WASHINGTON ― Republicans want to simplify the tax code, give everybody a tax cut and dramatically boost economic growth with one wonderful piece of legislation that could pass Congress as soon as next month.
Would the Republican tax bill do all those things? Not quite.
“Not quite” is a running theme when it comes to the proposed tax legislation, and nothing illustrates that as well as the example of the standard deduction.
At tax time, filers have to choose whether to reduce their taxable income with itemized deductions for things like mortgage interest and charitable donations, or to take the much-simpler standard deduction. It allows a married couple to subtract $12,700 from their taxable income, which is a good deal for 70 percent of U.S. households.
Republicans have big plans for the standard deduction and have made it a centerpiece of their tax talking points.
“We want to double the standard deduction, so that every American family can pay zero taxes on their first $24,000 in income,” Vice President Mike Pence said in a speech last week.
Unfortunately, $24,000 is not quite double $12,700. The number they’re looking for, according to a calculator, is $25,400. Somehow, in their once-in-a-generation scramble to rearrange the tax code, Republicans saw the correct sum either just escape their reach or it fell victim to ”fuzzy math.”
During a hearing before the House passed its tax bill last week, Rep. Bill Pascrell (D-N.J.) complained about the non-doubling, but Republicans didn’t respond to the criticism.
“This is a pretty simple thing,” Pascrell told HuffPost after the hearing. “If they’re getting this wrong, what the hell else is wrong in the thing?”
The almost-doubled standard deduction is key to Republicans’ plans for simplifying the tax code. With the bigger standard deduction, only 5 percent of households would still benefit from itemizing, compared to the 30 percent that do today. Raising the deduction would make filing taxes far simpler for those households, not to mention for the IRS.
But that simplification comes at a price. The tax bills moving through Congress eliminate an array of other deductions, some of which may be “special interest loopholes,” but not all. One of them is called the personal exemption, and it benefits all households earning less than a few hundred thousand dollars, even if they don’t itemize. It’s a deduction that reduces a filer’s taxable income by $4,050 per household member. Under current law, a married couple with two kids can already avoid taxes on its first $28,900 of income thanks to the modest $12,700 standard deduction plus four personal exemptions.
In other words, the Republican proposal to increase the standard deduction only partially offsets the loss of the personal exemption for families with kids. The Senate version of the bill ― which is still being debated ― doubles the child tax credit, but doesn’t index the benefit to inflation, which is what’s typically done for most parts of the tax code. And the increase expires in 2025.
Because the Republican plan offers lower marginal tax rates, but in some cases subjects higher amounts of income to taxation, experts have consistently found it would deliver a tax cut for most, but not quite all, households. The nonpartisan Tax Policy Center reported Monday that under the Senate version of the legislation, 9 percent of taxpayers would pay more in 2019, 12 percent would pay more in 2025, and fully half would pay more in 2027.
Even the simplification aspect of the plan has a huge asterisk. While the legislation eliminates deductions and the tricky “alternative minimum tax,” which prevents rich people from completely avoiding tax liability, the plan would also create a stunningly complicated system for taxing sole proprietors, partnerships and S-corporations.
Such “pass-through” businesses, so-called because their income is taxed when it passes through to owners’ individual tax returns, generate more than half the business income in the U.S., according to the Congressional Research Service. Right now, pass-through income is taxed at regular individual rates. The Republican plan would create a special new pass-through rate of 25 percent. Since individual rates would still be as high as 39 percent under the plan, high-earners would have a strong incentive to falsely reclassify wage income as business profit in order to get the lower rate.
Republicans promised they would set up “guardrails” to prevent rich people from abusing the pass-through rate. The House and Senate bills set up competing schemes to prevent such gaming, either of which would require a thicket of IRS regulations for determining what counts as “qualified business income.” Misreporting of pass-through income is already the single biggest contributor to the “tax gap” between what the IRS is owed and what it manages to collect, according to the agency.
“The pass-through rate is a mess and it’s going to be impossible to enforce effectively,” Gregg Polsky, a tax professor at the University of Georgia School of Law, said in an interview.
The government will collect a lot less revenue as a result of all those tax cuts, but Republicans say businesses will reinvest their tax breaks, resulting in higher wages and economic growth ― and increased federal revenues. House Speaker Paul Ryan (R-Wis.) and President Donald Trump have said tax reform would lead to sustained 3 percent growth over the next decade, which would be much better than the Congressional Budget Office’s sad projection of 2 percent or less.
Most economists agree that tax cuts in the Republican bill would boost growth. In an analysis of the macroeconomic effects of the legislation, for example, the Tax Policy Center said that the bill would boost growth by 0.6 percent next year and just 0.3 percent in 2027. Other organizations have come to similar conclusions.
“The estimated boost to output diminishes over time primarily because the effects of aggregate demand fade and the effects of additional federal debt on interest rates grow,” the Tax Policy Center said.
So that’s growth, just not quite as much as Republicans promise.
Arthur Delaney co-hosts the HuffPost Politics podcast: