The GOP Tax Plan: The Good and Bad News of the Tax Cuts and Jobs Act

During his presidential campaign, President Trump made tax reform one of the pillars of his platform. Cutting income taxes, reducing corporate taxes, improving the child tax credit, eliminate the estate tax: these were a few of Trump's proposed ideas. The much awaited Tax Cuts and Jobs Act (TCJA) was released last Thursday. If this Act passes, it will be the largest overhaul of the U.S. tax system since the Tax Reform Act of 1986. When legislation or public policy this complex and overarching is in the process of being enacted, there are multiple facets of the bill that hardly make it a "black and white"/"either-or" statement. Nevertheless, one can make a general conclusion after looking at the individual parts. This was similar when I looked at the Trans-Pacific Partnership about a year ago, a multilateral trade agreement that Trump nixed on his first day in office. While I did not like everything in the TPP, I generally thought that the TPP was a step in the right direction for freer trade. I would like to take a look at the major provisions of the TCJA in the same spirit to analyze the components, as well as determine whether or not this would be a net benefit.

Here Is The Good News...

• No changes for 401(k) payments. There had been rumors circulating that the Republicans were going to lower or eliminate the current deduction for the 401(k). Fortunately, this did not take place because a lower deduction would have made it more difficult for people to save. 
• Lower cap on the mortgage interest deduction (MID). Starting next year, the cap on the MID would decrease from $1M to $500K. Reducing the cap is important because it reduces the percent of eligible households from 21 percent to less than 4 percent. Considering that a) the MID does not increase household ownership rates, and b) it causes other unintended consequences, I'm happy to see this make it into the bill. It doesn't downright eliminate the MID, but it is a step in the right direction. 
• Estate tax phasing out and repeal. If this TJCA passes, then the estate tax will have the exemption doubled immediately, followed by a repeal six years later. Considering how I feel about the estate tax (a.k.a. the death tax), I would consider this a win. 
• Simplified tax code. One of the things that makes the tax code burdensome is the complexity. A simpler tax code with a broadened tax base would mean less compliance costs for taxpayers and less administrative costs for the government. Not only does the TJCA reduce the number of income tax brackets from seven to four, but it also eliminates a number of tax breaks (e.g., sports stadiums, medical expense deduction, adoption tax credit).
• Elimination of the alternative minimum tax (AMT). The AMT is a supplemental, flat income tax that was created in 1969 to target millionaires in order prevent the wealthy from reducing their tax base through the use of tax preference items. However, it targets those making between $250K and $1M, as well as those in high-cost states and those with children. Since the AMT affects 30 million people, it affects more of the middle class than upper class. Additionally, the AMT is quite a complex tax, which increases compliance and administrative costs. As such, it is a good thing that AMT is being repealed. 
• Creation of a territorial tax system for business taxes. To make a long story short, I am in favor of this change in tax policy. 
• Elimination of state and local tax deduction. The state and local tax (SALT) deduction allows for taxpayers who itemize on federal income tax to deduct state and local real estate, property, and income taxes. The SALT deduction acts as an indirect federal subsidy to state and local governments in the sense that decreases the net cost of nonfederal taxes. 
• Proponents argue that repeal could end up being more regressive and allow for double taxation (although there is a counterargument on the "double taxation" argument). On the other hand, the SALT deduction acts as an indirect subsidy towards high-income, high-tax states, as well as towards higher-income individuals. Plus, the existence of SALT incentivizes states to increase taxes and government spending, thereby increasing state-level government debt.
•  Not only does the Center for Freedom and Prosperity estimate that 99.7 percent of taxpayers would benefit from this repeal, but the Heritage Foundation estimates that it would generate $1.6T of revenue over the next decade. 
• The SALT deduction for income and sales tax will be repealed, but the SALT deductions for property and business remain. 

Here is The Bad News...

• Huge deficits. The bill contains $5.8T in tax cuts and $4.3T in revenue raisers. According to the Joint Committee on Taxation, this tax plan is going to add a net $1.487T deficit over the next decade (see a policy-by-policy breakdown here). The CFRB calculates that this would increase the estimated 2027 debt-to-GDP ratio from 91 percent to 99 percent (see below). Another way of phrasing that is "debt will increase by about 9 percent with the passage of this bill." This assumes that the true cost of the TJCA is not being hidden with accounting gimmicks. 
• Because it causes a deficit, it might not get enough votes to pass. Senator Bob Corker (R-TN) already said he would not support a bill that adds to the deficit. If one more Senator feels the same way and votes accordingly, then the TJCA will not pass. 
• Senate budget rules, especially the Byrd rule, state that the budget cannot add deficits outside the next decade, which means that the TJCA will need to undergo modifications before enactment.
• The deficits are simply not an issue of a higher debt-to-GDP ratio. As the Brookings Institution points out, this is bad fiscal policy. Right now, we are near full employment, which means we should be running a surplus. This is the time for contractionary fiscal policy, not expansionary. 

• Corporate tax rate reform will not be enough. Under this plan, the corporate tax rate is to decrease from 35 to 20 percent. Needless to say, I'm all for lowering the corporate tax (see here and here). Even so, there is still a question of how assets overseas are treated in order to get a sense of the overall corporate tax plan. But that is not the only concern. Per the previous point, the deficit is causing procedural issues with the TJCA passing. For this Act to pass, there will need to be deficit reduction. The best way to achieve less deficit is weakening the corporate tax reform, which means that this reduction will only be temporary and have minimal effect. 
• Employer-sponsored health insurance. The employer-sponsored health insurance tax break is the largest in the tax code, and yet it remains untouched. Employer-sponsored health insurance has multiple adverse effects, including driving up health costs, causing excess consumption in health care goods and services, incentivizing employers to offer more expensive plans instead of offering higher wages, and exacerbating income inequality. If you want a good reason as to why health care costs are higher in the United States versus other countries, this tax break is a major reason. 
• Some lower- and middle-class households will have higher taxes while the rich benefit. There is a lot in play in the TJCA: child tax credit reform, the doubling of the standard deduction, the elimination of personal deductions, and raising the lowest marginal tax rate to 12 percent. Some will experience tax increases, others tax deductions, and for some, it will not change. It really depends on multiple factors, including income bracket, geographic location, size of household, and composition of household. The Tax Policy Center found that 28 percent of households will have their taxes raised, whereas the JCT puts the figure at 18 percent. 
• 11-10-2017 Addendum: The Tax Policy Center had to retract and reissue its report on the TCJA. It found that only 7 percent of households will experience tax increases in 2018. However, that number will increase to 25.5 percent by 2027 (See below). 

• There is a complaint that the top 1 percent would reap 50 percent of the tax cuts (Institute on Taxation and Economic Policy). On the other hand, the top 1 percent pay nearly 40 percent of all income taxes. On the other hand, our tax system is more progressive than other countries, which is why, in large part, the rich benefit more from tax reform. 

Source of Graph: Slate

• Increase the child tax credit. I have commented on the Child Tax Credit (CTC) before, and I am not a fan (see here and here). The modifications of the CTC not only make the current flaws of the CTC more pronounced, but it will add an extra $640B to the debt over the next decade (JCT). 
• Modified education savings plan. The Coverdell Education Savings Account is a tax-deferred trust account that encourages parents to save for future education costs. This Savings Account is to be rolled into the 529 savings plan (see here for difference between Coverdell and 529). The people over at Heritage Foundation were thrilled about rolling the Coverdell into the 529 because it supposedly encourages education choice. I do not share this enthusiasm. As the Brookings Institution illustrates, the 529 savings plan drives up the very college costs that it was meant to help meet. This is no surprise since federal loan subsidies for college do the very same thing (see here and here). Needless to say, this does not leave me inspirited about higher education costs. 
• Graduate Students: Tax Exemption. If you are a graduate student, you might end up paying more under the TCJA. The TCJA is expected to roll back or eliminate tax breaks used by graduate students who are research or teacher assistants. About 177,000 students use the Qualified 117(d) Reduction. If repealed, it could cost these students an average of $2,000 a year, which adds up for those in years-long PhD programs. 

Conclusion
There are quite a few features of the TCJA that I like, and I am happy to see a bill address some major issues with the tax code. At the same, I think still comes with major issues, the foremost being that of increasing the deficit. Don't get me wrong. High tax rates have an adverse effect on the economy (e.g., here), but at the same time, tax cuts are only part of the solution. Without reduced spending, tax cuts become tax-shifting, which means that we would pay with higher tax rates in the future. Even the libertarian Cato Institute and Mercatus Center acknowledge that real tax reform is not about lowering or eliminating tax deductions, but rather about raising revenue in the least distorting way possible with the longer-term goal of paying off debt so we don't get pummeled by it in the future. Plus, lowering taxes while raising spending is one of the worst ways to go about fiscal policy since it exacerbates the debt-to-GDP ratio.

If I had to grade the TCJA as a whole, I would give it a B/B-. Yes, it takes a serious attempt at tax reform. At the same time, it increases debt. Additionally, it does not even address the largest tax exemption, the very one that needlessly drives up our healthcare costs. I would feel much better if the TCJA were more revenue-neutral and eliminated the deduction for employer-sponsored insurance. Even so, there is an argument to be made that the TCJA allows for revenue to be collected in a more efficient and less destructive manner.

Furthermore, the Tax Foundation is estimating that on net, it will create more jobs and create bigger tax cuts on average. Like any major bill, there are going to be winners and losers. We also know that this is not the final version (especially since it creates a deficit, not to mention that the Senate version needs to line up with the House version). At the same time, we have a sense of where Republicans are going with tax reform. I definitely think some modifications are in order, but I am happy to see that Congress making a concerted effort to make taxation a simpler, more efficient process.