Tax Reform – Repeat Performance

By: 
Al Jacobs

Treasury Secretary Steven Mnuchin certainly sounded positive on Wednesday, April 26th, as he outlined the administration’s tax proposals. As massive tax reform constituted one of the major planks of President Trump’s campaign platform, big things seem to be in the works. For those of you unaware of the sweeping changes being contemplated, I’ll give you a brief summary of the major items under consideration.

  • Conversion of the seven existing personal tax rates, now topping out at 39.6 percent, to three rates of 10, 25 and 35 percent.
  • Elimination of all personal deductions except for charitable contributions and mortgage interest on a residence.
  • Increase of the personal standard deduction for married couples filing jointly from $12,600 to $24,000.
  • Elimination of the Alternative Minimum Tax.
  • Reduction of the corporate tax rate from the current 35 percent to 15 percent.
  • Elimination of the estate tax

Changes in the tax laws are nothing new. Since the enactment of the 16th amendment to the Constitution, when, in 1913, income tax became the law of the land, the number of brackets and the applicable percentages varied widely. Initially the tax set a flat 1 percent on incomes over $3,000 for individuals ($4,000 for married couples) with an additional 6 percent surtax on very high incomes. By the conclusion of World War II in 1945, numerous brackets existed, the lowest, between $750 and $2,000, taxed at 23 percent, with income over $200,000 at 94 percent. Thereafter the top rates periodically dropped. If the number, size and tax rates of the brackets constituted the sole variables, income tax analysis would be a simple matter. However, it’s by the granting of various exclusions, exemptions, deductions and credits that taxation of income takes on its true character, and it’s through the use of these devices the effective rates are distorted into a bewildering array of meaninglessness.

As for the Alternative Minimum Tax, the concept dates to 1969 when Congress enacted, and the president signed, a law designed to ensure 155 multimillionaires did not utilize unconscionable loopholes to avoid paying their fair share of income taxes. In the nearly 50 years since its enactment, it devolved into a device which requires a tax filer, utilizing a prescribed formula, to calculate taxes both with and without authorized personal deductions. The taxpayer will then pay whichever method results in the greater amount. The effect of the ATM is no longer reserved for the super-wealthy. As the law incorporated no index to inflation, it now applies to middle income wage earners. What was once rationalized as a method to raise revenue from a small number of super-rich Americans is now a contrivance which, it’s estimated, causes 27 million taxpayers to pay $35 billion annually.

The last two items, the corporate and estate taxes, pose little significance for the average middle-class citizen. The 35 percent rate on the former applies only to net corporate income exceeding $75,000 yearly. Taxes on the latter are not assessed on estates less than about $5.5 million.

What truly matters is the percentage of gross income remaining in the hands of the mass of Americans after the tax collector gets his. From the standpoint of the citizen, things are not getting better. At its inception in 1913, only 2 percent of the U.S. population paid any income tax whatsoever. On the eve of World War II in 1941, the effective rate on the 82 percent of Americans with taxable income under $3,000 remained at single digit levels. Thereafter the escalation proceeded with no respite. Taking into consideration state and federal taxes, Social Security and Medicare contribution from both employee and employer, and payroll deductions such as disability and the like, the average middle-income American today gets to keep about half of what’s earned.

How may we now evaluate the intent of President Trump’s professed desire to simplify the tax system while lowering the rates we citizens pay? I suggest we tune back to our last massive tax reform of 1986, championed by another president with only the best of intentions, Ronald Reagan, who also desired lower rates and a simplification of the system. At that time the top marginal bracket for the taxpayer was 50 percent, while numerous personal deductions and a mass of complex provisions cluttered the tax laws. For months the legislators haggled over the details until they finally agreed upon “a massive tax reduction for the benefit of the taxpayer.”

Commonly referred to as the Reagan Tax Reform Act of 1986, enacted on Oct. 22, 1986, and promoted on the basis of its reduction of income tax rates, it actually triggered a wholesale elimination of deductions, exclusions and credits constituting the average taxpayer’s only tax shelters. Foremost among these was the deduction for personal interest expense, which for those of you old enough to remember, enabled many persons with chronic personal debt burdens – particularly credit card debt – to somehow survive. While the easing of the tax rates, with top bracket of 38.5 percent lowered to 28 percent, did little to assist most citizens in their day to day bill paying, the elimination of the interest deduction constituted the straw which broke many a worker’s back. Its practical effect: an increase in the cost of carrying debt, often representing the difference between making it and not making it. Of course, as is customary when stripping benefits from the citizen, these changes phase in over a number of years. In this case only 35 percent of the interest deduction became disallowable in 1987. The disallowance increased to 60 percent in 1988, to 80 percent in 1989, to 90 percent in 1990 and finally to 100 percent by 1991. Understandably, the instigators presumed by the time a benefit is fully gone, most taxpayers will have forgotten who took it from them. And with the top marginal tax rate now in 2017 greater than the original rate, how did the average citizen actually fare? I think you can guess the answer to that question.

I now confess to having no idea how this tax reform proposal will play out. The leaders of the minority party seem dead set against anything the president favors. Senate Minority Leader Charles Schumer, D-N.Y., claims: “That’s not tax reform. That’s just a tax giveaway to the very, very wealthy that will explode the deficit.” Steven M. Rosenthal, senior fellow at the liberally-oriented Urban-Brookings Tax Policy Center, predicted “wealthy and sophisticated taxpayers would exploit the drop in the corporate tax rate to pay less in taxes on their income.” Oregon Senator Ron Wyden, top Democrat on the Finance Committee, called it “an unprincipled tax plan that will result in cuts for the 1 percent and crumbs for the working people.”

It’s also probably accurate to suggest many Republican legislators are no more enamored with Donald Trump than are the Democrats, partially due to the castigation a number of them received from him during the election. For this reason, as well as the indescribably intricate set of tax arrangements all negotiated over the years between every conceivable interest group, the entire tax reform measure may collapse in much the same way as did the attempted repeal of Obamacare.

A final thought: tax reform is not an altruistic balancing of noble intentions with the good of the nation at heart. It is, instead, cold-hearted scheming where the participants strive to secure the most favorable results possible for themselves and their allies. And while you, as a taxpayer, are haggling and wangling, never ignore what it is the government wants from you: it wants your money.

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

Category:

Add new comment

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
CAPTCHA
This question is for testing whether you are a human visitor and to prevent automated spam submissions.
Image CAPTCHA
Enter the characters shown in the image.

Beachcomber

Copyright 2017 Beeler & Associates.

All rights reserved. Contents many not be reproduced or transmitted – by any means – without publisher's written permission.