Not Just “Something”

The Republican Congress is moving ahead with passage of a bill to enact tax “reform.”  Actually, if one takes a close look, it really is not tax reform, but rather a tax cut.  Some of us may be for it, some of us may be critical of it, some of us may think that there is no need for a tax cut at this point.  Whichever approach you favor, there are elements to the proposal that all of us need to understand as we will all hear different spins on the bill as more and more of it becomes clear.

The one thing we do not need or want — whether or not one favors the current tax cut proposal — is what I increasingly hear from Republican members of Congress.  That refrain is something along the lines of what’s important isn’t so much the details of the legislation but that this Congress must pass something.  Anything.  They could not deliver on Repeal and Replace and have so far not enacted any significant legislative at all.  Something has to pass or voters will think that they are ineffective and unable to govern.  As a result, the argument goes, they will be decisively punished at the polls in 2018 and therefore something is better than nothing.

Wrong.  I could not think of a worse reason to pass a bill, especially one that will impact every single American tax payer and business.  The last major attempt at tax reform took place under President Reagan in the early 1980’s.  Thus we hear that this is a once in a generation legislative achievement.  True or not, it is clearly significant and will have a lasting impact on our economy.

So, whether or not one supports the current bill, there are some things of which we all need to be aware as we decide if this is a good idea or not.  As usual, a few caveats apply.

The final version of the bill is unknown.  Even as I write, negotiations are taking place that will cause certain provisions to change or get modified as the wheeling and dealing takes place.  This deal making can substantively change the bill and not necessarily for the better.  Even as the version in the House is getting all of the attention, the Senate is working on its own bill, the provisions of which are being kept under wraps.  We can assume that it will probably be similar to the House version, but there is no guarantee.  The competing bills then go to conference where negotiators hash out the differences.  The question will be whether or not the “deals” see the light of day before voting takes place.  Finally, recall that the Republican leadership in the House and the Senate have decided to lock out the Democrats and pass the bills on a straight party-line vote.  Regardless of whether or not this is a good idea, certain Senate rules kick in as a result which means the House and Senate may not be able to do all that they want.  If they break certain rules — outlined in the just passed budget bill which got little attention because of other events — then the Senate will require 60 votes to pass the legislation, which is unlikely if the Democrats are locked out of any input to the bill.

I know, a lot of inside baseball type maneuvering, but it matters because the rest of us have to live with the results.

There are two major economic reasons for fooling around with taxes (either raising or lowering them).  One is to stimulate the economy to get it growing again.  The other is to bring about a balanced budget to stop or bring down the growth of our national debt.  The two are not necessarily mutually exclusive, but they tend to act in competition in a modern economy.

Some argue that the economy cannot be stimulated further because current unemployment rates are very low.  According to the Labor Department, unemployment in October was 4.1% and there were 6.2 million open jobs on the market.  Demand for workers is exceeding those available.  During the presidential campaign, the Republican candidate claimed that the government’s statistics were “false” and that the unemployment rate was really much higher.  He now argues that the numbers are correct.  Regardless, an argument can be made that although the unemployment rate is the lowest in decades, there are many people that have stopped looking for jobs even though there are 6.2 million available.  Why the disparity?  Probably because the skill levels needed for the empty jobs is greater than, or a poor match with, the skills of those that stopped looking for jobs.  Couple this information with the fact that worker productivity is the highest ever — thanks to automation and other technology advances — and one can rightly ask how this tax cut is going to further stimulate growth in the economy.

The usual reply is that corporations will create more jobs by using dollars that would have gone to taxes to instead expand production.  This assumes that there is more demand for their products, an assumption that may or may not be true but is an unknown and should not be assumed.

The use of “dynamic scoring” helps the case for the tax cuts.  This is the theory that more money not spent on taxes will enter the economy as people have more cash to spend and this in turn causes the economy to grow and will actually bring in more tax dollars in the long run than are lost with the cuts.  Historically, this has rarely if ever happened.

The proposed tax cuts now before Congress will not balance the budget and will in fact increase the national debt by at least 1.5 trillion dollars over ten years.  (By the way, this is one of those intricate rules that the Senate must follow under the just passed budget.  They cannot go over that number or 60 votes will be required for passage.)  One might ask what happened to the Republican “deficit hawks” that argued for the past decade that the debt was growing too fast and even argued for a balanced budget amendment to the Constitution.  Beware of the need to pass something.  One can also argue that it is not good governance or good policy to finance a tax cut through increasing the deficit.  It narrows the options going forward when it may be necessary to finance a major catastrophe or war through deficit spending.

In fact, the current proposal cuts government revenue by roughly 4 trillion dollars.  For those that argue for smaller government and less spending, that may be attractive.  Remember that many in Congress are also arguing for increased defense spending, major infrastructure spending, no cuts to Medicare or Social Security in an aging population, and other measures that will increase spending.  The money has to come from somewhere.

To get the 4 trillion in cuts down to 1.5 trillion in actual lost revenue, the bill makes up the difference by eliminating many current deductions.  This is where it starts to get interesting to you and me.

There are always winners and losers in these types of bills.  Depending on where you sit, you may or may not like what you see.  To me, we need to understand who wins and loses and decide for ourselves whether or not our elected representatives should vote for or against the bill.  There are philosophical reasons to support or oppose it and there are also practical reasons to do so or not.  Sometimes those line up, sometimes they do not.

As an aside, it is impossible to know if the president makes out well or not through the provisions of this bill because we do not have his tax returns.  Every analyst that I have seen opines that if his stated worth and holdings are true, the man and his family makes out “bigly” if the bill passes.  Call it a tycoon real estate developers dream.

Those that authored the tax cuts tout it as a huge win for the middle class and not so much for the wealthy.  Please investigate it for your self and do not take as gospel the talking points of anyone in the House or Senate, Republican or Democrat.

Here are some of the more eye-opening provisions.  These are only a sample.  Read the 429 page proposal for yourselves and see if it meets your needs.

According to the talking points, the attempt at tax reform is to simplify the tax code.  If you dig through the details, it really does not do that.  There will be no “post card” sized tax form unless you already use the “1040 EZ” form and use photo shop to make it fit on a post card.

According to the talking points the cuts will put about $1,182 into the “typical family of four.”  First, I’m not sure what a “typical” family might be (more on that in a minute), but more broadly, of the $1.5 trillion cut about $1 trillion goes primarily to corporations, about $300 billion to tax payers, and about $200 billion to the most wealthy Americans via the elimination of the estate tax.

Back to the typical family.  Some will receive a tax cut, although how much is in dispute by some economists, but they generally agree that some will get a cut and that some middle class folks will actually have their taxes go up.  The main argument from the bill’s authors is that increasing the standard deduction ($12,000 for individuals and $24,000 for married couples) will eliminate the need to itemize deductions as most people will be better off not doing so.  Perhaps.  Individual circumstances vary so widely that it is hard to generalize.  But middle class tax payers should know that among other deductions that are to be eliminated include:

• Federal deductions for state and local taxes (known as SALT) are eliminated.  Property taxes will be deductible up to $10,000.  The argument against “double taxation” — used in eliminating the estate tax — doesn’t seem to matter here.  For states with state and local taxes (including sales taxes) one will pay twice on the same income.  Arguments that high state taxes that are deductible means those with no or low state taxes subsidize them do not hold up.  There are many ways to analyze the return on investment, but in general, states with low or no state taxes get back more from the federal government than they send to Washington in taxes and just the opposite for the supposed free loaders.  For example, New York (high state tax) gets back about 75 cents for every dollar it pays in federal taxes and Florida (no state income tax) gets back about $4.50 for every tax dollar.
• The Alternative Minimum Tax (AMT) is repealed.  This is the methodology that hits many middle class tax payers (although it was originally designed to keep wealthy people from paying no taxes through shelters and other tax dodges) requiring that when certain marks are reached, the owed tax is calculated in two different ways and the higher rate prevails.  Estimates are that the president will save tens of millions of dollars every year with the elimination of the AMT.
• Elimination of the deduction for medical expenses.  Currently, one can deduct all expenses over 10% of adjusted gross income.  No deductions will be allowed under the new proposal.  This obviously impacts people with major medical bills, often the elderly, as it includes long-term care and other services needed for the aged or infirm.
• Deductions for student loan interest is eliminated.
• Estate Tax limits rise from the current $5.9 million to $11 million and then is eliminated in 2024.  This is a hot button issue.  Most of us will never be impacted by it, but Republicans claim it is “double taxation” (see above) and harms small businesses.  Its elimination adds about $200 billion to the deficit over ten years.  Estimates are that about 80 businesses were impacted by it last year.  The president’s family is expected to increase their inheritance by approximately $500 million through its elimination.  Keep an eye on this.  One proposal to pay for this change would provide for estates passed to heirs to be valued at their original prices (such as stock you bought 20 years ago and want to pass on) rather than the current rule where the origination value is that that it held at the time of passing.  This would impact far more people than currently affected by the estate tax.
• A lower rate for “pass through” business income also sometimes called the “Trump loophole.”  This applies to businesses such as partnerships, “S” corporations, sole proprietorships, and the like.  It allows the owners to “pass through” profits from their businesses to be taxed as their personal income.  Thus pass through income is taxed at no more than 25 percent — far below the 39.6 percent top individual income tax rate that now applies to pass-through income, or the 35 percent top rate that would apply to individual income under the Republican plan.  Many very wealthy people such as the president use these types of arrangements for their businesses.  It is expected that many will restructure their business arrangements to take advantage of this new loophole.
• There are proposals over the weekend to include repeal of the Affordable Care Act, or portions there of in the tax bill.  Mixed signals from law makers make it unclear whether or not they will try to sneak that into the bill after failing to pass it into law over the last seven years.
• And a whole lot more, but you get the idea.

Clearly a “typical family” with a mortgage (deductions are limited under the bill) who are suddenly hit with catastrophic medical bills while paying off the student loans they took out to meet the needs of the new work place will fare totally differently than those families used in the talking points.  Very little is “typical” of any family.

Primarily we all need to keep an eye on the negotiations that will keep specifics of the bill in flux until the day it is voted up or down.  Whether for or against these provisions, we should insist on a fair and transparent process where our representatives know what they are voting on and what the implications for the new laws will be.  All of us will be impacted in some way.

Tax reform is a good thing.  There are many complicated elements to the current law and other elements that are unfair to some or too generous to others.  It’s complicated.  It’s messy.  Not everyone will be happy.  What we don’t need is a closed door, rushed job, unclear bill that gets passed only because they had to do something.