The Good, the Bad, and the Ugly of the House Tax Bill
House Ways and Means Committee Chairman Kevin Brady (R-TX) has released the Tax Cuts and Jobs Act, the first version of tax reform to be put into legislation. The bill has some similarities with the previous framework, but there are many details now filled in and some changes to items that were in the framework.
According to Chairman Brady, the bill will cost $1.5 trillion; however, the bill includes a few gimmicks that could significantly worsen the "true cost" of the package. The table below summarizes in detail how the bill would change major provisions of the tax code.
| Area | Current Law | Tax Cuts and Jobs Act |
|---|---|---|
| Individual Tax | ||
| Tax Rates | 10% | 15% | 25% | 28% |33% | 35% | 39.6% | 12% | 25% | 35% | 39.6% |
| Standard Deduction | $6,350/$12,700 | $12,000/$24,000 |
| Personal Exemptions | $4,050 per person, phased out at higher incomes | Replaced with $300 credit per person through 2022; eliminated without replacement after |
| Child Tax Credit | $1,000/child not indexed for inflation – phased out at higher incomes | Increased to $1,600/child – phased out at higher income than current law |
| Alternative Minimum Tax | Alternative tax targeting higher-income people with low tax burdens; 26% and 28% rates | Eliminated |
| Earned Income Tax Credit | $500-$6,300 credit, phased out at higher incomes | Same as current law but with program integrity measures |
| Mortgage Interest Deduction | Available to itemizers for up to $1 million of debt | Limit lowered to $500,000 of debt for new mortgages on primary residences |
| Charitable Deduction | Available to all itemizers | Mostly similar to current law |
| Health Exclusion | Employer-paid health insurance excluded from income; 40% tax on high-cost plans beginning in 2020 | Same as current law |
| State & Local Tax Deduction | Available to all itemizers | Eliminated for income and sales taxes; limited to $10,000 for property taxes |
| Medical Expense Deduction | Available to itemizers with medical expenses above 10 percent of adjusted gross income | Eliminated |
| Municipal Bond Exclusion | Available for public and private bonds | Private activity bond exclusion eliminated for new bonds |
| Capital Gains from Home Sales | $500,000 exclusion for capital gains from home sales | Exclusion phased out for high earners |
| 401(k) Retirement Accounts | Up to $18,000 of employee contributions on a tax-deferred or Roth-style basis | Same as current law |
| Capital Gains and Dividends | Taxed at 0%, 15%, 20% with 3.8% surtax for income above $250K | Same as current law |
| Higher Education Tax Benefits | $2,500 American Opportunity Tax Credit ($1,000 is refundable); additional tax benefits available | Consolidated to single benefit |
| Indexing of Tax Provisions | Some tax provisions indexed to inflation using CPI-U | Chained CPI used for inflation adjustments |
| Other Itemized Deductions | Various deductions for itemizers | Mostly eliminated |
| Other Tax Provisions | Various credits, deductions, exclusions, and other preferences available | Several provisions repealed |
| Business Tax | ||
| Corporate Rates | Top rate of 35% | Flat rate of 20% |
| Pass-Through Businesses | Taxed at individual income rates | Top rate limited to ~35% for active owners, 25% for passive owners |
| Depreciation Schedule | Accelerated Depreciation (MACRS) | Full expensing of certain equipment for five years; current law afterwards |
| Small Business Expensing | Allows immediate expensing up to $500,000, limited to $2 million | Increases limit to $5 million and phaseout to $20 million for five years |
| Domestic Production Deduction | 9% of income deduction generally available | Eliminated |
| Interest Deduction | Interest expenses generally deductible, subject to 50% leveraging limit | Limit lowered from 50% to 30% of income |
| Inventory Accounting | Last-in, First-Out (LIFO) accounting allowed | Same as current law |
| R&E Credits | 2 credits available for incremental increases in R&E expenses | Same as current law |
| Meals and Entertainment Expenses | Deductible with 50% reduction; certain extravagant expenses disallowed | Deduction eliminated for entertainment expenses; retained for meals |
| Executive Compensation | Deductible up to $1 million (exception for performance pay) | Performance pay exception eliminated |
| International Tax | Worldwide w/ deferral | Territorial w/ base erosion provisions and one-time transition tax |
| Fringe Benefit Deductions | Deductions for certain fringe benefits | Eliminates most deductions for fringe benefits |
| Other Tax Provisions | Various credits, deductions, exclusions, and other preferences available | Several provisions repealed |
| Other Taxes | ||
| Excise Tax on University Endowments | No tax on university endowments | 1.4% tax on endowments exceeding $100,000 per student |
| Estate Tax | 40% tax on estates worth more than $5.49 million (adjusted for inflation) | Exemption increased to $11.2 million through 2023, then the tax is eliminated |
Sources: Joint Committee on Taxation, Ways and Means Committee.
Overall, we are disappointed to see tax reform add so much to the debt at a time when debt is already too high. On the other hand, the legislation also includes some smart reforms. Here's a rundown of the good, the bad, and the ugly of the Chairman’s Mark of the Tax Cuts and Jobs Act.
The Good
A detailed tax reform plan. Over the past two years, the President and Congress have put forward numerous memos, outlines, blueprints, and frameworks for tax reform. All included some level of detail, but they focused much more on the giveaways, like tax rate reductions, and much less on how tax reform would be paid for. Today's legislation is the most detailed effort to date, itemizing each proposed change to the tax code along with appropriate transitions, base erosion protections, or other details where necessary.
Significant tax base broadening. Not surprisingly, today's legislation includes many tax cuts, but it also proposes significant base broadening to help finance those tax cuts – more than was suggested in the Unified Framework. The bill would eliminate the state and local income and sales tax deductions, the medical expense deduction, the domestic production activities deduction, and the business entertainment deduction, along with many smaller provisions. Meanwhile, it would scale back or reform numerous other tax breaks and deductions, including the mortgage interest deduction, the business interest expense deduction, the property tax deduction, and higher education tax benefits. The package includes dozens of smart tax changes that belong in any comprehensive tax reform package.
The Bad
The largest tax expenditure is untouched. The exclusion for employer-sponsored health insurance (the ESI exclusion) is the largest tax expenditure in the code, estimated by JCT to cost $165 billion in 2017 alone. Not only is it expensive, but experts from across the ideological spectrum agree that it drives up health care spending and costs by encouraging employers to offer more expensive insurance rather than higher wages. The tax bill doesn't include any policy to directly limit or reform the exclusion. While repealing the ESI exclusion was never really discussed in the lead-up to the bill, we’ve written about numerous options to scale back or reform the exclusion in order to both generate tax revenue and help slow health care cost growth.
Backtracking on SALT. Most previous tax proposals put forward by Congressional Republicans and the President, including the recent Unified Framework, implicitly or explicitly called for repealing the state and local tax (SALT) deduction – a change that raises $1.3 trillion according to the Tax Policy Center. While today's legislation still repeals the SALT deduction for income and sales taxes, it retains the deduction for property taxes (though it does limit it to $10,000) and makes no changes to the business SALT deduction.
The Ugly
Massive new debt. The Tax Cuts and Jobs Act will cost $1.5 trillion over a decade. With debt already higher as a share of Gross Domestic Product (GDP) than at any time other than the aftermath of World War II, this new debt is likely to slow economic growth and hasten the country's fiscal deterioration. By our estimate, a $1.5 trillion deficit increase will result in debt reaching the size of the economy by 2028 and exceeding its post-World War II record a year or two later.
Gimmick #1: Phasing in estate tax repeal. Though the previous framework repealed the estate tax outright, the bill would repeal it only starting in 2024 while roughly doubling the exemption in the interim. There is no policy rationale for this delayed repeal other than to reduce the ten-year cost of the bill. This move would likely save tens of billions of dollars over ten years without affecting the long-term cost.
Gimmick #2: Arbitrary expiration of the $300 per person credit. In order to ensure the legislation has a middle class tax cut, the Tax Cuts and Jobs Act offers a $300 credit for every non-child dependent (plus a $600 boost to the child tax credit). However, this credit expires after five years with no particular rationale for that policy other than to reduce the ten-year cost. The tax writers likely intend on simply extending the credit before it expires, which could add significantly to the cost of the legislation.
Gimmick #3: Arbitrary expiration of expensing. In an effort to encourage investment, the Tax Cuts and Jobs Act proposes to let businesses fully deduct (“expense”) 100 percent of the cost of certain investments and increase the amount that small businesses can expense (Section 179). Like the $300 credit, however, these provisions are set to expire after five years. Not only is this sunset unwarranted, but it is likely to actually undermine the very growth it is trying to create. Because expensing changes the timing of deductions, the $25 billion cost of five-year expensing and $11 billion cost of expanded section 179 is likely many times lower than the cost of making the provision permanent, which is likely the intention.
*****
While the tax writers deserve credit for putting out new details with real base-broadening, much work is needed to turn the current legislation into a responsible and pro-growth tax plan. Rather than removing offsets, policymakers should work together to add new base-broadening provisions; what cannot be paid for with base-broadening should be offset with new revenue sources or spending cuts or by scaling back the tax cuts. Tax reform must not be allowed to add another $1.5 trillion (or more) to the national debt.
