The Trump Tax Proposal: Implications and Analysis

Trump Tax PolicyDonald Trump recently released a more detailed proposal for tax reform under his administration. Here, we seek to understand the implications of this proposal.

Summarize the implications of the tax proposal. All Americans would likely see a reduction in federal income taxes; however, the benefit would be most significant for the highest wage earners. The top 1% of wage earners would see a 14% reduction in effective tax rates, while the bottom 20% of wage earners would see a reduction of 0.7%. The plan would significantly reduce tax rates on corporate profits and transfers of wealth between generations. It would significantly reduce federal revenue and increase the national debt by a projected $7 trillion over the next decade.

What is his goal with tax reform? Trump has indicated that he has a few key objectives with tax reform.

  1. Simplify the tax code
  2. Reduce tax rates for everyone
  3. Increase tax breaks to businesses

How would federal income taxes change? The current tax system has seven different income brackets that are taxed at different rates. It is a progressive tax system in that higher income earners pay higher tax rates. Trump has proposed cutting the number of tax brackets from 7 to 3. He also hopes to change the current system of tax deductions; a deduction is an expense that can be listed on your tax returns to reduce the amount of taxes that you have to pay. For instance, if you make $100,000 but donate $40,000 to charity, you can “deduct” that $40,000 from your income and pay taxes as if your income was only $60,000. Each taxpayer gets a “standard deduction” regardless of the expenses you incur throughout the year. This is designed to simplify the tax system so that tax payers do not have to itemize every “deduction” unless these deductions would reach total value over the “standard deduction.” For example, if I donated $20 to 100 different charities for a total of $2000, I would not have to list each one of these donations on my tax returns because the total of $2000 is still less than the current “standard deduction” of $12,600. The Trump proposal would “increase the standard deduction for joint filers to $30,000, from $12,600, and the standard deduction for single filers will be $15,000. The personal exemptions will be eliminated.”

How do some people pay no federal income tax?  It is true that many people do not effectively pay any federal income tax. This does not mean that these people do not pay any taxes. The reason that this is possible is primarily due to tax credits, exemptions, and deductions. For example, take a family of 4 earning $28,000/year.1 With the current $12,600 standard deduction + the personal exemption of $4000/person (total of $16,000), the net taxable income would be less than $0. Families earning higher wages still benefit from these same deductions, but those at the lowest income brackets have such a small amount of money to deduct from that the effective tax rate ends up being zero. Tax credits introduced after the recession in 2008 also increased the percentage of households that were effectively paying no income tax. It is also important to remember that unique tax breaks are often given to the elderly, families with children, etc that also increase the % of people not paying federal income tax.

Washington Post Trump AnalysisWho would benefit the most from the plan? Trump contends that all Americans would see a tax break under the plan. The average tax break would be 4.3% spread out among everyone. However, the highest income earners will see the biggest breaks under his proposal. Those in the top 1% would see a 14% reduction in federal income tax. The top 0.1% would see an average tax break of $1.1 million.2 Middle income earners would see a tax cut of $1,010 – equivalent to 1.8%. The poorest families would receive a tax reduction of $110 – equivalent to 0.8%. In comparison with the current tax plan, Trump’s proposal is relatively regressive in that the greatest share of benefits go to the highest income earners.

How will the plan affect business taxes? The current corporate tax rate is 35%. Trump’s plan would lower the corporate tax rate to 15%. The plan would also make a significant change to something called “pass-through entities”. Under the current tax code, corporate earnings are taxed at the corporate tax rate of 35%, and profits distributed to stock holders are taxed at the personal income tax level for the beneficiary. The change proposed by the Trump plan would likely allow many companies to restructure in a way that would allow companies to have all profits taxed once at a rate of 15% – profits distributed to owners and stockholders would be exempt from personal income tax. This would likely significantly increase the income and wealth accrued by business owners. In essence, businesses, owners, and share-holders would likely see a significant reduction in taxes. Trump argues that these changes would disincentive companies from relocating overseas to avoid US taxation. The changes to the corporate tax structure would yield very large increases in the federal debt, accounting for over 3/4 of the total increase in federal debt that would be attributed to Trump’s tax proposal.

How will the plan affect estate and inheritance tax? The current estate tax is 40% for estates valued at over $5.45 million per person. Because most estates are less than $5 million, only the wealthiest 0.2% of people end up paying any estate tax upon death. Trump’s plan would eliminate the estate tax completely. Trump argues that this will protect small businesses and farms passed down through families. However, a very small number of farms and small businesses currently pay any estate tax under the existing plan. Only 20 farms or small businesses paid any estate tax in 2013, and the rate of taxation was less than 5%.

How will Trump’s plan affect federal income and the national debt? Taxes make up the revenue from which the federal government provides basic services such as Medicare, Medicaid, Social Security, etc. Lowering tax rates by definition reduces federal revenue. Unless this revenue deficit is matched with federal spending cuts, the federal budget deficit will increase and the federal debt will increase over time. Trump’s plan would substantially reduce federal income. An analysis by the Brooking’s Institution’s Tax Policy Center suggests that Trump’s plan would increase the national debt by over $7 trillion in the next decade and $22 trillion over the next 20 years. The current national debt is $19 for a point of comparison. Trump has not provided any information about how he would reduce federal spending to account for the reduction in tax revenue.

In Trump’s own words:

If we have another 3 or 4 years–we’re at $8 trillion now–we’re soon going to be at $20 trillion. According to the economists–who I’m not big believers in, but, nevertheless, this is what they’re saying–that $24 trillion–we’re very close–that’s the point of no return. $24 trillion. We will be there soon. That’s when we become Greece. That’s when we become a country that’s unsalvageable. And we’re gonna be there very soon. We’re gonna be there very soon. 3

The hedge fund guys (gals) have to pay higher taxes ASAP. They are paying practically nothing. We must reduce taxes for the middle class! 4

We’re going to cut taxes BIG LEAGUE for the middle class. She’s raising your taxes and I’m lowering your taxes! 5

When will our country stop wasting money on global warming and so many other truly “STUPID” things and begin to focus on lower taxes?  6

  1. 27% of families have a medial household income of less than $28,000/year
  4. Twitter, September 5th
  5. Twitter, October 9th
  6. Twitter, February 5th, 2014