August 11, 2017    5 minute read

Here Are the Consequences of United States Tax Reform Proposals

Taxman Cometh    August 11, 2017    5 minute read

Here Are the Consequences of United States Tax Reform Proposals

“In this world, nothing can be said to be certain, except death and taxes”. At least, according to Benjamin Franklin. Out of these two certainties, there is nothing to be done for the first. Much can be done, however, to improve the latter.

Taxes are a delicate subject. The citizens of a country are conscious that they must contribute their fair share of money to the state. This amount of money is then returned to them in the form of public services. On the other hand, the state must facilitate and simplify this whole process and make sure that everyone pays what they should. In theory this looks like a simple thing to do, but in practice it is anything but. Powerful groups of interests and the government’s inability to act are the main factors that lead to an inefficient tax system.

US Reform

Currently, there is a wide consensus in the United States that there is need for a big tax reform. The last time there was a considerable change in the tax code, it was in the Reagan Presidency. Now, the Republicans have once again a majority and in the White House there is a President that has expressed a strong will to reform the tax system.

However, six months have passed and apart from the noise, too little has been done. There has not been any real discussion as to the actual proposals and their consequences. What the GOP should avoid at all costs is the mentality of passing the law first and then reading it later. This is what happened with the Affordable Care Act (Obamacare) and everyone can see what resulted from that.

First, preparing the taxes with the current code is a difficult process for most families. As the Tax Foundation reports, there are around 10 million words in the US tax code. As the White House reports taxpayers spend approximately 7 billion hours filling their tax forms, which have around 211 pages of instructions. Also, there are seven tax brackets, as seen in Table 1. Moreover, many argue that taxes, both the corporate and income one, are very high, stopping the GDP from growing even further, as will be explained later in this analysis.

There are two main proposals that address these concerns. The first is the one coming from the White House. It decreases the tax brackets from seven to just three, 10%, 25% and 35%. In addition, for the first $24,000 that a couple earns and the first $12700 an individual receives, no taxes will be paid. Furthermore, it plans to lower the corporate income tax rate to 15% from the 35% that is now. Capital gains will be taxed at a rate of 20% instead of 23.8%.

Death Tax

The death tax, also known as the estate tax, will be removed. This tax applies to property that is passed through a will from a deceased person to their relatives. The proposal also eliminates the Alternative Minimum Tax, which is a form of taxation for wealthy individuals, estates and corporations that due to exemptions pay a lower amount of taxes. Lastly, the Obamacare 3.8% tax that targeted individuals with more than $200,000 or couples with $250,000 or more of modified adjusted gross income.

On the other side, The House Republicans have made their own proposals. The differences with the one presented by the President are very few. This plan includes a decrease of the corporate tax to 20%. The tax rates for the three brackets they suggest are 12%, 25% and 33%. They want to abolish the death tax and the Alternative Minimum Tax too. Both proposals have much in common and are based on two pillars: tax cuts and simplification of the tax code.

Closing Loopholes

On top of these, both the President and the GOP in Congress want to close the loopholes and the unnecessary tax breaks.  However, the Republicans in the house have made a controversial proposal as well, named the border adjustment tax. According to this, goods will be taxed based on their destination not the country of production. The main beneficiaries will be the US manufacturers that will export without paying taxes.

It is difficult to judge these reforms without analyzing their consequences. It is widely accepted that tax cuts are good for the economy. The GDP of a country is the sum of private consumers, investments, government spending and net exports. If income taxes are reduced then people will have a higher disposable income. Thus, they will spend more. Moreover, if the corporate taxes are lowered, companies can hire and invest more. Therefore, the demand will go up, and capital formation is stimulated, leading to a higher income for the country.

There is a concern with these plans. The critics argue that the tax revenue will not be enough and this will raise the deficit. However, this reform plans to cut between 10% and 20% the unnecessary spending. This is believed to generate around $750bn over the next decade. This is coupled with the closing of the loopholes and tax breaks. Due to the tax cuts, the economy will be stimulated, wages will grow, inflation will rise and the debt will not increase.

Conclusion

If successful, this will be the biggest reform since Reagan-era and the American GDP will increase more than 3%. The Republicans have much to lose, so surely this will be a top priority as soon as the recess ends. They need to collaborate among each other and get things done. Not to mention that the stock markets are expecting and pricing it in. Thus, the stakes are very high, politically and financially.

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