Republicans will lay out a framework for a transformative tax reform plan on Wednesday by issuing a set of individual and corporate tax cut targets jointly agreed on by the Trump administration and GOP leaders in the Senate and House of Representatives.
The outline, which Trump will tout in a speech in Indianapolis, is a conservative approach to spurring economic growth and providing relief to middle-class families.
Most of the nine-page document obtained by the Washington Examiner is in line with the administration’s previous proposals. But this time, it has sign-off from the “Big Six,” the group of Trump officials and congressional leadership who have negotiated the plan over the course of months.
Business
The centerpiece of the plan will be lowering the corporate tax rate from 35 percent to 20 percent. That target is above President Trump’s long-stated goal of 15 percent but below the average for developed nations, and near the limit of what experts think is possible as part of a package that doesn’t cut overall tax revenues.
For businesses that file through the individual side of the code, such as S-Corporations and partnerships, Republicans aim to create a special new top rate of 25 percent, as opposed to today’s top rate of 39.6 percent.
The framework will call for allowing businesses to immediately deduct the cost of new investments in equipment and machinery for at least five years, a major part of a policy long sought by House Speaker Paul Ryan.
And, in a step strongly desired by multinational corporations, the outline will end the unusual Treasury practice of taxing U.S. businesses on overseas earnings, while applying special low one-time rates to the estimated $2.6 trillion in earnings companies are holding offshore.
Individual
On the individual side, the number of income tax brackets will be reduced from seven to three, set at 12 percent, 25 percent and 35 percent. The framework won’t include income cutoffs for the brackets, and instead leaves those details to the tax-writing committees in Congress.
One wrinkle in the plan is that the bottom rate would be higher than today’s bottom bracket, which is 10 percent.
But Republicans aim to more than make up for the higher rate with a near doubling of the standard deduction, to $24,000 for couples. That would effectively place many more taxpayers in what the framework calls a “zero tax bracket,” as they wouldn’t have any tax liability on income up to that amount.
The framework as “completely designed with [the] middle-class in mind,” a senior administration official told reporters Tuesday.
The document states that the reform is meant to ensure that the new code “is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers.”
Without further details, it’s not possible to determine whether or how those provisions would lower tax burdens for lower-income families. Because the framework would eliminate personal exemptions, available today at $4,050 per household member, it would take additional safeguards to ensure that families with children don’t see tax increases.
Toward that end, committees will be tasked with increasing the child tax credit “significantly” and making it available to more people in order to offset any possible tax hit. Today, the credit is $1,000 per child.
The framework also calls for a new $500 credit for non-child dependents, such as an elderly relative.
The “Big Six” document allows for the possibility of a fourth, higher income tax bracket with a higher tax rate, if needed to ensure that the plan raises enough revenue and remains progressive.
Lastly, the outline will set the goal of eliminating the estate tax and the alternative minimum tax.
Altogether, those tax rate cuts and breaks would total in the multiple trillions of dollars.
Impact on the deficit
Nevertheless, Republicans maintain that it will not add to the deficit. When the bill is finalized, a White House official said, “this is not going to add to the deficit … it is going to be a revenue-neutral bill.” The cost of the cuts, the official explained, would be offset by eliminating tax breaks and creating faster economic growth.
The framework will give only a partial accounting of which of the code’s current deductions, credits, and loopholes will be done away with in order to offset the revenue losses.
“Most” itemized deductions will be eliminated the document states, including the state and local tax deduction. When filing taxes, individuals can choose either the standard deduction or itemize deductions. Because the framework calls for doubling the standard deduction, itemized deductions would tilt toward higher earners.
The deductions for mortgage interest and charitable giving would be protected, according to the document, and committees would be instructed to find ways to include incentives for retirement, higher education, and work. That means that breaks like the ones for 401(k)s and 529 college savings plans could face changes.
For C-Corporations, the ability to deduct the cost of interest payments on debt will be limited, and several other breaks will be targeted. Yet breaks for research and development costs and for low-income housing will be spared.
Those proposed eliminations are necessary to achieve the tax cuts that Republicans want without blowing out the deficit, but would require rank-and-file members to take a number of politically difficult votes. In particular, Republicans from high-tax states like New York and California would have to vote against their state governments’ interest in eliminating the state and local deduction.
Response
At the same time, however, the plan’s sweeping supply-side vision drew strong support from outside free-market groups positioned to aid its advancement.
“All of these are excellent signs that some of the the most difficult hurdles that Congress will face internally and externally in dealing with the executive branch are being cleared,” said Pete Sepp, president of the National Taxpayers Union.
Grover Norquist, the head of Americans for Tax Reform, called the framework “a phenomenally pro-growth tax cut,” and compared it to the tax changes President Reagan carried out.
He encouraged Republicans to press ahead with the plan even if provisions they sought were not included or are likely to be dropped to lower the cost, and predicted that the unified GOP government would move more tax cuts in future years — for example, making permanent the policy of allowing companies “full expensing” for new investments.
Republicans also appeared willing to consider the possibility of a higher-income tax bracket, even though Republicans in the past have sought much lower top individual rates. Mitt Romney, for example, called for a top rate of 28 percent in his 2012 presidential campaign.
“If that’s what it takes to get something done, I think it’s important to get something done,” said Rep. Jim Renacci, R-Ohio, a member of the Ways and Means Committee charged with writing the tax bill. He suggested that the top rate would only apply to people making multiple millions of dollars. Today, the top bracket kicks in at $470,700 for couples.
If Congress did follow through on the possibility of a higher rate, some high-earners could be at risk of losing their deductions and credits on one end, and not getting compensated with lower rates on the other. Wealthy people, however, still benefit from lower taxes on whatever business income they earned, in addition to the repealed AMT and estate taxes.
Norquist expressed skepticism that the GOP commitees would follow through with maintaining the 39.6 rate, and downplayed the problems it would create if they did. “Failing to cut someone’s taxes may be stupid, but it’s not a violation of the pledge,” he said, referring to the pledge his organization maintains, signed by most Republicans, not to raise taxes.
The biggest unresolved tension, perhaps, in the Republican framework is the loophole that would be created by creating a special 25 percent rate for pass-through businesses.
Tax experts believe that the special rate would spur high-salary professionals, such as lawyers and athletes, to redefine their relationships with their employers in order to lower their taxes. The fear is that they could set up LLCs and present themselves as contractors. That way, their earnings would be taxed at the 25 percent rate rather than the 35 percent rate, or the even higher top rate to be added by the committees.
Bill Self, the coach of the University of Kansas men’s basketball team, performed exactly that maneuver when that state eliminated taxes on pass-through income.
In the framework, it would be left to Congress to write rule to prevent such gaming of the tax code, the senior administration officials said. Republicans have said they are confident they can write such guardrails, but experts are skeptical.
On its own, the tax cut for pass-through businesses would cut revenues by around $1 trillion, but the subsequent gaming of the tax code would add another $1 trillion in fiscal costs over 10 years, Goldman Sachs estimated earlier this year.
Sen. Ron Wyden of Oregon, the top Democrat on the Finance Committee, slammed the special rate as a giveaway to financiers and other wealthy people in a call with activists Wednesday, saying that it “takes a page out of Gordon Gekko’s playbook.”
In the past, businesses have demonstrated that they are very responsive to opportunities to arbitrage tax rates. In the 1980s, the vast majority of all business income was earned by C-Corporations. But after the Reagan 1986 reform lowered the top individual rate below corporate rates, pass-through structures, such as partnerships and S-Corporations, became more attractive. Today, pass-throughs account for about half of all business income.
