Republican leaders recently told Americans about their new tax reform proposal, introducing it as part of a key bill in the House of Representatives. Most of the provisions in the bill were expected, including a simplified set of tax brackets for individual taxpayers, lower corporate tax rates, the phasing out of the estate tax, and the elimination of other provisions like the alternative minimum tax.
One key break for individuals involves a near-doubling of the standard deduction. Although many taxpayers worried that the elimination of the personal exemption would lead to a net tax increase on larger families, the current proposal includes a replacement in the form of a tax credit of $300 per non-child dependent, in addition to increased child tax credits of $1,600 for eligible children. Yet while the child tax credit increase would be permanent, the $300 credit amount isn't, and that has some questioning the motives of lawmakers.
Watching the sun set on non-child dependent credits
Many of the provisions of the tax reform package would be permanent. Lower corporate tax rates and the elimination of the AMT would take place immediately, and they're slated to remain in place indefinitely with no sunset provision.
However, the $300 credits for non-child depends are subject to sunset provisions. The current legislation puts them in place for five years; after that, if Congress and the President don't take action, then their sunset provision will take effect and remove the tax credit for tax years beginning in 2023.
Why would Congress leave the credit up in the air?
The primary problem that lawmakers have is that they're operating under highly restricted rules. In order to move a bill through Congress without fear of a Democratic filibuster in the Senate, Republicans had to keep the tax reform package as part of broader budget reconciliation legislation. The limit for increased deficits over the next 10 years for such treatment is $1.5 trillion.
Therefore, proponents of the measure are looking closely at every penny spent under the proposal. Because scoring for budget purposes only looks 10 years into the future, the key period is from 2018 to 2027.
By setting the credit to expire in 2022, lawmakers only have to count five years' worth of the credit's cost against the $1.5 trillion amount. However, proponents of the measure will argue that their intent isn't to let a valuable middle-class tax cut expire any sooner than necessary. By leaving a sunset provision in the current bill but promising later extensions of the credit, lawmakers get to claim the benefit of the credit without being on the hook for paying for it under current budgeting rules.
A lesson from the past
Republicans would be well-advised to look at history to see how similar sunset provisions have worked in the past. The Bush-era tax cuts in the early 2000s were set up with a 10-year sunset clause that would have automatically reverted to pre-cut levels in the early 2010s. In the end, it was up to a Democratic White House to negotiate with lawmakers to figure out which of the Bush-era tax cuts to extend. The compromise involved sustaining many benefits for low-income and middle-income taxpayers, but it resulted in the top tax rates on dividend income and long-term capital gains rising from 15% to 20%, and also returned the top tax rate to 39.6%.
Something similar could happen in 2023. Lawmakers in either party would be loath to allow a tax credit to expire, but at the same time, the sunset date would create a negotiating opportunity for both parties. The net result might be an extension of the tax break, but it could come at a cost for certain groups of taxpayers.
Be on your guard
Many taxpayers don't understand the sophisticated rules that govern budget-making on Capitol Hill. As lawmakers haggle over various tax proposals in the weeks to come, you'll want to make sure you keep your eye on the ways that certain provisions change. Without knowing the details of each provision, you could find yourself greatly misunderstanding the net impact of tax reform on your personal taxes.