On Wednesday, US President Trump revealed his plan to give his country’s tax code a major overhaul. This has potential ramifications beyond the US, both in terms of the global economy and other nation’s future budgets. Nothing is set in stone yet, and there weren’t many details, but here’s what the administration is proposing.
A Standard Deduction Increase
The plan would simplify tax cuts by doubling the standard deduction to $US12,000 for individuals and $US24,000 for married couples who file jointly. It would also increase the child tax credit and the income limits at which that credit starts to phase out. According to the plan, this would prevent the marriage tax penalty (some couples actually pay more when they file together).
However, offsetting this, the plan would get rid of itemised deductions, save more when they itemise their many deductions — the new plan gets rid of that option so that they will have to take the standard deduction instead. That could be good for some taxpayers; it could hurt others who stand to gain more from itemising.
That said, the plan specified that the mortgage interest deduction and charitable contributions wouldn’t be eliminated. They’d also add a $US500 non-refundable credit for non-child dependents and repeal the estate tax and generation-skipping transfer tax, which affects beneficiaries who receive gifts or inheritance.
New Tax Brackets
The new plan would also condense America’s current tax bracket system, which includes seven brackets, into three at 12%, 25% and 35%.
However, it doesn’t specify the actual brackets for these rates, so it’s hard to determine which taxpayers would or wouldn’t benefit and how much more they may stand to save or pay. The current lowest tax rate is 10% and the highest is 39.6%, meaning the highest taxpayers would presumably get a tax cut while the lowest tax rate gets an increase.
A Big Tax Cut For Businesses
Trump plans to cut the corporate tax rate from 35% to 20%. The plan also proposes a tax rate of 25% for pass-through businesses, like sole proprietorships, partnerships, and S-corporations. According to CNBC, 95% of businesses in the United States are structured as pass-through businesses. They explain:
The name comes from the profits and losses of such businesses that pass through directly to their owners, unlike public corporations.
Pass-through profits are now taxed at top individual income-tax rates as high as 39.6 per cent, higher than the top corporate income tax rate of 35 per cent — a disparity that pass-through business owners have long complained about.
The administration also proposes moving the worldwide tax system to a territorial one, which would be a huge change for multinational corporations.
Basically, this means these corporations would only pay taxes on the income they earn domestically. Currently, when corporations earn money overseas and they bring it back to the U.S., they have to pay a tax, called a repatriation tax, but are also given a credit for any foreign taxes they have paid. The new plan is designed to encourage these companies to bring any overseas profits back to the U.S. instead of keeping the money offshore.
No More Alternative Minimum Tax
The Trump tax plan would also eliminate the Alternative Minimum Tax, a tax designed to keep wealthy people from taking advantage of too many loopholes.
Here’s a brief history of the AMT: As the Tax Policy Center explains, in the late 60s, Treasury Secretary Joseph W. Barr informed Congress that 155 taxpayers with incomes over $US200,000 ($254,617) (a significant amount at the time) hadn’t paid any federal income tax in 1966. Eventually, the AMT was established to address the outrage among other taxpayers and fix the problem. Here’s how the IRS describes the AMT:
The alternative minimum tax (AMT) applies to taxpayers with high economic income by setting a limit on those benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax.
The argument against the AMT is that it has made taxes complicated for many middle-income taxpayers, too. CBS News reports:
By shearing away a host of deductions, many of them commonplace like for state income taxes, many taxpayers who aren’t plutocrats nowadays find themselves paying more under this tougher method of calculations. The AMT, as it’s called, wasn’t indexed to inflation, so over the years, this tax swept in more and more Americans who don’t own private jets.
The counterargument is that while the AMT has complicated taxes for some middle-income taxpayers, it still keeps the super wealthy from almost completely dodging their taxes.
When Trump’s own 2005 tax return was leaked, for example, it showed he paid $US36.5 ($46) million — without the AMT, he would have only paid $US5.3 ($7) million.
What It All Means For Ordinary Workers
Trump says the biggest winners of the plan will be “everyday American workers,” and Republicans praise it for being a much-needed overhaul to the USA’s complicated tax system. Democrats argue it will mostly benefit the wealthiest taxpayers and economists worry it will drive the US deeper into debt (it will add trillions to the deficit).
While the theory is that the tax cut will pay for itself because it will stimulate the economy, economist Alan Cole of the Tax Foundation explains, “There’s no pure tax cut that pays for itself.”
Meanwhile, it’s hard to really see how the plan will affect the “everyday American worker” because it lacks even basic detail about how different income brackets will be taxed.
However, CBS News estimates that lower-income taxpayers, in general, will come out ahead with an increase in the standardised deduction. Taxpayers who live in high-tax states might get the short end of the stick, as it’s possible state and local tax deductions will be nixed. They report:
For the most part, these are blue states like California and New York. The GOP plan spares deductions for home mortgage interest and charitable donations, allowing taxpayers to continue taking them. Like most deductions, the one for state and local taxes tends to benefits high-income folks, who itemize deductions. According to the Tax Policy Center, households with yearly incomes over $US100,000 ($127,308) would get hit with 90 per cent of the resulting tax boost, and those with more than $US500 ($637),000 would shoulder 40 per cent of it.
Again, nothing is yet set in stone, and the plan still has to make it through Congress. And before anything passes, Congress will need more detail and possibly some significant changes.