase 1.6 percent and 1.9 percent, respectively. The biggest increase, 2.9 percent, would go to those in the top-earning one-fifth of taxpayers.
TCJA makes the progressive income tax system more regressive. Tax rates are lowered for everyone, but they are lowered more for the highest-income taxpayers.
The primary structural changes on individual tax returns come “below the line,” meaning that they appear AFTER Adjusted Gross Income (AGI) is calculated. Significant changes have been made to the Standard Deduction, Itemized Deductions, and Personal Exemptions, effective through 2025.
TCJA doubles the Standard Deduction to $12,000 for a single filer and $24,000 for Married Filing Joint returns. At the same time, all Personal Exemptions are eliminated! The increase in the Standard Deduction would benefit approximatley six million tax filers, according to Evercore ISI. But, for many income brackets, that won’t offset lost deductions.
For smaller families, these changes … along with lower tax rates … will generally result in a tax savings. However, families with several children will generally pay more because of the loss of the Exemptions.
Open Warfare Among Governments
TCJA also puts a $10,000 cap on State and Local Taxes (SALT), which will force some taxpayers to adopt the Standard Deduction, and others to pay higher taxes. Many taxpayers have Itemized Deductions which far exceed even the new higher Standard Deduction. They pay a combination of State and Local income taxes, real property taxes, personal property taxes, and sales taxes which can amount to $15,000-30,000. Add in mortgage interest and charitable contributions and deductible medical expenses, and these taxpayers MUST itemize. So, the $10,000 cap on SALT is a burden on many taxpayers.
High-tax states will suffer from the $10,000 cap on SALT, a provision which Republicans knew would disproportionately affect Democratic-leaning states. Some states are creating novel approaches to dealing with these provisions, such as allowing state and local tax payments to count as deductible contributions to charity.
Expect clashes between the Congress and state legislatures on a multitude of issues in the coming months.