President Trump unveiled the Republicans’ latest tax proposal Wednesday, a wish list of cuts embraced by the party’s Congressional leaders that would reduce individual and business taxes by trillions of dollars — with the benefits overwhelmingly flowing to the wealthiest Americans.
Precious little has been said about how the cuts would be funded, yet Congressional rules demand that they must be paid for — in part, if not in full.
Among the possibilities, one revenue-raising approach being discussed involves eliminating the deduction for state and local taxes. That would be bad news for Massachusetts residents because about one-third of taxpayers here rely on that deduction, more than in most other states.
Central to the Republican tax plan is a dramatic reduction in the corporate tax, from 35 percent to 20 percent. The idea is to give corporations more money to hire and invest; plus, businesses might have new reason to set up shop in the United States, rather than overseas.
In addition, the plan would:
■ Cut rates for pass-through companies. Small partnerships, independent contractors, and some larger firms don’t pay corporate taxes. Instead, their profits are passed along to owners and principals, who treat it like a salary and include it on their individual income tax filings. A new 25 percent rate would apply to such earnings, which risks creating a tax avoidance problem by encouraging some workers to pretend they are pass-through businesses.
■ Reduce some personal income tax rates. Instead of seven tax brackets, the Republican plan calls for three. The top bracket could be lowered to 35 percent (though an allowance is made for a higher rate if this proves too expensive), while the bottom rate would be increased slightly to 12 percent.
■ Repeal the estate tax and the alternative minimum tax. The estate tax only applies to the richest 0.2 percent of US households, so repealing it will have a concentrated effect. The alternative minimum tax is designed to ensure that high earners can’t avoid taxes by invoking lots of deductions and loopholes, but over time it has expanded to affect more upper-middle-class families, which has increased interest in reform.
Most of these changes are targeted to help higher-income Americans, but other parts of the Republican tax plan reach farther down the income ladder.
Republicans want to nearly double the standard deduction, allowing families to shield more of their earnings from taxes. Additionally, there would be an expansion in the child tax credit, something that would help families with young kids.
Yet, the effect on middle-class taxpayers will probably be small. That’s virtually inevitable when making these kinds of changes. Nearly half of families don’t pay any federal income tax at all, so lowering rates can’t help them.
And then, behind all these changes, lies the vexed question of cost. Taken together, these tax cuts would reduce revenue by more than $5 trillion during the first 10 years, according to a preliminary estimate from analysts at the right-leaning Tax Foundation.
And that won’t do, not unless Republicans change their whole legislative strategy. Right now, they’re planning to use a powerful parliamentary tool called reconciliation, which will allow them to avoid a filibuster in the Senate and pass tax cuts with just 50 votes.
But the reconciliation bill specifies that the cuts must cost no more than $1.5 trillion during the first decade — and that they be deficit neutral after that. It’s not clear how Republicans will hit these targets, and promises of faster economic growth won’t be enough to fill the gap.
Traditionally, the tax reform dance works like this: you lower rates and make up for it by cutting loopholes and spreading tax responsibilities more evenly. Some Republicans have said they want to take this approach, but there are two major problems.
First, there might not be enough loopholes in the entire tax code to fill a gap this big. One recent estimate from the nonpartisan Tax Policy Center found that eliminating all corporate tax loopholes would only allow the corporate tax rate to drop to 26 percent. Any lower, and the government would end up losing revenue.
Second, Republicans haven’t been able to agree on which loopholes they plan to close. Every quirk in the tax code has its beneficiaries, often powerful ones willing to fight for their dollars. That gives lobbyists a lot of incentive to shape this plan and complicates Republican efforts to agree on which deductions to eliminate.
One thing that seems to be on the chopping block is the deduction for state and local taxes. Say you’re a taxpayer who earned $100,000 last year. If you paid a combined $20,000 in property tax and state income tax, then you wouldn’t owe federal taxes on the full $100,000, just the $80,000.
That can be a big tax boon, especially for taxpayers in rich states like Massachusetts. Not because state and local taxes are especially high here (they’re not). But because the deduction only applies to people who itemize, and Massachusetts is full of the kind of high-earning individuals most likely to do so. More than 30 percent of Massachusetts households claim the state and local deduction, and the average write-off is nearly $15,000.
Because Massachusetts has no Republicans in Congress, our position on this issue probably doesn’t matter. But there are GOP representatives from other states that would be disproportionately affected, including New York, California, Virginia, and Illinois. They might worry about facing voters after taking away a prized tax deduction.
That’s the problem in a nutshell. Planning to cut taxes is easy. Paying for them isn’t. And Republicans have mostly stuck to the former, building up an expensive list of tax cut priorities without settling on a way to compensate for the lost trillions of dollars.
Only now does the real test begin, as Republicans battle with lobbyists — and each other — over which loopholes to eliminate.
There isn’t much room for error, given the slim Republican majority in the Senate. And while the party is more united on taxes than it ever was on health policy, there is still a real chance that the unified tax cut plan announced by Trump Wednesday will ultimately collapse amid recrimination, like the Republican effort to repeal the Affordable Care Act.