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President Donald Trump has unveiled the broad strokes of his plan to overhaul the country’s tax code in a one-page outline that said he would cut the corporate tax rate, eliminate the alternative-minimum and estate taxes, and replace the current seven income tax brackets with three. There are still plenty of details to come, but as discussions proceed in Washington, D.C., about the plan and how to effectuate Trump’s desired changes, DrexelNow spoke to two Drexel University professors about what you need to know.
Norman Stein, JD, is a professor of law in Drexel’s Thomas R. Kline School of Law and a nationally recognized authority on tax law. Sebastien Bradley, PhD, is an assistant professor of economics in the LeBow College of Business. Their answers have been condensed.
Q: Treasury Secretary Steve Mnuchin called the new plan “the biggest tax cut and the largest tax reform in the history of our country.” Do we know enough yet to predict just how significant this reform will be?
A: “It’s an amazingly large tax cut,” said Stein. “But a tax cut isn’t good because it’s the largest ever. If it’s good, it’s because it will improve people’s lives and stimulate the economy and not create massive amounts of debt and make the tax code fairer and maybe less complicated. Those are the things you judge a tax cut on, along with its distributional impacts — whether it primarily benefits the wealthiest Americans or primarily benefits middle-class Americans.”
“If adopted, the entire package of proposed tax cuts and changes to the structure of the tax system would indeed imply a massive reduction in the federal tax burden,” said Bradley. “An earlier analysis by the non-partisan Tax Policy Center of then-candidate Donald Trump’s proposed cut to the corporate tax rate from 35 to 15 percent said it would cost $2.4 trillion in lost tax revenue over the 10-year horizon. Whether this is ‘the biggest tax cut in history’ is mostly a matter of conjecture given the Trump proposal’s lack of substantive details and unsupported assumption that the tax cuts will pay entirely for themselves through economic growth.”
Q: What does the broad outline released thus far tell us about the potential impacts of these proposals?
A: “It’s a bonanza for the wealthiest Americans,” said Stein. “It’s very likely going to increase taxes for a very significant part of the middle class because it would take away deductions, primarily the deductions for state and local taxes. Cynical people believe this was designed to hurt people in blue states because blue states tend to have higher state and local taxes and more people who are not rich but are on the upper 25 percent of what we generally think of as middle class. Those people are really going to be hurt.”
“I think it is fair to say that the administration’s outline for tax reform should be viewed primarily as establishing a starting point for negotiations in the House and Senate rather than as a concrete basis for final legislation,” said Bradley. “As such, the immediate impact of the administration’s proposal is mainly to foster discussion around particular objectives, many of which are long-standing mainstays of the Republican agenda, while leaving the details up to Congress.”
Q: Who will benefit from the shift from seven to three tax brackets, and who might it hurt?
A: “Benefits could vary widely, depending on what fraction of a taxpayer’s income is currently subject to higher rates than under the three-bracket regime,” said Bradley. “Clearly, taxpayers in the current top tax bracket (39.6 percent) earning over $470,000 per year for couples would be unambiguously better off. More generally, fewer tax brackets would tend to make the overall system less progressive.”
“It is worth noting that discussions about the complexity of the tax code have essentially nothing to do with the number of tax brackets,” said Bradley. “Complexity arises due to the proliferation of special tax preferences and anti-abuse provisions, the alternative minimum tax, etc., all of which primarily affect the calculation of taxable income. Computing the corresponding tax liability based on graduated rates is a trivial exercise. Thus, reducing the number of tax brackets has little to do with simplification of the tax system, contrary to the manner in which it is presented.”
Q: What impact would we see from the change in the corporate tax rate?
A: “Aside from the lost revenue, one of the problems with reducing the corporate rate to 15 percent is that it’s higher than the lowest rate for single taxpayers, so people will have a lot of incentive to keep money at the corporate level where they’re only paying 15 percent rather than 25 percent,” said Stein. “Apparently this would provide for a 15 percent tax rate on all income from business conducted by a partnership or limited liability company as well, and if it does that it means people who have businesses will be taxed lower than people who have wages — and not only that, but a reasonably wealthy self-employed individual will be able to set up a limited liability company. If you’re a lawyer or doctor, an accountant, a very successful Uber driver — anybody with a business will be paying tax at 15 percent rather than their current marginal tax rates. But if you’re just a working Joe, and you’re an employee, you’ll be taxed at the regular rate.”
“In some ways the more radical element of the tax reform proposal with respect to businesses is the extension of the corporate tax rate to pass-through entities, which includes both small and large family businesses (including Donald Trump’s) as well as large partnerships,” said Bradley. “Such a system would give rise to obvious incentives for tax avoidance involving the re-characterization of personal income as business income and would likely require a significant expansion in tax enforcement to deter abuse.”
Q: What would these proposals mean for the economy?
A: “The effects on revenue are going to be extreme and will hurt people at the bottom,” said Stein. “The White House seems to think magic will happen and this will stimulate the economy, a theory that has never proven accurate. It’s the idea that if you reduce tax on business income, there will be tremendous investment and hiring and the economy will cook up and produce so much additional revenue that even though that revenue is being taxed at a lower rate, the tax cuts will pay for themselves. But to a lot of people that sounds idiotic.”
“The most optimistic projections of increased economic growth in response to tax cuts suggest that growth might compensate for around a third of revenue losses, at best,” said Bradley. “Consequently, the obvious concern for someone interested in both the efficiency and fairness of the tax system is knowing how revenue losses would otherwise be offset so as to avoid dramatically increasing the government deficit (and, implicitly, the tax burden borne by future generations to repay the accumulated debt). The Trump administration has not provided details as to how they plan to offset revenue losses.”