This Much is Certain: Tax Rates Will Be Changing

With a new president, many are expecting major tax changes.  Looking through the Trump tax plan, it appears to mirror the Reagan tax cuts (the Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986), with some of the largest tax cuts in American history.  That said, those plans were over 30 years ago, so let’s look at what happened then.

The top tax bracket dropped from 70 percent to 28 percent, and the number of brackets was cut from around 15 to two.  Many deductions, such as interest on personal loans, were significantly reduced or eliminated. By 1993, subsequent tax increases had raised the number of tax brackets to five, and the rates to 15 percent, 28 percent, 31 percent, 35 percent and 39.6 percent.

 Currently we still have these brackets, plus phase-outs of many benefits, such as personal exemptions and itemized deductions, and surtaxes related to the Affordable Care Act. The IRS data show that in 1981, the top 1 percent of taxpayers paid about 18 percent of the individual income taxes. By 1989, the top 1 percent paid 25 percent, and today, they pay 38 percent.

Now look at the share of the income—the top 1 percent had 8 percent of the income in 1981, and by 1989 it was up to 14 percent. Currently the top 1 percent have 19 percent of the income. But analyzing tax proposals goes further than just the top rates and determining who pays that tax.

During his campaign, Trump proposed cutting the top individual tax rate to 33 percent and reduce the number of tax brackets to three: 12, 25, and 33 percent. It would maintain a maximum rate of 20 percent on capital gains. The alternative minimum tax and the 3.8 percent Affordable Care surtax on investment income would be eliminated. As far as deductions go, the plan would cap itemized deductions at $200,000 for married filers and $100,000 for single. The standard deduction would increase to $30,000 for married filers ($15,000 for single). All personal exemptions and the head-of-household filing status would be eliminated. The plan would allow income from pass-through entities (partnerships and S-corporations) to be taxed at a 15 percent rate.

Further, the estate tax would be eliminated. There would be no step-up in basis of assets allowed for estates exceeding $10 million.

As for corporations, there are currently four brackets—15, 25, 34, and 35 percent—but the benefit of the lowest brackets is eliminated once taxable income exceeds $235,000. The Trump proposals would reduce the top rate to 15 percent and eliminate the corporate alternative minimum tax, eliminate all business tax credits except the Research and Development credit, eliminate the domestic production activities deduction (Section 199 deduction), tax carried interests as ordinary income, and tax amounts repatriated from foreign countries at 10 percent.

Since 1996, a 10-year budget window has been used by Congress when evaluating tax legislation. The 10-year budget projections are officially prepared by the Congressional Budget Office. If a bill is estimated to produce a revenue loss over the 10-year window, it is a more difficult to get through Congress. So a bill with a revenue increase over the 10-year budget window is generally desirable.

Two organizations independently evaluate tax proposals: Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution aimed at providing independent analysis of current and emerging tax policy issues, and the Tax Foundation, a nonpartisan tax research group devoted to educating taxpayers, the media, and policymakers.   

In evaluating the tax proposals, both organizations include the increased interest costs and macroeconomic effect to analyze how the economy would fare under the tax proposal. Both estimate that tax revenue would be significantly reduced over the 10-year budget window.  

The Tax Policy Center estimates that revenue will decrease by $6.2 trillion; the Tax Foundation puts it at $4.4 trillion and $5.9 trillion. However, their estimates of the impact on the economy vary drastically. The Tax Policy Center estimates the federal deficit would rise by $7 trillion over 10 years. 

The Tax Foundation does not provide an estimate of the effect on the deficit, but it does estimate that after accounting for the larger economy and the broader tax base, it would reduce revenue by between $2.6 trillion and $3.9 trillion.

Other potential changes could dramatically alter tax policy, include changes proposed by the House Republicans in June 2016. These include a full expensing for business costs under a border-adjustable destination-based cash-flow business tax system.

At the end of the day, the details of the Trump tax plan are yet to be seen. It seems that the only thing we can say for sure is that policy change is coming.