The tax reform “framework” issued Wednesday by President Trump and congressional Republican leaders told us little we didn’t already know about their shared tax policy goals—while continuing to leave many key questions unanswered.
Today’s plan lines up pretty closely with the tax reform goals first outlined last April by Treasury Secretary Steven T. Mnuchin. From New York’s standpoint, the most problematic element remains the proposed elimination of the itemized deduction for state and local income taxes.
Key proposed reforms include the following:
- Federal rates would be cut. There are now seven brackets: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, 35 percent and 39.6 percent. Mnuchin in April indicated they’d be reduced to three: 10 percent, 25 percent and 35 percent; today’s plan calls for a bottom bracket of 12 percent. Depending on the cutoff points, the changes would equate to a big tax savings for middle-income payers, in particular—although the savings will be less than realized by households with the same incomes in lower-tax states.
- The federal standard deduction would be nearly doubled. The standard deduction now ranges from $6,300 for single filers to $12,600 for married-joint filers. It would be increased to $12,000 and $24,000, respectively. Crucially, at the same time, the existing personal exemption (now $4,050 per filer and dependent) is to be “consolidated” into the standard deduction, the plan says. For a family of three or more, this effectively wipes out the value of the increase in the standard deduction.
- The Alternative Minimum Tax (AMT) would be repealed. As of 2014, New York was home to 483,900 AMT filers, second only to California. Their AMT comes to an average of $9,081. The AMT—under which state and local tax deductions are already disallowed—originated in the late 1960s as a way to prevent the very rich from avoiding taxes, but over the past 20 years has become a tax that applies mainly to an affluent band of low- to mid-six-figure households. Roughly 22 percent of New York’s AMT filers earned between $100,000 and $200,000; the lion’s share of the rest earned between $200,000 and $500,000.
The loss of the state and local tax deduction (or SALT) will affect different families in different ways, depending on family size and place of residence. As explained here a few weeks ago, for New York City residents subject to the state’s “millionaire tax,” the net effect of the Trump change will be to produce a tiny tax cut of 0.75 percent—while significantly widening the net tax price of living in New York compared to a state with no income tax, such as Florida.
The summary document released by House Republicans also says:
“An additional top rate may apply to the highest-income taxpayers to ensure that the reformed tax code is at least as progressive as the existing tax code and does not shift the tax burden from high-income to lower- and middle-income taxpayers.”
In that case, the plan will significantly raise combined federal, state and local tax burdens on the wealthiest New Yorkers, compared to their counterparts in low-tax states.
Either way, any significant relative change in the state’s tax burden on income millionaires would threaten to disrupt a state tax base that is more heavily dependent than ever on taxes paid by wealthy residents.
As for the middle class …
“Strengthening and growing the middle class, and keeping more money in their pockets” was a key goal identified near the top of the summary plan released by the House Ways and Means Committee today. However, depending on key variables, the plan may generate only minimal, if any, tax savings for middle-class families in New York—particularly the six-figure-earning, home-owning middle-class in the metropolitan New York City suburbs.
Consider a hypothetical family of four living in the (by no means posh) Suffolk County hamlet of Ronkonkoma. Assume the filers in this example are among the nearly 20 percent of Ronkonkoma taxpayers earning adjusted gross incomes of $100,000 to $200,000—an average of roughly $137,000 per household in that class, most of whom are married and claim itemized deductions.
This couple can claim $16,200 in personal exemptions, plus itemized deductions that in 2015 averaged about $29,000 in Ronkonkoma’s $100,000-$200,000 bracket, including $15,000 for state and local taxes. These tax breaks add up to just over $45,000, reducing the household’s taxable income to $92,600, putting it in the 25 percent marginal income tax rate.
Under the Trump plan, the same family will be able to claim a standard deduction of $24,000 and (maybe) remaining tax breaks for charitable and mortgage interest averaging $13,500, reducing taxable income to $99,500. (This assumes the plan will allow both a standard deduction and continued itemized tax breaks, in some form, for charitable contributions and interest. But it could be much less generous than that. See note at bottom of post for more.)
A 25 percent tax bite on the $6,900 in added taxable income would equate to $1,725—assuming the bracket threshold is unchanged.
The final net impact depends on as-yet unspecified details.
If the new 12 percent bottom tax bracket replaces the 10 percent and 15 percent tax brackets right up to the top of current 15 percent threshold, the tax on income in that lower bracket would be reduced by $1,332, reducing the family’s net tax increase to $468. An increase in the phase-out range for the child credit, suggested but not specified in the Trump-House GOP outline, could turn this tax hike into at least a small tax cut. Under current law, the child credit is phased out for incomes above $110,000, which limits total credits to $650 for parents earning $137,000. Any expansion of the phase-out range would increase the credit by a maximum of $1,350—or more, if the credit itself is increased under the plan, which is also left unclear. In the alternative, if the phase-out range is not changed but the credit is increased by $500 per child, that would add another $325 in savings.
This much is clear: a couple falling well within the middle class by downstate standards—people, in most cases, living paycheck-to-paycheck in modest suburban homes—will realize much smaller savings than their counterparts in lower-cost, lower-taxed states across the country. The net impact of the proposal will be to shift a larger portion of the remaining tax burden to households in New York and other northeastern states, as well as California.
The Trump-House GOP plan also calls for a sharp reduction in the corporate rate, from 35 to 20 percent, and a top rate of 25 percent on participants in unincorporated “pass-through” entities, which includes most small businesses. However, this also begs yet another question: will these firms keep their state and local tax deductions, as corporations presumably will do? Many other aspects of the business tax cuts, especially those involving expensing of investments and deductions for interest, also are unclear and are likely to be special interest flash points.
**Note: Keen readers of this post have wondered why the hypothetical example assumes that the Trump-House GOP plan would allow a family to claim both the newly increased standard deduction and tax breaks for charitable contributions and mortgage interest. Good question. The House GOP summary says that, in eliminating most itemized deduction, the plan “retains tax incentives for home mortgage interest and charitable contributions.” That can be read to imply filers could claim both those “incentives” and the standard deduction. But if taxpayers must choose one or the other, in the absence of any change in the current 12 percent and 25 percent tax bracket thresholds, this could translate into a federal tax hike for most middle-class New York homeowners with low six-figure incomes and dependent children. In the hypothetical example above, for example, the Ronkonkoma family would owe $5,100 more in taxes based on tax tables alone, before accounting for any saving from expansion of the child credits. To be sure, such a family would be more likely to get a tax cut if the top of the new 12 percent bracket is moved to a higher income level, or if the child credit phase-out range is expanded much higher and the credit itself is increased. As with so many other key aspects of the plan, it’s just not clear.**
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