Last week, the Trump administration outlined its proposals for tax reform. Entitled the “Unified Framework for Fixing Our Broken Tax Code”, the proposals, if enacted, would result in the most significant changes to the tax code in 30 years.
Reduction in the number of brackets
For individuals, the proposal would reduce the number of tax brackets from seven to three, with tax rates of 12%, 25% and 35%. The current lowest tax rate is 10%, and the highest 39.6%. The framework gives Congress the option of creating a higher, fourth, rate above 35%.
Importantly, the proposal did not specify which income levels would be taxed at each rate. The chart below reflects income thresholds carried over from the 2016 House Republican plan.
Increased standard deduction
The plan proposes the doubling of the standard deduction to $12,000 for individuals and to $24,000 for married couples filing jointly. Doing so would allow many taxpayers to avoid the complex, time-consuming process of itemizing their taxes to claim various credits and deductions.
Itemized deductions limited
Most itemized deductions, including those for state and local tax expenses, would be eliminated. However, the proposal would preserve the deductions for mortgage interest expense and charitable giving, and keep incentives for education and retirement savings plans. For businesses, most deductions would also be eliminated, though tax credits for research and development and low-income-housing would be maintained.
Increased child tax credit and new non-child dependent credit
The proposal would increase the child tax credit from $1,000 to an unspecified amount, and create a new $500 tax credit for non-child dependents, such as the elderly.
Elimination of the alternative minimum tax and the estate tax
Provisions such as the alternative minimum tax (“AMT”) and the estate tax. The AMT limits some deductions for high income earners to ensure that they pay a pre-defined minimum amount of tax. The estate tax applies to estates larger than $5.4 million, and affects approximately 0.2% of the people who die each year. Eliminating the estate tax is estimated to cost the government $269 billion over 10 years.
Reduction in the corporate tax rate
The proposal would reduce the corporate tax rate to 20% from 35%. Because the proposal does not eliminate all corporate tax deductions, Congress will need to find several hundred billion in spending cuts if it wishes to keep this provision revenue-neutral.
Change in taxation of pass-through businesses
The proposal would create a new tax rate of 25% for so-called “pass-through businesses”, such as partnerships and sole proprietorships. At present, these businesses are currently taxed at the rate of their owners. About 95% of the businesses in the US are structured as pass-through entities, and they generate the majority of government’s corporate tax revenue. Most pass-through entities are small sole proprietorships currently paying less than a 25% marginal tax rate. But a small number (less than 2% of pass-throughs) are very large, and generate over 40% of all pass-through income. These businesses currently pay tax at the top 39.6% rate, and the proposal would deliver them a huge tax savings.
One obvious question is: what will this cost? The non-partisan Congressional Budget Office (CBO) has not yet produced a report. However, analysts are projecting that the tax cuts alone would reduce tax receipts by approximately $5.8 trillion over 10 years. The administration believes that the aforementioned elimination of many deductions will reduce the shortfall to about $2 trillion. The difference, it is argued, would be made up by higher economic growth.