The Framework for Tax Reform

On September 27 President Trump released a nine-page “framework” for new tax legislation.  The framework adds some detail to the one-page outlines that had been released earlier by the administration.  The new target for the corporate tax is 20% instead of 15%.  The “border-adjustable tax” is history.  Pass-through entities (used by most small business owners) would be taxed at 25%, but safeguards are promised to avoid abuses, such as characterizing personal service income as business income.

Although the nominal top bracket rate drops from 39.6% to 35%, the framework leaves open the possibility of an additional tax bracket for the highest income earners.  The framework is silent on the surtaxes from the Affordable Care Act.  There is also no mention of any change to taxes on capital gains.

Most itemized deductions would be repealed under the framework.  “Tax incentives” would be retained for home mortgage interest and charitable contributions.  The use of that phrase in the framework, instead of simply retaining the deductions, suggests that caps or other limits may be forthcoming on those items.  For example, the Obama administration proposed limiting the benefit of itemized deductions to 28%, instead of whatever the taxpayer’s highest marginal rate might be.

Democrats purport to want higher taxes on “the rich,” and the biggest tax increase on the rich in the framework comes from the elimination of the deduction for state and local taxes. But the state and local tax deduction is claimed disproportionately in the “blue” states, so Democratic support for this idea is not assured. With the doubling of the standard deduction in the framework, the vast majority of taxpayers would have no need for that deduction anyway.

However, there is less to that doubling than meets the eye.  The personal exemption would be eliminated.  For a single taxpayer, the “zero bracket” would therefore be increased by just 20%, not 100%.  Married couples with children might be even more adversely affected—but that could be offset by unspecified increases in the child tax credit.  A $1,000 tax credit is equivalent to a $4,000 personal exemption for a taxpayer in the 25% tax bracket.

The framework calls for elimination of the AMT, because it no longer serves its intended purpose and is a source of complexity.  The death tax (actually, the federal estate tax) and generation-skipping transfer tax would be repealed—no rationale is provided by the framework.

Moving tax legislation through Congress before the end of the year seems unlikely, especially given how many months it took just to write this nine-page summary.  Some observers believe that early in 2018 is a realistic goal.  If a tax cut on wages is enacted in January, it could be made retroactive to the beginning of the year, and withholding tables could be adjusted fairly quickly. Thus, most taxpayers might be seeing more in their paycheck as the 2018 election approaches.