Hike in Standard Deduction Would Signal Philosophical Shift
SMITH BRAIN TRUST – Among the pages and pages of proposed changes in the still-evolving Republican tax plan, the Smith School’s Sam Handwerger detects some signs that perhaps the party is becoming more open to a flat tax.
One of the most telling changes the proposal would make to the tax code, says Handwerger, a lecturer in the accounting and information assurance department at the University of Maryland’s Robert H. Smith School of Business, is a sharp increase in the standard deduction. Under the plan, released last week, the standard deduction would rise to $12,000 for a single filer, from the current $6,350 – or $24,000 for married filers, from the current $12,700. And as the plan increases the standard deduction, it erases a series of other deductions – effectively flattening overall tax law.
The move marks a slight departure from the current tax code, Handwerger says, and perhaps a philosophical one. Lawmakers have historically used the tax code to encourage certain social and economic behaviors.
“Everyone says that politicians are afraid to move to a flat tax because it forfeits the ability to manipulate the social economics of the world,” Handwerger says. “Heretofore, they have had the mortgage interest deduction, for example. It encouraged people to buy houses. They loved that.”
The flat tax, by its very nature, lets go of some of the incentivizing role that taxes can play.
There are two main tenets of a flat tax. For one, it sets a single percentage of income tax that all taxpaying earners would be assessed. (That’s not happening under this bill). And two, it sets a single standard deduction that applies for all taxpayers. Gone, for example, would be some deductions for homeowners, parents and charitable givers.
“The bill is doing away with a lot of the reasons to itemize, which you wouldn’t do if we had a flat tax,” Handwerger says.
The flat tax has always held a certain appeal with some voters, for its simplicity and seemingly leveled playing field. Steve Forbes built a presidential campaign around the merits of a flat tax in 1996. Other Republicans, and a few Democrats, have touted its appeal, but it’s an idea that’s never gained a lot of traction.
Handwerger says he sees clues that the GOP might be quietly, gradually, slowly warming to a flat tax, with gradual steps that would play out over five years. And that means doing away with tax benefits that only apply to some taxpayers, in favor of a single deduction, applied to all. Perhaps, some might say, that the message is not so quiet. After all the bill does use the words, "simplification and reform off deductions" in its pages of explaining the reasons for certain changes.
He details a few of the signs:
Personal exemptions: Gotten rid of. The GOP tax plans does away with personal exemptions for spouses and dependent children. “In short, some parents will pay more, bearing some of the weight of a higher standardized deduction for everyone,” Handwerger says.
Child care: Going bye-bye. The original draft of the GOP tax plan called for the elimination of the use of flexible spending accounts that allow parents to use pre-taxed dollars to pay for child care. The plan did not delete the child care tax credit, but the flex account provides more relief by saving on social security taxes.
The child tax credit would increase for all dependent children under the age of 17. It would become $1,600 per child, rather than the existing $1,000 per child. It’s a significant increase, but with the pre-tax flex spend going away and the loss of the personal exemption, some parents could end up paying much more in taxes. Amid outcry, Republicans revised the tax proposal this week, bringing back the popular $5,000 flex-spending benefit, while still keeping the child care tax credit. Still, even under the revised plan, the flex-spend benefit is set to go away after five years.
The mortgage interest deduction: Scaled back. Taxpayers currently can deduct interest paid on loans of up to $1 million dollars, for a single home or for several. The tax bill proposes lowering the cap to $500,000 and limiting the benefit to just one home.
State and local tax deduction: Repealed. The GOP plan would erase the amount that taxpayers deduct from their federal bill now because of the state and local taxes they pay. It also would erase the tax that can be deducted in property taxes.
“The real losers are high income tax states, like New York, New Jersey, Massachusetts, California, and even Maryland,” says Handwerger. “This will be a difficult pill to swallow for Republican lawmakers from those states. And there are enough of those to potentially sway the fate of the bill.”
Medical Deductions: Gone, gone, gone. No more deduction for this even above 10% of your adjusted gross income. Seniors are sure to balk at this change.
The estate tax: Fading away. The estate tax, which currently applies only to inheritances in excess of $5.45 million, would be weakened and would later go away under the GOP tax plan.
The government currently taxes an heir who inherits more than $5.45 million from a parent or other single benefactor. (Roughly $11 million if the inheritance comes from two parents, or two other individuals.) Under the GOP’s proposed new rules, inheritances would only be subject to tax is they top $11 million from a single benefactor, or $22 million per couple. After five years, the estate tax would go away entirely under the GOP’s tax plan.
Business entertainment expense: Shutout. Want to entertain clients with your NFL season tickets (or MLB tickets or opera tickets)? You can’t deduct that anymore.
Child adoption credit: Orphaned. The plan ends the child adoption credit.
Electric vehicle credit: Scrapped. The electric vehicle credit is not included in the GOP’s plan.
Moving expenses: Moved out. Taxpayers would have to shoulder completely their own relocation expenses with no tax help.
Rehab tax credit: Trashed. The plan retires the tax credit to investors who rehabilitate historic structures.
Employee achievement awards: Congrats, but it’s no longer tax-free. Taxpayers currently can receive up to $400 in employee achievement awards, tax-free. It was a small amount, but it’s gone.
Business equipment expenses deduction: There are few new tax credits under the GOP plan, but there is this one. The business equipment expenses credit would allow taxpayers to reduce their tax burden when they buy gear for work, but the benefit vanishes after five years.
Tax Brackets: The brackets get squeezed towards a middle ground. Instead of seven brackets - just four with the current low of 10% going up to 12%. Reportedly the bill reluctantly kept in the highest 39.6% rate, but significantly decreases the amount of high income earners affected by this rate.
A footnote about the AMT: The plan would also repeal what Handwerger calls “the dreaded alternative minimum tax,” of AMT. “The AMT was originally an experiment with a flat tax by having a dual tax system inside the one Internal Revenue Code,” he says. “It was, truth be told, a complicated mess in its efforts to reduce the tax effects for people with high itemized deductions. Now the tax code, by curtailing a lot of those itemized deductions right in your face, so to speak, possibly brings us a step closer to a one-rate system.”.
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