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Now that both the House of Representatives and the Senate have passed their specific versions of the Tax Cuts and Jobs Act of 2017, the focus has shifted to how they might resolve their differences. Next up, the combined Congress must meet to come up with a final version of the bill and send it to the White House for the signature of President Trump. The U.S. Senate last Saturday passed its version of the GOP tax plan by a 51-49 vote (Republican Senator Bob Corker of Tennessee had a “No” vote), and the House had passed its version on November 16 in a 227-205 vote.
Many of the provisions in the two bills have raised concerns, and experts are weighing the implications of the outcome of the reconciliation process for individuals and corporations, as well as the impact on the federal deficit beyond 2025.
In the reconciliation process, the leaders of the tax writing committees in the House and the Senate will try to iron out the differences in the bills they passed, noted Alan Auerbach, professor of economics and law at the University of California at Berkeley. After resolving those differences, the two committees will create a single document, which is voted on again by the House and the Senate. Auerbach is also director of his university’s Robert D. Burch Center for Tax Policy and Public Finance.
Assuming the House and the Senate pass the revised document, it goes to the President for his signature. Meanwhile, the government will run out of its current funding on Friday at midnight, and the two parties must agree on fresh funding by Saturday to avert a government shutdown.
According to Daniel Hemel, professor of law at the University of Chicago, the Senate will have the upper hand in the bill negotiation process. The reconciliation, which is a special process for budget bills, is subject to some Senate-specific rules. One of those is the “Byrd Rule,” which requires all provisions in the bill to be funded by revenues, and they cannot increase the deficit beyond the 10-year budget window. That amendment to the Congressional Budget Act was passed in 1990 and named for Democratic senator Robert Byrd.
Hemel noted that the House tax plan didn’t comply with the Byrd Rule, and so it wouldn’t have been able to pass the Senate in its current form. “So I look to see more of the Senate provisions rather than the House provisions make it through now,” he said.
Auerbach and Hemel discussed the specific impacts of potential tax reform on several fronts on the Knowledge@Wharton show on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
“If you view a lot of these provisions as being intended to be permanent, the deficit effects are far higher than has been estimated for the bills themselves.” –Alan Auerbach
For individual taxpayers, the impact of the provisions on their tax rates and various deductions will depend on where they are in the income distribution, said Auerbach. For example, those that are currently in the upper-middle income category typically opt to itemize their deductions, so they will feel the impact of the reform more than those who don’t.
The biggest change will be the elimination of the state and local income tax deduction and the capping of the property tax deduction. On the other hand, the elimination of the alternative minimum tax would help many people who live in high-tax states. Individuals could also see adjustments in the tax bracket they fall under.
The tax plan provides some households with tax cuts and other households with tax increases. But the tax cuts are unambiguously for corporations and “pass-through businesses” (where people include their business income on their individual tax returns), Auerbach noted. “It’s really a deficit finance business tax cut, and tax increases on the individual side.” Assertions from the White House that the tax plan would save money for millions of people “goes in the category of alternative facts,” he added.
Hemel agreed with Auerbach that lower- and middle-income households will not see a big tax break. However, he noted that under most projections, lower- and middle-income households will see their tax bills go down “quite moderately” over at least the next couple of years. He said the increase in the child tax credit will help them and will more than offset the repeal of personal exemptions for people in the bottom brackets.
In the deductibles for mortgage interest payments, the House bill lowers the ceiling to borrowings of $500,000, while the Senate bill retains the current level of $1 million. If the Senate bill prevails in the reconciliation, homeowners will not see any direct change in their mortgage interest deductions, said Auerbach.
However, two factors will influence people’s decisions to buy houses or how much housing they would buy, Auerbach said. First, many people would move from itemizing their deductions to the higher standard deduction the new plan offers. Those individuals will not see any additional benefit from interest deductions if they buy a house because they would be taking the standard deduction. “So their incentive to buy housing is reduced,” he noted.
“If you are a homeowner with a low six figure salary and the ability to pay down your mortgage faster, this is probably a good time to do that.” –Daniel Hemel
Second, if the homes they buy have property taxes above $10,000, a proposed cap on the deduction would ensure that they don’t get any extra benefit even if they itemize their deductions, Auerbach said. “This is not only going to affect buyers; it’s going to affect the prices of housing,” he predicted.
Hemel noted that the National Association of Realtors and the National Association of Home Builders have opposed the proposed cap on property tax deductions. He had some advice for homeowners: “If you are a homeowner with a low six figure salary and the ability to pay down your mortgage faster, this is probably a good time to do that.”
Widening Health Insurance Gap
Another “hugely important” casualty is the repeal in the Senate bill of the individual mandate under the Affordable Care Act for all taxpayers to have health insurance, Hemel said. An estimated 10 million to 13 million people will end up not having health insurance as a result. “Not only are we seeing a tax overhaul; we’re seeing an overhaul of our health care system [as well],” he added. The House bill doesn’t have the provision to repeal the individual health insurance mandate, but he expected the repeal to make it into the final version.
According to Hemel, the repeal of the individual mandate saves the government money, which is why it was included in the Senate version of the tax bill. Under current rules, individuals who don’t buy health insurance have to pay a penalty with their tax returns. But insurers have been increasing health insurance premiums, which will in turn increase the size of government subsidies, he added. The fewer the number of people with insurance, the smaller the subsidies the government has to provide, he explained.
“Those cost savings are then used to offset the long-term impact of the huge corporate tax cut in the bill,” said Hemel. “Basically, we are taking away health insurance for 10 to 13 million people [over 10 years] and using the savings from that to give a 15% tax cut to corporations.”
The Congressional Budget Office and the Joint Committee on Taxation have estimated that “repealing the mandate would reduce federal deficit by about $338 billion over the 2018–2027 period and increase the number of uninsured people by 4 million in 2019 and 13 million in 2027.”
Worries for Education
The deepest cuts for higher education were in the House bill and not in the Senate bill, Hemel noted, referring to the proposal to eliminate the deduction for student loan interest payments. However, he did not expect that provision to prevail because, in his estimation, the Senate will have the upper hand.
Even so, the education sector continues to have reason to worry on three counts, Hemel pointed out. For one, both the Senate and the House bills have a proposal to levy a 1.4% tax on the investment income of university endowments.
Second, while the bill retains the deduction for charitable contributions, universities may see a reduction in the charity funding headed their way. That is because “a very small portion of the population” will itemize deductions under either the House bill or the Senate bill, and opt instead for the higher standard deduction, Hemel said. The plan nearly doubles the standard deduction for individuals to $12,000 and for couples to $24,000.
“Right now about a third of the population has a tax incentive to give to charity,” said Hemel. “That’s going to drop to the single digit numbers. Private universities are charities, so they care about the fate of the charitable contribution deduction.”
“The rate at which the federal funds rate is increased by the Fed over the next couple of years is likely to change as a result of the passage of the [tax] legislation.” –Alan Auerbach
Third, fewer people will leave their estates to universities and other schools because the new tax plan gives them the option of leaving them to their children, estate-tax free. That is because of the provision to repeal the estate tax in the House plan, and the cuts to the estate tax between now and the end of 2025 under the Senate plan.
Federal Debt Outlook
Auerbach noted that the tax cuts would lead to higher national debt beyond the 10-year budget window. That is because many of the so-called temporary provisions “aren’t intended to be temporary.”
Auerbach pointed, for example, to a provision in both the House and Senate bills that allows businesses to write off their investments immediately – so-called investment expensing – but only for five years. “That’s not a sensible way to run a tax system and [members of the House and the Senate] acknowledge that and they don’t really want it to be temporary,” he said. “So if you view a lot of these provisions as being intended to be permanent, the deficit effects are far higher than has been estimated for the bills themselves. This is going to have an impact on the economy directly in terms of interest rates [and] availability of funds for business investment.”
Furthermore, Auerbach expected the tax plan to affect monetary policy formulation. “The rate at which the federal funds rate is increased by the Fed over the next couple of years is likely to change as a result of the passage of the [tax] legislation.”
Changes in Metrics
Hemel noted that Senator Mike Enzi, the chairman of the Budget Committee, will lead the decision on whether the final bill complies with the Byrd Rule to contain the deficit to $1.5 trillion within the 10-year window. The Joint Committee on Taxation has estimated that the deficit would be about $1.4 trillion with static scoring, and closer to $1 trillion with dynamic scoring. Traditionally, the Budget Committee Chair defers to the Joint Committee on Taxation, he added.
Auerbach was also concerned about the use of dynamic scoring. He noted that the Joint Committee on Taxation had last week showed that even with dynamic scoring, the deficit effects were large. “The fact that the Senate essentially ignored that analysis indicates that the concerns about the deficit were really concerns about deficits produced by Democrats, and not concerns about deficits overall,” he added.
Hemel pointed to another “big, though subtle, change” that would also impact the computations: Instead of using a fixed weight measure for inflation, a “chained measure” will be used, which takes into account changes in consumption patterns when consumers substitute higher-priced goods with cheaper goods. “Practically, what this means is the inflation measures used in the tax code will go up slower, and people’s deductions will go up more slowly,” he said. “The tax bracket thresholds will rise more slowly. This will have a huge impact especially on lower- and middle-income households that are claiming the standard deduction.”
Hemel agreed. ”Over the long term, people will be paying more in taxes because of this change in the inflation measure,” he said. “But they might not realize that that’s what’s going on. It’s a very subtle way to increase people’s taxes.”
“This [tax plan] creates a fiscal Niagara Falls at the end of 2025.” –Daniel Hemel
According to Auerbach, although the potential effects of the House and the Senate versions vary, “in the big picture, these bills share important characteristics.” In the long run, he expected members of Congress to necessarily revisit the so-called temporary provisions in the bills. “They’re going to have to revisit them because nobody thinks having all of those provisions explode makes sense,” he said. “The question is whether we wait until they explode, or whether we try to revisit them earlier.”
Auerbach recalled one lesson from what happened after the Reagan tax cuts of 1981. “It took them exactly one year to revise the 1981 tax bill. There was a tax increase passed in 1982. There was another one passed 1984,” he said. “That was a different era than the current one, but it’s quite possible that we’ll be back next year or the year after, depending on the congressional elections next year, reconsidering some of the provisions of this bill.”
Hemel said that in an ideal situation, he would “have a smaller corporate tax cut and get rid of the extraordinarily complicated provisions about pass-throughs, which are only necessary really because of the huge size of the corporate tax cut.” Savings from reducing the deficit should be used to deliver relief to lower- and middle-income families with a larger child tax credit, he advised.
Hemel recalled the so-called “fiscal cliff,” the term that then-Federal Reserve chair Ben Bernanke used in late 2012 to describe the large tax increases and spending cuts that were set to take effect in January 2013. “This [tax plan] creates a fiscal Niagara Falls at the end of 2025,” he warned. “So we’ll definitely have to address key pieces of the legislation then. If Democrats regain control of both houses of Congress and the presidency in 2020, then we’ll see changes a lot sooner than 2025 – we’ll see changes early in 2021.”