Can you really cut taxes for everybody, with nobody feeling any pain?
The answer is yes — but that’s not what President Donald Trump proposed when he announced his tax-cut framework on Sept. 27. Trump’s plan, for now, is more ambitious than a simple across-the-board tax cut. He wants to simplify the whole structure of the U.S. tax code and create better incentives for companies to do business in the United States. In general, tax experts agree these are worthy goals.
The catch is that restructuring the tax code would undo tax breaks many filers have relied on for years, and in some cases, force them to pay more taxes in the end. Congress still has to work out the details that will determine winners and losers, but Trump’s starter framework suggests that a meaningful number of Americans could end up paying more in taxes, on net, rather than less.
The main change to watch is the proposed elimination of the deduction for state and local taxes, which tax experts refer to as SALT. About one-third of the 145 million households filing a tax return — or roughly 48 million filers — claim this deduction. It’s more popular among the wealthy, because they’re more likely to itemize their deductions instead of opting for the standard one. Among households with income of $100,000 or more, the average deduction for state and local taxes is around $12,300.
What would happen if SALT is eliminated
If my family’s adjusted gross income were $200,000, a deduction of $15,000 in state and local taxes would reduce our tax bill by $4,200. (We would be in the 28% tax bracket, so our net savings would be 28% of $15,000.) So, eliminating SALT would push our tax bill up. Under the Trump plan, lower tax rates are supposed to offset this bump by reducing the federal take overall. So the savings from a lower rate would have to exceed $4,200 for us to end up better off.
“Upper income people who deduct state and local taxes are most likely to be the biggest losers,” says Joe Rosenberg of the Tax Policy Center. “It would really hit a small group of high-income but not extremely affluent taxpayers.”
Many news outlets have pointed out that killing the SALT deduction would hurt taxpayers in Democratic states more than those in Republican ones. But that’s misleading. Taxpayers who claim the SALT deduction would be hit in every state. There are more of them in populous, high-income states such as New York and California, which happen to vote Democrat most of the time. But there are taxpayers in swing states such as Ohio and Michigan, and red states such as Texas and Alabama, that would fare exactly the same if the SALT deduction disappeared. The aggregate dollar-figure is simply bigger in more populated states with higher incomes.
Same fate as Obamacare
There’s an analogy for this approach to reworking the tax code in the Affordable Care Act, of all places. The architects of that controversial law argued that it would make the public better off overall, because more people would end up with health insurance coverage. They turned out to be right about that — about 20 million more people have coverage now than before the law went into effect in 2014. But they overlooked the fact that a smaller number of people would end up paying more for coverage— in some cases, a lot more — and some who earned too much to qualify for ACA subsidies would find insurance unaffordable and go without it. The group hurt by Obamacare is relatively small — perhaps a couple million. But the fact that the government would harm anybody at all turned large chunks of the population against the law, which has hurt its effectiveness even now and opened the door to major changes. A Trump tax bill could suffer the same fate if it harmed some in order to help more.
There are a couple other possible land mines in the Trump tax approach. The first involves the lowest tax bracket, which Trump would raise from 10% to 12%. That looks like a tax hike on the lowest earners, but it wouldn’t be, because the standard deduction would be doubled, effectively pushing down the net tax bill (in some cases, to 0). Taken out of context, however, Trump is proposing a tax hike on the poorest workers, if you only consider the tax rate alone. Some Democrats running against Trump and his fellow Republicans in the 2018 midterms seem certain to make that error of omission when characterizing Trump’s plan at campaign events.
Finally, while it sounds like a good idea to reduce seven tax brackets to three, it might not be. There’s nothing inherently wrong with seven tax brackets, or 50, for that matter, as long as they’re clearly delineated and you can easily look up your bracket, based on your adjusted gross income (AGI). Fewer brackets would leave bigger gaps between earning groups, and it’s possible some filers could end up in a higher bracket instead of a lower one. Whether you’d pay more tax after ending up in a higher bracket, however, depends on how Congress sets the income levels that correspond with each bracket, and which deductions remain in the new tax code.
As Congress works through all of this, they’ll basically be asking taxpayers to trust them — to believe that any pain will be worth the gain, that getting something unknown will be better than losing something familiar. It would be ideal if Congress could cut everybody’s taxes unambiguously, but that’s not how it works. There will be tremendous pressure to come up with new sources of tax revenue — which can only happen by adding new taxes or killing existing tax breaks — in order to institute all the tax cuts Trump and his fellow Republicans favor. Keep your eye on every shell.
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Rick Newman is the author of four books, including Rebounders: How Winners Pivot from Setback to Success. Follow him on Twitter: @rickjnewman