This time of year everyone seems to want to either review the previous year or predict what will happen next year. I guess I am no different from anyone else. I’ll steer clear of trying to summarize what has been one one of the craziest years in my experience, and try to bring some sanity to the year just ahead.
I can say one thing with certainty. Tax filing for 2016 returns will begin January 23, 2017. This is a few days later than last year, but not much. And since Congress made most of the so-called “extensions” permanent in 2015 we don’t have to worry about any surprises or stumbling blocks for tax filing.
However, I don’t think we will be able to say the same thing about 2017.
I feel confident that there will be serious efforts as tax reform. Deep and profound tax reform. Probably something akin to the Reagan reforms in the early 1980s. There will be shifts of focus on things like deductions and preferences and how business taxes are handled. I’ll bet there will be a reduction in the number of tax brackets, and a reduction in the top brackets. Probably the surcharges related to Obambacare will be eliminated. I’m also fairly certain that an attempt will be made to reduce corporate tax rates as an effort to bring profits back to the US. Even some effort to level out the tax rates charged for corporations and those charged for business earnings reported on pass-through returns.
That last paragraph was a doozey. It was full of information and not much explanation. First, let me give a generalized view about tax policy. This is based on my general knowledge of taxes and how they affect the economy. It is not based on any knowledge I have of what any politician or administration official has in mind. After that I’ll explain three of the items I mentioned and their impact and why I think they will make an appearance.
OK. The one basic reason for taxes is to collect money to operate the government. No surprise there. Of course, we operate at a deficit and we have a huge national debt. Like any other economic entity, we have to pay interest on our debt, or no one will lend to us. The federal government does have an additional advantage–it can print money. And our government is very very good at printing money. And our money is sought after all over the world. For example, more US $100 bills are in circulation overseas than in the US. And, most of those foreign held C-notes are used as a store of value, not as circulating cash. See the advantage we have?
But–and this is a very big but–there is no guarantee that this privileged status of both our money and our debt will stay in place. I’m not crying “wolf” or yelling that the “sky is falling.” I’m just saying that we have this privilege because of the strength of our economy, our national integrity and the fact that our military still protects most of the countries in the world that create the world’s wealth.
But if you don’t realize that the past eight years have seriously weakened that economy, that integrity and that military, then you haven’t been paying attention. But I said “weakened,” not destroyed.
I am not a fan of Donald Trump. But I do believe that between the two choices we had, we are lucky that he won. Not so much for what he will do, but because he has reset American politics so that fiscal conservative voices can once again be heard. He says the right things about the economy, and Congress is inspired to follow that economic path. And so tax reform comes to the surface.
We have to have money to run the country. Roughly $16 or $17 trillion, plus what we can borrow. When the tax laws discourage business expansion the lack of economic activity depresses tax collections and thereby increases the deficit. Look, we can save money through waste reduction and fraud elimination. But those methods save only billions, and we need to bring in additional hundreds of billions.
To summarize, tax reform can encourage business growth, which increases profits. More profits increase tax collections, even if tax rates are reduced. It works. It has worked before under Kennedy and under Reagan for the two most recent examples.
So, here are the three areas I want to expand on
1. Reduction in the number of tax brackets seems to be both favored and common. That was the core of the Reagan reforms, too. Also the top bracket will be lowered. I’ve heard things like 15%, 20% and 25%, with a high zero tax threshold to eliminate taxes for the lowest income group.
To maintain collections, certain deductions will need to be adjusted. Perhaps the medical expense deduction which has already been raised to a 10% threshold. And there is also the issues of tax credits like the American Opportunity Credit which allows middle class Americans to get some relief from the high cost of higher education. And how do we adjust the standard deduction and the personal exemption.
I’ve heard proposals all over the map on these issues.
Here’s the thing. When these amounts are adjusted, how will it affect the ability of the government to collect enough to minimize or eliminate the deficit? Sure, economic growth increases tax collections, but by how much? Statisticians can work their magic, of course. One limiting factor, however, is the fact that the economy has been so depressed, and funding for expansion is difficult to get.
What happens if the lower rates simply result in people paying less tax? Obviously, the deficit goes up and government borrowing continues.
2. Obamacare is and has been a drag on the economy. Even it’s proponents said that. Although they said it would get better later, and that has not happened. So eliminating it is wildly popular. But until is vanishes, the removal of the additional taxes–the surtax on very high incomes and the additional medicare tax for certain taxpayers for example–how will the costs associated with a draw down of the program be handled?
Obamacare relied on the government subsidizing the costs of health insurance for those who could not afford it. What happens now? If it is simply repealed, then how are those who relied on th program going to pay for health insurance. Even if the market forces argument works, it takes time for market forces to become effective.
These reductions may lead instead to increases in government spending at the state and local level for which states may not have the tax base to support.
3. Reducing the corporate tax rate can have a real impact. It is true that the US corporate rate is the highest in the world. And it is not graduated like the individual tax rate. Now the argument is that many multi-national businesses stash their profits outside the US to avoid paying that high rate. But, since the money cannot come to the US, it is not available to invest in expansion in the US. So businesses are encouraged to expand outside, thus losing more US profits as well as destroying American jobs.
This argument may sound best of all three mentioned here. Without going into all the details of American worker productivity and quality, it makes sense that a US company would want to have better control over its operations by having them in the US. Besides, it is clear that companies do not pay taxes, individuals do. So if a company is taxed more, it simply raises prices or slashes costs (like using cheaper foreign labor) to make up for the bigger tax bill.
One potential gotcha, however, relates to small business. If a sole proprietor pays for his profits at personal tax rates that top out at 25%, but a corporation pays only 15% (one of the suggested new rates) then that small businessman is harmed. And he is less likely to hire new employees, or even to keep his business going. So how do we adjust for this situation?
Just based on these issues, it is clear that the political debate in 2017 is going to be a vigorous one. I’ll do my best through the year to keep you up with what’s going on and to keep you informed of the steps you should take to be prepared for the outcome.
I’d love to get some comments from my readers about what you think.