The Trump administration recently released the framework of their plan to overhaul the U.S tax system. It’s a 9-page document that proposes rewriting the entire 2,600-page tax code. Needless to say, most of the crucial details are yet to be determined.
It will be up to Congress to flesh out the details, and they will ultimately decide how—if at all—the tax code is rewritten. Congress gets to decide what rates individuals have to pay, which industries get to keep their special provisions, and how hard to crack down on multinationals that use tax havens.
Still, the framework will help guide Congress’ tax debate, and it gives us some idea of what the President will be looking for in a bill. Here’s a look at the plan, what we know about how it would change the tax system, and just as importantly, all the things that will have to be sorted out by Congress.
How would individuals’ taxes be affected?
A new set of tax brackets
Trump’s plan calls for reducing the number of federal tax brackets from seven to three. On the lower end of the income spectrum, the rate would be increased from the current 10% level to 12%, while at the top the rate would be reduced from 39.6% to 35%. Crucially, the Trump plan doesn’t specify the income levels that the new brackets would target, so it’s impossible to calculate how anyone’s taxes would be affected by this change. For example, if Congress decides the 35% rate kicks in at $500k, it will be a tax cut for the wealthy, but if they decide it kicks in at $300k then it will be a tax hike.
For middle-income earners, Congress will decide what this means when they set the income levels for President Trump’s proposed 25% bracket. Under current law the 25% bracket covers income above $37,950 but below $91,900. If the new 25% bracket were to cover income below $37,950 it could increases the amount of taxes middle-income earners have to pay. But if Congress decides to kick it in at a higher income level it could be a substantial tax cut for the middle class.
Less itemizing and a bigger standard deduction
In order to simplify the tax filing process, Trump wants to get rid of most of the deductions and exemptions that taxpayers can claim when they choose to itemize. Only two itemized deductions would remain—the mortgage interest deduction and the deduction for charitable contributions. However, the plan also calls for doubling the standard deduction to $12,000 for individuals and $24,000 for married couples, so it’s likely that many taxpayers would have their tax liability reduced by opting to take the standard deduction, even if they have mortgage interest and/or charitable contributions to claim. On the other hand, people who still choose to itemize their deductions (e.g. people with large mortgages and/or substantial charitable contributions) may have to pay taxes on more of their income than they do currently.
No more Alternative Minimum Tax
The Alternative Minimum Tax (AMT) is a mechanism in the tax code that is supposed to guarantee that everyone—wealthy individuals, large corporations, trusts, etc.—pay their share of taxes. It’s a sort of check valve that kicks in if taxpayers use so many loopholes and deductions that their taxes are below a certain amount, though they AMT itself has loopholes that mean it can be avoided by the ultra-wealthy. It mainly hits households that earn between $500k and $1 million per year, but in rare cases it can increase taxes for people who earn more or less than that as well. Trump’s tax framework would completely eliminate the AMT.
Some have questioned whether this tax plan is designed to benefit President Trump. President Trump will likely benefit directly from eliminating the AMT. We know from Trump’s leaked 2005 tax return, that he paid $31 million in taxes that he would not have owed if there was no AMT. Eliminating the AMT is probably the piece of the tax plan that would benefit the Trump family and their political associates the most annually, although with the proposed elimination of many deductions, it could be less impactful than it is under the current, more complex tax code.
No More Estate Tax
This is another change that would exclusively benefit the wealthy. Under current law, people who inherit more than $5.49 million from someone who is not their spouse are currently required to give 40% of any amount they receive over $5.49 million to the government in the form of estate taxes. Trump’s plan would eliminate this tax, allowing all families to freely pass on their estates to future generations.
Only the wealthiest 0.2% of Americans ever have to pay any estate tax. According to the Washington Post, President Trump and most of his cabinet would likely be among the beneficiaries of this change. They calculate the potential savings to Trump’s cabinet members to be as much as $1.5 billion.
How would it affect corporations?
A lower corporate tax rate
President Trump’s plan would reduce the corporate tax rate significantly, from almost 39% to 20%. The U.S. currently has the fourth highest corporate tax rate in the world, so lowering this rate might encourage some multinationals to move more of their business back to the U.S., and it could entice new companies to settle in the U.S.
However, under current law many corporations use loopholes and aggressive tax strategies that enable them to pay an effective tax rate that is much lower than 39%. A recent study from the Institute on Taxation and Economic Policy found that, on average, Fortune 500 companies that turn a profit pay rate of 21.2%, and 20% of them pay less than 10% in taxes. So if this tax reform plan is effective at closing loopholes it may not end up being much of a reduction for many corporations, and for some it could amount to an increase.
A reduced rate for pass-through businesses
Currently, money earned by sole proprietorships, S corporations, and partnerships is taxed as regular income. That means if you run a hedge fund or a law firm or work as a consultant, and you earn, say, $500k per year, you may have to pay as much as 39.6% of your income in taxes. Under Trump’s plan, however, these so-called “pass-through” businesses will be taxed at a maximum rate of 25%. According to the Brooking Institute, about 95% of American businesses are set up as pass-throughs. These are primarily small businesses (the vast majority of all businesses, regardless of type, are small), but there are some big businesses that would qualify. For example, many financial, real estate, accounting, law, and consulting firms are set up as partnerships, and they can be large, global organizations.
This is another portion of the plan that could benefit Trump and his family directly. Trump’s financial disclosures show that he has set up more than 200 limited liability corporations, which would most likely qualify as pass-through businesses under this portion of the plan.
Bringing back multinationals’ offshore profits
Multinational corporations that are headquartered in the U.S. would no longer have to pay taxes on income that is earned in (and taxed by) other countries. To discourage the use of tax havens, multinationals would still have to pay a minimum foreign tax on any income that is not sufficiently taxed by countries where their subsidiaries are based. The minimum foreign tax rate is not specified in Trump’s proposal.
In order to encourage these companies to repatriate foreign profits that they have been stockpiling overseas, the plan would offer them a reduced, one time-tax that they would be able to pay over a number of years. Tech companies like Apple and Microsoft stand to benefit the most from this proposal, as they have both been holding more than $100 billion internationally.
What would it mean for the budget?
Economic analysts’ best guesses put the cost of the President’s tax plan at somewhere between $2 and $5 trillion over the next decade. The Committee for a Responsible Federal Budget estimates it will reduce federal revenues by $2.2 trillion over the next 10 years. While the Tax Policy Center says they expect it to cost $2.4 trillion over that period, and the Institute on Taxation and Economic Policy puts the cost at $4.8 trillion.
President Trump says he believes his tax plan will boost economic growth and generate enough new revenue to offset the costs of his plan. Most independent analysts, however, don’t expect his plan to provide that much of a boost. For example, Goldman Sachs says they would expect the plan to boost growth by just 0.1% to 0.2%, not nearly enough to pay for the proposed reduction in tax revenues. The most likely scenarios are for the plan to be financed by reductions in federal spending or by simply adding to the national debt.