A look at the proposed tax reform plan
On Wednesday April 26, 2017, the White House announced the broad strokes of their proposed tax reform. Those broad strokes can be summarized as follows:
Reducing the current 7 brackets to 3
Reducing the corporate tax rate to 15% (down from 35% - 39.6%)
Elimination of the Estate Tax
Let’s take a look at what this means, shall we?
Tax Revenue Breakdown
In 2016 the US collected roughly $3.3T (approximately 17.78% of GDP) in tax revenue, which can be broken down as follows:
Approx. $1.5 Trillion was from Individual Income Tax
Approx. $1.1 Trillion was from Payroll Tax
Approx. $300 Billion was from Corporate Tax
Approx. $400 Billion “other” which includes Excise Taxes, Estate Taxes, Gift Taxes, Customs, Duties, etc. Note: $20 Billion of this sum is estimated to be attributed to the Estate Tax.
There are 7 tax brackets which break down as follows:
The individual tax revenue is estimated (based on prior year distributions of tax revenue) to be broken out as follows:
($555 Billion) - 37% from the 39.6% bracket
($285 Billion) - 19% from the 33-35% brackets
($330 Billion) - 22% From the 28% bracket
($330 Billion) - 22% from the 10%, 15%, and 25% brackets
Implications of Proposed Tax Reform
If we apply the proposed 3-bracket tier to the existing revenue breakout we estimate the new revenue and bracket structure to look as follows:
35% Bracket = Est. $500 Billion in tax revenue
25% Bracket = Est. $525 Billion in tax revenue
10% Bracket = Est. $160 Billion in tax revenue
Total = $1.185 Trillion (down from $1.5 Trillion – a reduction of $315 Billion)
Eliminating the Estate tax would result in approximately a $20 Billion reduction in tax revenue. Note this essentially affects only those couples whose combined net worth is greater than $33 Million – assuming the use of a standard family limited partnership tax structure with a 70% discount for non-marketable securities and the $10M Gift Tax exemption.
The reduction of the Corporate Tax rate to 15% is projected to reduce tax revenue from approximately $300 Billion to approximately $100 Billion.
As a result the total reduction in tax revenue from the new policies is projected to be approximately $535 Billion (from $3.3T to $2.765T).
GDP Growth and Revenue Neutrality
The White House has announced that the proposed tax cuts would be revenue neutral. Let’s see what GDP needs to grow to, in order for that to be so.
Tax revenue as a % of GDP was 17.87%. With the new, reduced, numbers, that % is closer to 14.74%. If we use that lower % as a proxy for the effective rate of GDP as represented by the lower tax brackets, then we have the following equation (14.74% X = $3.3T). X therefore equals $22.39T (up from $18.76T). That GDP growth translates to a 19.35% increase of the $18.76T GDP. Now let’s put that into context. The White House said it hopes the Tax Policies that it has rolled out will spur GDP growth of 3%.
Clearly that is a far cry short of the 19.35% increase needed to achieve the goal of revenue neutrality.
The Debt and Deficit
So all else being equal, assuming these cuts are part of a 10 year plan, absent sizeable offsets for closing loopholes or any other source of offsets, the current broad stroke tax cuts will increase our annual budget deficit by 80% or so and add almost $5T to the national debt over the 10 year period. This assumes the current $3.9T in expenditures doesn’t increase.
However, given recent policy announcements for infrastructure projects, defense spending, and a border wall, the deficit and debt only project to balloon in size far greater than just $5 Trillion over the next 10 years. In fact, some projections show the Debt rising from $20T to $32T over that same 10 year period.
This isn't to say that people should not celebrate tax breaks, but understand that a revenue neutral tax reduction is not remotely possible given the GDP growth we’d need to achieve to make it so. And a ballooning National Debt only kicks that tax can down the road. So a tax dollar you save today, may cost you multiple tax dollars tomorrow, and that is not a cost/ benefit we will win.