Talk of big change is afoot in Washington. House Republicans have already passed their version of tax reform for individual taxpayers and corporations (officially known as the Tax Cuts and Jobs Act), and the Senate is currently debating the House bill and a proposal of their own.
Tax reform was arguably the top campaign promise for President Trump. It's all the more important that it succeeds in being signed into law, considering that healthcare reform fell flat on its face after multiple attempts and many months of trying.
Of course, success won't come easy, even though House Republicans have passed their bill. The Senate has just a two-vote majority for the GOP, meaning it can only afford to lose two Senators and still allow for Vice President Mike Pence to break a 50-50 tie. That's a tall order that failed to work during healthcare reform on numerous occasions. Nevertheless, Republicans in both the House and the Senate are in agreement that their bills will be good for middle-class families, as well as for businesses.
At the core of both tax-reform bills is a simplification of the individual tax code that largely increases the standard deduction and removes a number of credits and deductions in the process. For corporations, their peak marginal income tax rate would drop from 35%, one of the highest levels in the world, to 20%. The GOP believes that by putting more into the hands of corporations, they'll be able to hire, expand, and pay higher wages. In turn, consumers with more disposable income are liable to spend it. Since our economy is about 70% dependent on consumption, it would appear to be a formula for stronger GDP growth.
Surprise! These key tax breaks would disappear by 2026 (or sooner)
But there are clear concerns about both the House and Senate GOP tax plans. These worries include adding to an already bloated federal deficit over the next 10 years and the possibility that tax reform favors the wealthy far more than it'll favor lower- and middle-income individuals and families.
However, the biggest issue of all, and perhaps the greatest surprise of this tax-reform process, is that individual taxpayers could be in for a rude awakening in just a few years' time, depending on which version of the bill is signed into law (assuming either is approved by Congress and the president). According to Congress' Joint Committee on Taxation (JCT), five critical tax breaks for individual taxpayers are set to expire by Dec. 31, 2025, or sooner, sending tax liability for many low- and middle-income folks screaming higher in 2026 and beyond.
1. $300 per-person flexibility credit (expires Dec. 31, 2022)
In the House's Tax Cuts and Jobs Act, in addition to a proposed $1,600 Child Tax Credit is a $300 per-person flexibility credit for parents and non-dependent children. This new credit is designed to counteract the loss of the personal exemption and other deductions and credits for working families. However, the House GOP bill notes that this credit would sunset at the end of 2022, removing this key break for millions of taxpayers.
2. 23% deduction for pass-through firms (expires Dec. 31, 2025)
The House and Senate certainly approached pass-through income differently. (Pass-through income is received by owners in sole proprietorships, S-corporations, and limited-liability companies.) The House capped profit income at 25% from pass-through businesses, while the Senate created a 23% deduction for certain pass-through income. In the Senate bill, this deduction expires at the end of 2025, leaving owners of these businesses to once again pay much higher income tax rates.
3. Expanded child tax credit (expires Dec. 31, 2025)
An initial version of the Senate GOP tax bill proposed raising the maximum Child Tax Credit (CTC) from its current $1,000 to $1,650. Following revisions, that proposal now sits at doubling the CTC to $2,000. But as noted by the JCT, this provision in the Senate's bill would expire just over eight years from now, removing a critical credit from the pockets of millions of low-income working families.
4. Nearly doubled standard deduction (expires Dec. 31, 2025)
Both the House and Senate bills propose a major increase in the standard deduction, which is designed to make up for the elimination of a plethora of deductions and credits that should make preparing your taxes simpler. The Senate version proposes lifting the standard deduction to $12,000 for single taxpayers, $18,000 for heads of household, and $24,000 for joint filers. That's almost double from where the standard deduction currently sits. However, by Dec. 31, 2025, these beefed-up standard deductions would expire under the Senate bill, lifting the tax liability of numerous low- and middle-income taxpayers.
5. Lower individual income tax rates (expires Dec. 31, 2025)
Unlike the Tax Cuts and Jobs Act, the Senate tax bill retains the seven individual tax brackets, with a minor reduction in effective tax rate and an adjustment to the earned income subjected to those brackets. These modestly lower tax rates are probably what individual taxpayers care about most, but they'll also sunset in the Senate bill by the end of 2025. This means the current tax schedule would be reinstituted beginning Jan. 1, 2026. Most folks earning less than $75,000 a year would see a tax increase by 2027 if the individual tax bracket changes sunset.
Meanwhile, these two tax provisions would be permanent
While these five tax provisions would sunset without an extension, certain aspects of Republicans' tax reform would presumably stick around for good.
The Senate bill, for instance, would make corporate tax cuts to a peak marginal rate of 20% permanent. Of course, the potentially fatal flaw in the GOP's tax-reform plans is that no one knows what exactly businesses will do with the extra cash they're allowed to keep. Republican lawmakers assume it'll lead to hiring and better wages, but it could just as easily boost share repurchases and dividends for publicly traded companies. That might help investors, but it won't do a thing for working Americans.
Additionally, the GOP proposals would keep the Chained Consumer Price Index (CPI) as its inflationary tether for tax provisions beginning in 2024 and beyond. Unlike the Consumer Price Index that's being used now, the Chained CPI takes into account the idea of substitution bias, which is where consumers trade down to cheaper goods or services if other products become too pricey. The GOP contends that substitution bias mimics real-world buying habits and is thus a more accurate representation of inflation. It would, however, result in lower inflationary increases that could push folks into higher income tax brackets over a long period of time.
Understandably, there's still a lot left to be debated on tax reform in Congress. But as things stand now, the benefits low- and middle-income taxpayers are set to receive could turn out to be short-lived.