Many people have asked for my thoughts on the GOP Tax “Reform”. Despite how black and white the media and politicians want you to believe it is, it’s actually a very complex topic, so I’ll cover this in depth over multiple posts.

In this post, I’ll briefly cover the main changes in the tax bill and whether I think each is good or bad. I won’t explain each in depth for brevity–in fact, some of my answers may sound completely unintuitive. I’ll cover the key ones in depth in future posts.

Process, Politics and Optics

I want to focus most of this on the contents of the tax bill so let’s get this out of the way first.

The process, politics and optics of this were far from ideal. It’s a hugely complex and long bill, rammed through at the last moment along party lines, that looked intended to punish “Blue State” voters in California and New York (limiting State and Local Taxes, and Mortgage Interest Deduction). The last point is felt more acutely because the blue states already contribute far more to the Treasury than they receive. Moreover, due to the razor thin margins, hold-out GOP Senators were able to extract specific concessions like a specific deduction for pass through businesses that benefit real estate property owners (you can guess who that benefits).

The temporary nature of the individual tax cuts is also deceptive to voters who may see a near-term tax cut but eventually the cost for that tax cut will catch up on them (due to the bill’s contributions to the deficit) at the same time that their tax cuts expire. Moreover, some of the short-term revenues will come from a one-time discount on repatriating profits held abroad. When the 2020 elections come, voters won’t have felt the squeeze of the belt-tightening from the expiration of the individual tax cuts nor the impact to the federal deficit.

Policy Changes

You can see more details about the bill on Wikipedia.

Many of the specific changes are not bad. The real problems are in

  • the omissions (not going far enough in many cases)
  • the clear bias towards corporations, for example:
    • retaining key deductions that have been cut for individuals (like SALT)
    • eliminating the corporate Alternative Minimum Tax (while keeping the individual AMT)
    • making the individual tax cuts temporary while making the corporate tax cuts permanent)
  • the timing and transition plan
  • the impact to the federal budget, which will be used to justify cuts to social programs

For Businesses

  • Reduces the corporate tax: 4/5. A cut is good because headline corporate rates are high in the US but it wasn’t paid for by cuts in deductions.
  • Introduces a territorial system of taxation: 4/5. Simpler and more consistent with other countries.
  • Limits interest deduction to 30% of EBITDA: 4/5. Great direction. Doesn’t go far enough. Should eliminate interest deduction completely.
  • Eliminates the corporate Alternative Minimum Tax: 4/5. It’s fine to simplify corporate taxes but the bill should’ve eliminated more corporate deductions to make a corporate AMT not necessary.
  • Creates a 20% deduction for certain pass-through businesses with tangible assets like real estate firms: 2/5. It’s just a kickback for certain politicians and further complicates the tax code.
  • Allows immediate deduction of certain capital investments: 2/5. More corporate giveaways and complications without serious justification.
  • Creates a discount for repatriating foreign earnings: 2/5. It’s a one-time boost and rewards companies for hoarding cash abroad.

For Individuals

  • Doubles estate tax exemption to $11.2m/giver (or $22.4m for a couple): 1/5. Nobody needs to receive more than $10m of tax-free money to start off their life. Generational wealth is the biggest contributor to growing inequality.
  • Caps state and local taxes (SALT) to $10k: 2/5. In principle, I agree with eliminating (or drastically reducing) deductions for SALT (especially property tax). In practice, it was imposed too suddenly and doesn’t give states and individuals time to adjust. Moreover, companies can still deduct their taxes. If it were truly about incentivizing states to lower their taxes, it should give states time to do so (phasing it in over five years?).
  • Doubles the standard deduction: 2/5. The fact that standard deduction and itemized deduction don’t add up is bad. Doubling the standard deduction magnifies the issue. The presence of the standard deduction means that most people don’t benefit from deductions and it complicates taxes. (For example, what’s the impact of donating? Should I buy this house assuming I can deduct the interest?) This tension can be resolved by eliminating the standard deduction, eliminating itemized deductions, or combining the two.
  • Updates the tax brackets: 4/5. The new brackets make more sense for a few reasons (although the rates didn’t have to be lowered so much)
    1. It eliminates weird brackets like the 35% for individuals rate ($424,950-$426,700)
    2. It eliminates the marriage penalty for most couples if you ignore the deduction limits.
    3. It indexes the brackets to chained CPI measure of inflation, which more accurately tracks purchasing power because it accounts for substitution effects.
  • Eliminates the personal exemption: 4/5. The child tax credit is a simpler way of “subsidizing” child-raising, although the merit of using tax policy to steer family planning decisions is dubious.
  • Limits mortgage interest deduction (MID) to 750k of principal: 4/5. Good idea in principle. It doesn’t go far enough and the transition plan contributes to a liquidity issue. The MID is regressive, expensive and creates many problems. It should be phased out over a number of years (5-15) and should affect all mortgages, not just newly originated ones, because creating two classes of mortgages will lower liquidity for the housing market (mortgage is worth more to the homeowner than to the potential buyer, widening the bid/ask spread).
  • Eliminates individual mandate for health insurance: 1/5. A terrible clause to sneak into the bill that will cripple health insurance markets in subtle ways. You may be wondering why it’s expected to save money even though we would no longer be collecting fees? It’s because it’s estimated to take 20 million+ people off insurance, which is partially subsidized.
  • Raises exemption for AMT: 3/5. More deductions should be removed and AMT will just become irrelevant. It’s a needless complication if the main line tax system were simpler.

Implications and Conclusion

The economy doesn’t need a fiscal stimulus right now. It’s at or near full employment. Companies are sitting on record amounts of uninvested cash because there aren’t many profitable investment opportunities, not because of punishing tax rates. Yet, this bill will add trillions to the debt over the next decade.

The right way to pay for these tax cuts is eliminating more deductions–including deductions taken away from individuals but kept for corporations–and special status for certain types of income (i.e. capital gains on primary property, carried interest, etc).