It is expected that later this year the administration will bring forward a new tax bill. With the struggles to replace “Obamacare” (officially known as the Affordable Care Act), the pressure is building to deliver on tax reform. While the President’s campaign promises on taxes are many, the press “rumors” say that those working on the policy are struggling to find the right balance of revenue raisers and losers, so as to present a revenue-neutral proposal.
While we do not know exactly what revenue raisers would be included, let us mention some candidates from those he noted in his campaign. Then, let us also look at the ten tax provisions that cost the most federal revenue – because repealing or limiting these would provide the most funds to pay for other tax priorities.
The following items are revenue raiser ideas based on Trump’s campaign promises. Note that none of these will produce the kind of federal revenue to offset the President’s tax campaign promises, so these alone will not address the problem.
1. Impose a ceiling on itemized deductions of $200,000 married-filing-joint ($100,000 single). While $100,000 or $200,000 of itemized deductions sounds generous, it would be an issue for those of incomes of $1 million or more, as they typically will have six figures of mortgage interest, property taxes, charitable deductions, etc. Also, it is not uncommon for the tax returns of the charitably-minded to reflect six figures of charitable contributions with much lower amounts of income than $1 million.
2. End the “carried interest” rule for hedge fund managers. These managers, rather than being paid in cash or salary, will usually choose to be paid in the form of a preferential capital gains return on the performance of the fund. The result is that they are compensated in a form that is less taxed than typical compensation. It is important to note that there is wide bipartisan support for this idea, and it was included in the campaign proposals of both Clinton and Trump.
3. Offer a one-time deemed repatriation tax. Right now, U.S. companies are sheltering billions of dollars overseas in their foreign subsidiaries. Under current U.S. international tax law, taxes on the funds are deferred from U.S. taxation until they are pulled into the U.S. from the subsidiary. The proposal is to tax all overseas cash owned by foreign subs of U.S. companies at a one-time fee of 10% – a “deemed” repatriation. After this one-time fee, the deferral of foreign earnings would end.
These revenue raiser ideas are based on the cost to the federal treasury, according to the bipartisan Joint Committee on Taxation. It should be noted from the beginning that each of these ideas have their own constituency and lobby. The repeal or limiting of any of these would bring a contentious political debate and would test the resolve of whoever proposed it. These items are listed in order of the amount of tax revenues they cost over the 2016-2020 time window.
1. Retirement plans. These plans, including IRAs, 401(k)s, and 403(b)s, have several tax benefits. It starts with a tax deduction to the individual or company who makes the contribution. Although the individual has taxable income when the sum is later withdrawn from the account, there is a significant timing difference as the withdrawal is usually taken decades later. Second, the contribution is frequently made during peak earning years while the withdrawal is taken into income in retirement, when tax rates are probably lower so the taxpayer gets a rate differential benefit. Third, the growth inside the account happens on a tax-deferred basis. Fourth, some types of accounts, like Roth IRAs, are never taxed on their earnings as long as the rules are followed. Cost – $1,201.3 billion.
2. Employer health insurance. Generally, compensation paid to employees is a deduction to the company and offsetting income to the employee. This is true whether the income is cash (like a weekly paycheck) or non-cash (like the personal use of a company car). However, health insurance is a notable exception to this rule. The employer receives a full tax deduction for the amount paid for the employee’s health insurance, but the employee does not have taxable income for this benefit received. Further, this policy arguably disadvantages the self-employed and retired who pay for their own coverage. Cost – $863.1 billion.
a. It is interesting to note that, unlike most items on this list, the Treasury Department has struggled to quantify the cost of this benefit. Since the amount that a company pays for specific employees is not reported, it is hard to know the revenue impact of this policy. However, in recent years, the Affordable Care Act has required larger employers to provide this information on the employees’ Form W-2, so better tax cost estimates will be available in the future.
3. Preferential tax rates. Certain types of income are given lower tax rates. The premier example is the lower rates on qualifying dividends and long-term capital gains. Cost – $677.7 billion.
4. Earned income credit. This credit benefits the lower income and can actually produce a tax refund for someone who does not owe tax. As such, it would seem that this credit is politically “safe.” Cost – $373.4 billion.
5. Deduction of taxes. A popular itemized deduction is property taxes and state and local income taxes. Arguably, the deduction for property taxes rewards homeowners and other real estate investors without a corresponding benefit for renters. Similarly, the deduction for state and local income tax helps residents of high-tax states like California and New York, without a similar benefit for residents of Texas and Florida. Tax policy acknowledges this inequity by allowing the deduction of state and local income taxes OR state and local sales taxes. Therefore, it would seem from a policy perspective that the tax deduction for income and sales taxes are indirectly linked. Finally, note that any deduction of taxes is ineffective at the higher levels of income since many of these taxpayers are subject to the alternative minimum tax, where a deduction for taxes is not allowed. Cost – $368.8 billion.
6. Deduction of home mortgage interest. This is one of the clearest examples of using tax policy to encourage certain behavior for economic and social reasons. Americans have long believed that home ownership has many benefits, including a sense of ownership in the local community, and a method to build net worth. While renters do not have an equivalent federal deduction for their rent, some states do provide a renter deduction. Arguably, no restriction on this list brings a fight with the force of the U.S. real estate industry, so a loss of this deduction would seem to bring a battle that no elected official in Washington would want. But there are many ways to restrict this deduction short of a full repeal. Currently, one can deduct the mortgage acquisition debt of up to $1 million of debt on two residences, plus another $100,000 of home equity debt. Ways to limit this deduction without repeal include (1) removing the deduction of equity line interest, (2) removing the deduction for a second home, or (3) reducing the mortgage debt deduction to some amount lower than $1 million. Cost – $357.0 billion.
7. Health premium tax credit. This credit under the Affordable Care Act provides a tax incentive for those with income under 400% of the federal poverty limit to carry health insurance. Cost – $326.6 billion.
8. Child tax credit. This credit of $1,000 per dependent child under age 17 is very popular with young families of moderate to low income. Cost – $270.5 billion.
9. Charitable contributions. While perhaps one of the most politically-loaded items, this deduction does not benefit those of moderate income who claim the standard deduction. Also, certain forms of the charitable contribution deduction overwhelmingly benefit the wealthy, including charitable contributions of conservation easements, and the deduction for the full value of long-term capital assets, without the need to reflect income for the appreciation. Cost – $230.5 billion.
10. Social security. At lower levels of income, no social security receipts are taxable. At the highest levels of income, 15% of social security will remain tax-free. Note that there is an argument that it is unfair to tax 100% of social security receipts in any event because the wage earner did not receive a deduction when social security tax was paid in. Cost – $213.8 billion.
As you can see, while the battle to “repeal and replace” Obamacare is quite difficult, the advocacy groups within the tax reform detail will also battle to save their favorite deduction or credit. For any tax revenue idea on this list, there are one or more advocates for keeping the specific break. It is difficult to see how to pay for tax reform without a bruising fight.