Tax Reform – Some Details (Part II)

When it comes to tax policy many things are said and promised but few actually make it into the tax code. As a candidate Donald Trump laid out a tax policy that was both ambitious and probably unrealistic. Most analysts found that candidate Trump was following typical political speak and promising lower taxes that would be offset by job and economic growth to keep revenue at current levels. He is not the first to make such promises and certainly will not be the last. Democrats have pounced on some of his promises but they forget that their candidates, and office holders, have made similar promises based on faulty projections.

One thing different with Trump is that he has not laid out a plan and remained static. He has constantly redone his proposals and even acknowledged (this part is new politically) that what he is proposing is only a first offer and that he would have to negotiate (now this is novel) with Congress to come up with a final plan for tax reform.

The last major tax reform was done in 1986 and was the result of negotiations between President Ronald Reagan and Speaker of the House Tip O’Neill. This was 30 years ago and in the intervening years the code has been changed and once again become so complicated and burdensome that reform is desperately needed.

That attempt at tax reform was very interesting. It was the first time that the top rate was reduced and the bottom rate increased in the same piece of legislation. It was successful in basically reducing 15 brackets to two (there were actually four). Previously the top bracket was 50% and the bottom one was 11%. There were changed to 15% and 28%. (the four comes into play with some income being taxed at 33% and then going back to 28%). Of course to accomplish this a lot of deductions were abolished.

One of the more interesting aspects of this package was the requirement that taxpayers show proof of dependent children in the form of a social security number. Previous to this the IRS accepted whatever dependents that taxpayer listed, sort of an honor code. Within one year seven million children suddenly disappeared on tax returns. Not sure what really happened to them.

So now we are in 2016 and with the Republicans in charge of the House, Senate and White House there is renewed enthusiasm for finally beginning the work of reforming the tax code. Since that monumental change 30 years ago we have seen the code become more cumbersome and the top rates increase from the 28% level to 39%. We have seen the corporate rate grow to 35%. The tax code has grown to over 7,000 pages and that has to be shrunk down.

So who are the major players? In the Senate we have Chairman Orrin G. Hatch (R-UT), Ranking Member Ron Wyden (D-OR), Majority Leader Mitch McConnell (R-KY) and Minority Leader Chuck Schumer (D-NY). This is an interesting mix and a change in one key player may make all the difference. Chuck Schumer replaces Harry Reid and their personalities are very different.

In the final years of his leadership tenure Reid became very hardline and was the backstop for the Obama Administration in opposing anything the Administration objected to in tax law. Schumer is more of a negotiator and probably realizes that without the threat of a veto his power has been reduced. Wyden has always been known as someone that likes to find common ground on legislation and that bodes well for getting some form of a deal. Couple those facts with the number of Democrats running in states won by Trump and you may well have all the ingredients for a comprehensive tax reform package.

In the House the rules make it a lot different. Kevin Brady (R-TX) is the Chairman of the Ways and Means Committee and the new Ranking Member is Richard Neal (D-MA). He replaces Sander Levin who has voluntarily stepped down. Speaker of the House Paul Ryan (R-WI) is a former Chair of the tax committee and a well known tax wonk. The Democrat Leader, Nancy Pelosi (D-CA), will be what she has been for the past several years but the challenge to her in the leadership race showed that one-third of her caucus has lost faith in her and she espouses the same old and tired liberal ideas.

 

So what will a new tax code look like? The bullet points below are some ideas that I think will be incorporated:

  • Individual rates will be reduced and you will see fewer brackets. A top rate of 28% will again be the cap.
  • Corporate rates will drop and could go somewhere in the 22-25% range. I realize that most corporations don’t pay the top rate but it is symbolic.
  • A change in the capital gains tax. This has been a hotly debated point between Republicans and liberal Democrats. Obama has raised them to 23.8% (including the 3.8% surtax). This will come back down to the 15% area to encourage investment. (Remember Sanders wanted to tax gains at normal income rates)
  • I suspect that the Estate Tax, sometimes referred to as the death tax, will be eliminated. In reality it raised very little in revenue since the first $5M is exempt and the really wealthy have tax lawyers and insurance products or ensure they don’t really pay the tax.
  • In the business world one of the key provisions will be how to encourage infrastructure spending without gutting revenue. One proposals will be to eliminate business depreciation and allow full expensing in the tax year. What this means is that instead of depreciating an investment in equipment over a period of years a company can claim the full deduction in the year they spend the money and purchase the equipment.
  • At the individual level Trump and Republicans have signaled the tax cut will be geared to families and the middle class. That will probably mean an increase in the Earned Income Tax Credit (EITC). That is the quickest and most effective way to reduce taxes for this group of people.

This is just a rough outline of what we can expect and more details will start to emerge once Trump and his economic team are in office and start the negotiations with Congress.

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