Tax Cuts for All

With all but a blaring of trumpets, President Trump’s recently announced Republican tax reform plan just appeared. Understandably, his supporters are assuring us of its fundamental soundness and, as expected, his critics are finding nothing but potential disaster in every provision.

Typical of the hostile reviews, portraying the Republican Party as champions of the wealthy, is an article in The Washington Post, proclaiming “Report: Top one percent would gain the most from GOP tax plan.” The claim is valid, of course, as the top one percent of taxpayers pay nearly half of the federal income taxes. Inasmuch as the bottom 50 percent pay nothing, the headline might be equally accurate if it reads “Report: Bottom 50 percent would gain nothing from GOP tax plan” … but the desired message is then lost.

It’s actually a bit premature to know exactly who will benefit, and by how much, as only a broad outline of the proposed legislation exists. As always the devil is in the details, and the legislators must yet hammer these out. In general, the following changes are contemplated.

• Elimination of all personal deductions except home mortgage interest and charitable contributions.
• Doubling the standard deduction for both individuals and joint return filers.
• Consolidation of tax brackets from the current seven (10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and 39.6 percent) to three (12 percent, 25 percent and 35 percent)
• Reduction of the current corporate tax rate from 35 percent to 20 percent.
• Elimination of the Alternative Minimum Tax (AMT).
• Elimination of the 3.8 percent Obamacare tax on incomes over $250,000.
• Elimination of the estate tax.
• Eliminate taxes on repatriated funds (untaxed profits currently in foreign countries brought to the United States).
• Reduce tax rate on income to S Corps, partnerships and sole proprietorships to 25 percent.

As is traditional, any or all of the anticipated changes can be approved, rejected or twisted into unrecognizable shapes. At this time it’s not possible to know what the final tax reform bill will consist of. It’s for this reason arguments in support or opposition of any specific provision are little more than exercises in political posturing.

With this said, it’s nonetheless possible to analyze the plausible result of any of the modifications without injecting a partisan bias. I’ll do this as best I can. Let’s start with the elimination of personal deductions. The ones of greatest concern are state and local taxes, and in particular property taxes. Understandably, states with exorbitant income taxes as well as those with expensive homes – where high property taxes are imposed – will cause middle and upper middle income taxpayers to lose meaningful deductions. California, New York and Hawaii come immediately to mind, and all three will do what they can to oppose the loss of these deductions. You might note this non-deductibility provision is proving to be so highly controversial it may be removed from the tax package.

An effect exactly opposite to the loss of personal deductions is an increase in the standard deduction. It naturally follows its relative benefit increases as personal income decreases. A taxpayer with a six-figure income paying substantial state income and property taxes is better off retaining itemized deductions. Conversely, a $15 per hour worker living in a rental unit will fare better with the increased standard deduction. It’s not hard to figure out who favors itemization over the standard deduction.

Exactly what purpose tax bracket consolidation serves is uncertain. It’s my suspicion it’s designed to pacify those persons who harbor a fondness for simplicity, and particularly the flat tax concept. Possibly eliminating four of the current seven brackets could be rationalized if we knew what taxable income range each bracket includes, but no attention seems to be directed there. As nearly as I can tell, it’s merely a provision thoughtlessly thrown into the mix which no one bothered to question.

By contrast, eliminating the ATM is a change where a good bit of attention is directed. The law originated in 1969 as a device to prevent 155 wealthy tax avoiders from reaping too many benefits under the regular tax laws, but because Congress never indexed it to inflation – as is the regular income tax – each year, more and more middle-income taxpayers are snared by a tax originally targeted at the rich. As a result it grew into a bonanza from which the government will reap approximately $38 billion in 2017.

Whether or not AMT will be axed from the reform plan depends upon the true intent of reform. Will those government officials, of both parties, who eventually control all funds collected and determine how they‘re spent, be willing to forego the massive sums now regularly collected? Frankly, I think not. Although amidst a flurry of self-congratulatory platitudes the operational details of the rules may be manipulated a bit, I believe AMT elimination will never come to pass.

Another tax singled out to be scrapped is the 3.8 percent slipped into Obamacare on income over $250,000. Inasmuch as the vast majority of taxpayers aren’t hit by this, it’s an easy one to retain as a bargaining chip for negotiating out other more controversial provisions. If I were to lay odds, I’d say it will remain exactly as is.

One of the more ballyhooed changes is elimination of the estate tax; those favoring its rescission refer to it as a “death tax.” Despite the sound a fury, it’s not really an important levy. It produces less than one percent of the nation’s annual revenue, primarily because of the $5,490.000 exemption on the estate of an individual, or approximately double that of a married couple.

With the exception of a relatively large assessment on a deceased’s estate with a going business or large farm, only the truly wealthy are ever tapped. My guess is this will be handled in much the same way as the AMT battle. A few cosmetic changes will make it appear as though a compromise was reached, and the law will remain on the books.

This brings us to the one justifiably contentious item in the tax reform package: the corporate income tax. There are huge sums of money riding on this, and its resolution will truly affect how the United States prospers in this hostile world we occupy. I firmly believe our corporate tax rate must be substantially lowered, for our international competitiveness is a vital factor in the prosperity of all Americans, rich and poor.

As most of us recognize, the current 35 percent rate leads to the corporate contrivances distorting the playing field. What compromise rate will finally be agreed upon is uncertain, but I envision the haggling will be between 20 and 25 percent. A close friend I consider sophisticated and knowledgeable predicted to me it will end up at 22 percent. I believe we can live with that; we shall see what comes to pass.

A final comment: The political scene in America today is more erratic than at any period in my lifetime. Why this is so I don’t understand, but because of it, the economy of the nation is equally erratic. Prospering in this environment is a challenge. I can only suggest you exercise caution in your investments and place minimal faith in those persons who offer assurances they know where the economy is going and what you must do to thrive in the market.

Al Jacobs, a professional investor for nearly a half-century, issues a monthly newsletter in which he shares his financial knowledge and experience. You may view it on http://www.roadwaytoprosperity.com

al@beachcomber.news