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We have a new federal income tax system. The Republicans who created it say that it will transform our economy, of course for the better.

Taxes Change Behavior

Republicans insistently repeat that tax structure determines economic behavior: people will alter their behavior depending on how their money is taxed, including moving to states with lower taxes. Let’s examine what the tax bill shows about how Republicans think Americans should earn money.

In any tax system, there is good income and bad income. Good income is taxed at low rates and bad income is taxed at high rates. For example, in current US tax policy, so-called “carried interest” is very good income. Carried interest is a kind of performance fee for managers of private equity and hedge funds, a share of the profits, which is typically the major source of income for such investment managers. Although these managers earn enormous incomes, which would normally put them into the highest tax bracket of 39.6%, special rules tax this money at only 20%, less than the rate for normal income of the majority of Americans. That’s great income.

Republicans insistently repeat that tax structure determines economic behavior: people will alter their behavior depending on how their money is taxed, including moving to states with lower taxes.

Here’s an example of bad income that affects millions of retired Americans. If your only income is Social Security, you will probably pay no income tax on it. But if you also have some other pension income, you could pay taxes on up to 85% of your SS benefits.

Under the current system, a couple who received $40,000 in Social Security and another $20,000 in other pensions would pay under $100 in taxes. But if instead they got $40,000 in pension income, they would pay $4500 in taxes. That works out to an effective rate of about 23% on the added $20,000 in pension income, even though their total income only falls into the 15% tax bracket. Their extra pension income is bad, because it transforms non-taxable SS benefits into taxable ones.

The new tax system does not change either the good carried interest income or the bad pension income. Donald Trump famously said as a candidate that the carried interest benefit allowed the very rich to “get away with murder” and promised to eliminate it if he were elected. Of course, he has done no such thing, and the new tax bill continues this very favorable treatment of such income. No politician in either party has talked about changing the penalty for pension income.

The Republican tax reform creates new types of good and bad income. A new kind of “good income” is earned by owners of businesses which are not corporations. Their profits are taxed as individual income. Now they will be able to deduct 20% of what they earn from their taxable income, effectively dropping their tax rate by 20%. There is a limit to how much income can be sheltered this way, but complex rules put in at the last minute will allow very wealthy owners of real estate firms, like Trump himself, to shelter much more income.

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Other kinds of good income in the Republican tax bill are: inheritances between $5.6 million and $11.2 million, which used to be taxed but will be tax-free; and income used to pay private school tuition, which is now deductible for the first time.

New kinds of bad income are: money spent as moving expenses, which is no longer deductible; money spent as part of your job, which is reimbursed by your employer, now to be classified as income; many kinds of employee expenses, which are no longer deductible, such as business travel, research expenses, tools and supplies.

In the new tax bill there are good and bad tax cuts. According to Republicans, corporations deserve the best tax cut. Their tax rate falls from 35% to 21%, a provision which will add $700 billion to the deficit over 10 years, even under optimistic guesses about economic growth. That cut is permanent. The smaller cuts for individuals are temporary.

You can search far and wide looking for any Republican who says that making the tax cuts for individuals temporary is a good idea. They did this because they had to limit how much the tax bill would add to the deficit in order to be able to pass it with their tiny majority in the Senate. If those individual tax cuts become permanent, that would greatly raise the impact on the deficit. If they expire as the new law says, the advantages for individuals would disappear in a few years, while corporations would continue to benefit.

Leading Republicans admit that it’s “bad policy”: White House Budget Director Mick Mulvaney calls it “gaming the system”. Mostly Republicans just hope that the economy will expand so much that the individual tax cuts can be made permanent without hurting the deficit.

Why choose to make the so-called “middle-class tax cut” temporary and the corporate tax cut permanent? Why give most taxpayers a break by cutting rates and then take away much of that benefit by eliminating the personal exemptions? Why add provisions which only help the rich, such as reducing the estate tax? Why at the last minute reduce the top rate from 39.6% to 37%?

Why make some of the income of average people “bad” while making lots of rich people’s income “good”? That shows us what Republican economic policy is all about.

steve hochstadt

Steve Hochstadt
Taking Back Our Lives