Before beginning, however, I would briefly like to cover macroeconomic effects as a preface, the reason being that it doesn't neatly fit into categories of "good" or "bad." The President's Council of Economic Advisers calculated that the TCJA will grow the GDP by 3 to 5 percent, and was verified by three economists from Boston University (Benzell et al., 2017). The Right-leaning Heritage Foundation and Tax Foundation have similarly optimistic forecasts. The left-of-center Urban Institute is not so optimistic: it calculates that the TCJA will only boost the GDP by 0.8 percent in 2018, and will do virtually nothing for the GDP by 2027. The Joint Committee on Taxation, who officially estimates the effects of taxation for the U.S. government, estimates that the GDP will only grow by an additional 0.8 percent over the next decade. With that being said, let's begin, shall we?
The Good
Permanent corporate tax cut. This is definitely the most significant reform of the TCJA. As I commented as recent as September 2017 and also in August 2014 with considerable detail, lowering the corporate tax from 39 percent to 21 percent is a good thing. Even Presidents Obama and Clinton were eager to have the corporate tax rates lowered when they were in office. What is different with the final draft of the TCJA is that the corporate tax cuts are permanent, which makes for better tax policy (Hodge, 2017). With more capital, the capital-to-labor ratio will rise, which allow for higher wages because the United States will be able to better compete with other countries in the global marketplace, as well as counterintuitively help the average taxpayer. The leading economic research center in Europe, the Center for European Economic Research, found in its own research that the United States lowering its corporate tax will make the United States more competitive with other countries, particularly with Germany (Spengel and Heinemann, 2017).
Creation of a territorial tax system. I covered this in a previous analysis of the corporate tax, but essentially, the creation of a territorial tax system is preferable to a global one. After all it is no coincidence that more countries are trading in a global tax system for a territorial one.
Repatriation and a tax on international earnings. The final version of the TCJA sets a one-time mandatory 8 percent tax on illiquid assets and 15 percent tax on liquid assets from overseas earnings brought back in to the United States. Under tax law prior to the TCJA, any repatriation would have been subject to the corporate tax rate, which we already know is high to begin with. Not only would a lower tax on international earnings encourage U.S. companies to bring foreign cash back into the U.S. (e.g., Apple), but it would also bring a small boost to domestic investment.
Lower mortgage interest deduction (MID). Per my August 2017 piece on the MID, I think the MID should be completely repealed. The initial draft was going to lower the cap to $500,000. However, the final version only lowered it to $750,000. This means that 1 in 7 houses will be eligible for the MID, as opposed to the 44 percent of houses currently eligible. This item is one of those where I would have liked to have seen either a repeal or a lower cap, but at least it is a step in the right direction.
Removal of Obamacare individual mandate penalty. This is not the same as eliminating Obamacare, as much as I would love for that to happen. Over the next decade, this is estimated by the JCT to cost $297 billion. Not only will people be indirectly forced to purchase health insurance with this mandate, but removing the penalty is not tantamount to a tax increase.
Lower taxes for most taxpayers, especially middle class. In 2018, only 5 percent of taxpayers will see their taxes increase, whereas 80 percent will see their taxes lowered (Tax Policy Center). Even better, when looking at the percentage decreases of the tax cuts, the middle class will get a bigger cut than the upper class percentage-wise (JCT). The reason I am not going to compare who gets a bigger cut in dollar amount is because it should be obvious, as well as expected. The United States has a more progressive tax system in which the richest pay higher amounts both in terms of percent and dollar. Ergo, it is all the more remarkable that the middle class is experiencing a reduction in taxes in terms of percentage.
Repeal the state and local tax (SALT) deduction. I covered this topic in my initial analysis of the TCJA, but essentially, it will free up some revenue at the federal level while incentivizing state governments with higher levels of taxation to either lower their taxes or at least not raise their taxes. The final TCJA caps SALT deductions at $10,000. Granted, it's not as good as capping it at $0, but it sure beats the former lack of a cap.
Estate tax. Under the final version, the exemption increases from $5 million to $10 million. This increased exemption will temporarily exist until 2025, after which, it will revert back to $5 million. What this means is that the number of taxable estates drops from 5,000 to 1,800 estates under the new law. Much like some of the other provisions, repeal would be more optimal. However, something is better than nothing.
Alternative minimum tax (AMT). I covered the AMT in my initial coverage of the TCJA. In the final version of the TCJA, Congress only eliminated the corporate AMT. This is another step in the right direction, but Congress should have also eliminated the individual AMT instead of retaining it with a temporary increase.
Unprecedented capital expensing. Under the pre-TCJA tax code, businesses were able to immediately deduct their regular costs. This was not the case for capital purchases. When a business makes a capital investment, it has to deduct the cost over several years using deduction schedules. With the TCJA, businesses can now immediately deduct capital purchases. This makes me happy for two reasons, the first being that of tax code simplification. The deduction schedules were complex and more difficult to enforce. It's nice to see at least some effort towards tax code simplification because there is less of it in the final version of the TCJA. Second, this requires all businesses with capital equipment, and not just huge corporations, to pay the expense of financing the upfront expense, which creates more burdens to businesses. The third reason I am happy is that it should create a slight boost to the GDP. In October 2017, the Right-leaning Tax Foundation released a report on the effects of temporary capital expensing, and found that it would modestly boost the GDP by 0.78 percent over five years. It's not as big as the effects of lowering the corporate tax rates, but it's something.
The Bad
Temporary nature of individual income taxes and its relation to economic growth. You would have thought we would have learned from the George W. Bush era and his tax cuts that the only good tax cut is a permanent one, but here we are. By 2025, the individual tax cuts will have largely been phased out. In 2027, 53 percent of Americans will have higher taxes compared to the current law due to the phase-out (Tax Policy Center). Much like with the corporate tax cuts, the individual income tax cuts should be permanent.
Reduced infrastructure investment. The bill makes infrastructure financing more expensive for state and local governments. Read more from the Brookings Institution here or Econofact here.
Pass-through tax treatment. This pass-through taxation allows for taxpayers who have some or all of their business income taxed on their individual tax return to benefit. This provision would include S-corporations, LLCs, partnerships, and sole proprietorships. With the TCJA, the top tax rate for pass-through income will decrease from 39.6 percent to 29.6 percent. The tax deduction will allow for self-employed individuals to make more than their wage-earning counterparts, as well as create further tax code complexity.
Slightly more progressive tax system. As the Joint Taxation Committee points out, even when the individual tax cuts go away, the distributional effects tax code remains just about as progressive as it did pre-TJCA (see below). This means that fewer will pay taxes in the bottom and more at the top will see their taxes increase. On the one hand, that might sound good because the poor are not burdened with taxes. On the other hand, we have a system where 47 percent do not pay federal income taxes, a figure that will increase as a result of the TCJA.
Endowment tax on universities. The final version will include a tax on university endowments. Aside from having the function of collecting government revenue, taxes also disincentivize behavior. This is true all of taxes. In the case of an endowment, it will disincentivize large donors from making charitable contributions to university foundations, thereby undermining the financial stability of postsecondary institutions. Prominent conservative economists, including Gregory Mankiw and Michael Strain, think it is a short-sighted idea. Most of the world's top universities are located in the United States, and if Trump were concerned about making America great again, he would be against this tax, as well.
Employer-sponsored health insurance. This ended on the "Bad" list not because of what Congress did, but because of what Congress did not do. Employer-sponsored health insurance is the largest tax break in the tax code. Additionally, as I explained in my previous analysis of the TCJA, it has multiple adverse effects, including exacerbating income equality and driving up the cost of health care in the United States.
Increased child tax credit. The TCJA expands the child tax credit (CTC) to $2,000. Much like I pointed out in my initial analysis of the TCJA, the expansion of the CTC only magnifies the already-existing problems with the CTC. The JCT estimates that the CTC will cost $543.6 billion over the next decade.
Modified education savings plan. The TCJA rolls the Cordell Savings Account into the 529 Savings Plan. Read my TCJA analysis from November for more detail on why that is problematic.
Retained subsidies for wind energy. The TCJA did not deliver a blow to wind subsidies (pun intended). If anything, the TCJA maintains the subsidies for wind energy. I wrote this piece three-and-a-half years ago, but it still summarizes why I have an issue with wind energy subsidies.
Allowing for drilling in the Arctic National Wildlife Refuge (ANWR). The Republicans were able to accomplish a years'-long dream with the TCJA: drill for oil in Northern Alaska. I'm not opposed to the idea because the environmental costs would exceed the economic benefits. As I wrote a month ago, we have a fossil fuel supply glut that there is no need to drill at this time. Given the costs of drilling in Alaska compared to other places in the continental U.S., it would be costly and yield little profit. At this point, allowing for drilling in ANWR is more a symbolic gesture than it is a way to boost economic growth.
The Ugly
The worst part of the TCJA is the same as it was in the initial draft: it is going to substantially raise the debt. According to the bipartisan Committee for a Responsible Federal Budget, the debt-to-GDP ratio will increase by 18 percent by 2027 as a result of this bill. The JCT estimates that debt will increase $1.4T over the next decade, whereas the Penn Wharton Budget Model is even more pessimistic in saying that it will raise the debt by $2T over the next decade, as opposed to the CRFB's estimation of $1.2T. While the tax reform has noteworthy features, it still is not as bold as it could have been. The TCJA's effects are limiting because it does nothing to address government spending. Instead, it has allowed for fiscal discipline and restraint to officially die in the Republican Party (if it didn't die beforehand) when Trump signed that Act. When the provisions are up for expiration in 2025, this will come back to haunt the Republicans while biting the American taxpayer in the rear. As we saw with the Kansas tax cut experiment, tax reform should not exacerbate government debt.
Conclusion
If I had to give the TCJA a grade, I would give it a B/B-. If the Republicans did not rush the process, they could have added a spending cuts bill in addition to the tax cut bill. This would have helped avoid more debt and would have allowed for greater fiscal discipline. Not only that, the tax cut reform could have been bolder, which would have meant greater macroeconomic effects. Many of the major provisions, most notably the individual income tax cuts, are going to sunset in 2025. If Congress can reevaluate the individual tax cuts and extend them into a more permanent status, that would be great both for the economy and taxpayers. I would also say there is something to be desired, such as addressing the employer-sponsored health insurance tax break or further tax code simplification. There are some provisions I wish were not in the TCJA, as is illustrated by the "Bad" section of this blog entry. Nevertheless, I am glad to see some concerted effort at tax reform. Now that it is law, we'll get to see what effects, both good and bad, the TCJA actually has.
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