How Will Federal Tax Legislation Affect the Economy?

By John Gregory | 12/05/17 8:00 AM

Better clear out some room under your Christmas tree to make way for the gift Washington Republicans plan to leave for Americans this year.

“We are giving them a big, beautiful Christmas present in the form of a tremendous tax cut,” promised President Donald Trump last month.

The exact form of that gift is still taking shape as Congressional leaders work out the differences in the House and Senate reform proposals. Yet the sweeping tax overhaul they’re promising could result in massive changes to the economy, health care, education, and more.

KET’s Kentucky Tonight explored the key components of the federal tax plans under consideration and how they might impact Kentuckians. The guests were Anna Baumann, research and policy associate at the Kentucky Center for Economic Policy; Jennifer Bird-Pollan, tax law professor at the University of Kentucky; John Garen, economics professor at UK; and Jordan Harris, founder and co-executive director of the Pegasus Institute.

 

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An Overview of the Two Bills
The biggest – and costliest – provision in both the House and Senate bills is a permanent reduction to the corporate tax rate, which gets slashed from 35 percent to 20 percent. University of Kentucky economist John Garen says that will be good for those corporations and for people whose pension and 401(k) plans invest in those businesses.

For individual taxpayers, the changes are more nuanced. The House plan collapses the current seven tax brackets to four. The Senate plan keeps the seven brackets but reduces the top marginal tax rate from 39.6 percent to 38.5 percent. Other changes on the individual side could have greater impacts, though. For example, both plans nearly double the standard deduction individuals and households can take, but eliminate most itemized deductions.

The Pegasus Institute’s Jordan Harris says the House and Senate proposals follow the hallmarks of good conservative policies designed to move the country forward. He cautions Republicans not to overpromise on the economic boom the reforms could generate, but he says these changes will enable the nation to have more consistent growth going forward.

“I think that the calculation that underlies [the proposed changes] is that it’s better to have individuals and corporations guiding your economy than having the government guide your economy,” says Harris.

Opponents of the Republican plans argue the reforms won’t deliver the promised benefits to low- and middle-income Americans, and that they will balloon the deficit by more than $1 trillion. Jennifer Bird-Pollan, a tax law professor at UK, says most of the savings will go to those who earn the highest incomes and have significant accumulated wealth. She also notes that the individual income tax cuts proposed in the Senate plan are set to expire in 2025.

Even changes promoted as helping working families may not actually do that, says the Kentucky Center for Economic Policy’s Anna Baumann. She points to the child tax credit, which actually increases under both plans. But how that increase is structured will benefit middle- and upper income families more than lower-income households that pay little or no income tax. Baumann says that will leave behind hundreds of thousands of struggling Kentucky families and households headed by veterans.

Overall the plans will exacerbate income inequality, says Baumann, because they pay for the tax reductions going to the wealthy and corporations by cutting things that would help low- and middle-class individuals. She says that’s especially bad for Kentucky.

“We’re a low income state,” says Baumann. “Therefore not only will we be hurt disproportionately by cuts to those kinds of programs, but we also, because we’re a low income state, don’t get much of the benefit from those tax cuts that are so weighted to wealthy people.”

Helping Businesses Grow the Economy
Will reductions to corporate taxes along with provisions that encourage companies to repatriate international profits and assets actually spur domestic capital investment and job growth? And will those investments eventually trickle down to the pocketbooks of workers?

Harris and Garen say yes, because the plans promote an economic environment that’s good for business and individuals.

“This is not capital versus labor,” says Garen. “Both capital and labor tend to grow together in a growing economy, and I think that’s the kind of thing that ultimately lifts people out of poverty in a permanent way…. We help the low income [people] by enabling them to earn more and not by just giving them more handouts.”

Harris contends the economy isn’t a fixed pie that can only provide benefits to those at the bottom by taking from those at the top. Instead he argues that a growing economy helps everyone at every income level.

For example, as corporations get to keep more of their profits, Harris says shareholders will get 75 percent of that money, and workers will get about 25 percent, according to Congressional Budget Office projections. So workers get more pay, and shareholders, including pension and 401(k) plans investing in corporate stocks, get more money to spend and invest as they see fit.

Even if workers do see higher wages as a result of tax reform, Baumann says those gains will be offset by losses they suffer elsewhere in the Republican plans. She says there are better, more helpful ways to allocate federal revenues.

“Instead of giving that money away in tax breaks to those at the very top, we could invest in infrastructure,” says Baumann. “We could be spending more money in communities like in eastern Kentucky that are having a second recession. We could be investing in our child care resources.”

Bird-Pollan also questions the efficacy of provisions that encourage companies to repatriate their overseas revenues and assets. She says previous attempts to get companies to bring those resources home have failed to produce domestic investment.

“In 2005 there was a repatriation tax holiday,” says Bird-Pollan. “There’s much empirical evidence that shows in fact that money was distributed to shareholders in the form of dividends, not reinvested in infrastructure or expansion of corporate assets, or increasing jobs or wages.”

Another pro-business provision should be a boon to the commonwealth, says Harris. It would allow companies to immediately expense certain capital equipment purchases rather than depreciate that cost over time.

“That’s a great thing for Kentucky, an economy that is heavily dependent on manufacturing and advanced manufacturing,” says Harris. “It is reasonable to think that over the course of the next couple of years we can see significant capital improvements in our manufacturing sector here in the state.”

Other Key Provisions
Education: Currently, graduate students are not taxed on any tuition waivers they receive. But the House bill would count such waivers as taxable income. Bird-Pollan says that would be devastating for most graduate students who couldn’t afford to pay that tax.

The House plan also eliminates a deduction for interest on student loans. The Senate bill maintains that deduction. Baumann says another provision in both the House and Senate proposals would tax private colleges that have large endowments.

Under existing rules, parents can create tax-free savings accounts to help fund their child’s college education. The Republican plans would allow parents to start such 529 plans to also help pay for primary and secondary education, including at private schools, religious schools, and home-school settings. Harris says this provision will benefit parents who favor school choice, but Baumann fears it could end up hurting public education.

Health Care: The Senate bill repeals the Affordable Care Act’s individual mandate. The House version keeps the mandate in place.

“The [U.S.] Supreme Court’s decided that the individual mandate was a tax… so what better place to repeal a tax than in a tax reform bill,” says Harris, who argues that the majority of people who pay that tax earn less than $50,000 a year. “I think it’s great that it’s being repealed.”

But Baumann says eliminating the individual mandate will lead to millions of Americans no longer having insurance, including an estimated 181,000 Kentuckians.

“With an exodus of people from those plans, and fewer healthy people especially in the market, those premiums will go up for everybody,” says Baumann. “So it’s actually going to cost folks more.”

Plus, Baumann fears that as the deficit escalates as a result of the tax cuts, GOP lawmakers will want to slash funding for Medicaid and other vital entitlement programs.

Family Wealth: The House plan eliminates the federal estate tax by 2024. The Senate plan keeps the estate tax but doubles the allowable exemption. Bird-Pollan says this would allow for the further concentration of wealth and political power among the richest Americans.

“It’s really a message about valuing very high net-worth individuals… and it’s about the concentration of wealth intergenerationally,” says Bird-Pollan. “This is, in my view, just inconsistent with the fundamental values of the United States. We’re a meritocracy, we’re not an aristocracy. We have never been a country of concentrated wealth.”

Garen concedes that concentration of power is a legitimate concern, but he says that goes beyond wealthy individuals. He doesn’t want the government to have too much power either.

“People talk about getting the money out of politics,” says Garen. “My view is that we ought to get politics out of money, meaning let people make their money in a honest way and not have politicians trying to tinker around, regulate, tax, etc.”

Pass-Through Profits: Under current tax laws, profits earned by many sole proprietorships, LLCs, and other so-called pass-through companies go to the owners, who pay tax on those earnings based on their individual tax rate rather than the corporate tax rate. Under the GOP plans, pass-through profits would be taxed at a rate potentially much lower than the standard personal income tax rate.

About 95 percent of American businesses are already pass-through corporations, but this change could incentivize even more individuals and businesses to organize that way. Although politicians like to say this provision would help small, “mom-and-pop” businesses, Bird-Pollan says 70 percent of the money taxed under pass-through rules actually goes to the top 1 percent of income earners.

Harris says he opposes the pass-through proposal and knows of no sound economic reasoning for it. Garen says the corporate rate and the pass-through rate should be the same.

State Tax Reform
Gov. Matt Bevin and state legislative leaders have delayed discussion of state tax reform until the 2018 General Assembly session. But the battle lines in that debate are already taking shape.

Republicans and pro-business conservatives favor a decrease (or outright elimination) of personal and corporate taxes in favor of a more broadly applied sales sax. Harris says such a modernization of Kentucky’s tax code is needed to help move the commonwealth forward and make it competitive with neighboring states. He contends that any potential loss in revenues from reducing income taxes can be more than made up with greater sales taxes receipts.

“We exempt so many things right now, that it’s possible to completely change our system and pretty much stay at the same percentage of the overall economy,” says Harris.

Democrats argue that a shift towards consumption taxes puts more burden on poor and working families. Plus Baumann says other states that have relied solely on sales taxes to help fund education, infrastructure, and other government services wind up having fewer of those services.

“Sales taxes don’t grow as well as income taxes,” Baumann says. “It will squeeze our revenue situation even worse, and we already know going into this budget session [in 2018] that Kentucky cannot afford to slow revenue growth.”