Why 20% of American households will not benefit from tax cut
WASHINGTON, December 29, 2017: Congress has passed and President Trump has signed a law which cuts taxes for more than 80% of households. That means 20% of households will see no tax cut and many of those will see a tax increase.
Leading to the question of is it fair? It depends on the economic level the 20% live on.
Although presented to the public as a plan to give tax relief to millions of taxpayers, the primary goal of the tax plan is to stimulate economic growth. Following that economic growth, the goals were to provide tax relief to households with high federal income tax burdens. Then to ensure that all Americans pay their fair share.
What is the fair share?
The tax bill reduced the tax rates for every income group except the lowest income earners whose rate stayed at 10%. However, all lower income earners had their standard deduction increased which lowers their taxable income so that they end up paying fewer taxes.
The tax bill also eliminated or capped both the amount of state and local taxes (SALT) that can be deducted and the amount of mortgage interest expense that can be deducted. That means that while the tax rate declines for all homeowners, the tax liability will increase for those Americans who own homes in states where state income taxes and property taxes are very high.
Many taxpayers who own homes in California, New York, New Jersey and Connecticut will pay more in federal taxes. These states have high state income taxes and high property taxes. They also have high home prices meaning there are large mortgages with large interest expense. These households will now pay their fair share of federal income tax.
The new tax cut law is fair.
My friend David recently complained about the effects of the tax law.
“I am a Republican,” he said. “Under this new law, I can’t write off all of my interest and property taxes on my primary and secondary homes. This will cost me $10,000 per year. Why did I vote for Republicans who have passed a law that costs me so much?”
To respond to him I used an example.
Tax Cut: A tale of two houses
Suppose, we have two households that each have $200,000 per year in taxable income. Suppose their average tax rate is 20%, meaning they would each pay $40,000 per year in taxes.
One household freely chooses to rent a primary residence and rent the second home for vacation purposes. That household would pay the full $40,000.
The other household owns a home in New Jersey. They pay $12,000 in property taxes and $20,000 interest on their mortgage.
In addition, they own a second home in Florida and pay $6,000 per year in property taxes and $12,000 interest on that mortgage.
The household who owns the two homes has their taxable income reduced, so their tax bill drops from $40,000 to $30,000. By owning the two homes, the household saved $10,000. Under the new law, the $10,000 saving is eliminated.
The home renter has been paying $10,000 per year more than the homeowner likely for many years. Is that fair? American taxpayers who freely choose to rent homes have been subsidizing homeowners. The homeowner has been underpaying federal income taxes for as long as the homes have been owned. Now the renters and the owners will pay nearly the same amount of taxes. That’s fair.
Should the federal government encourage home ownership?
The argument for keeping the home deductions is that the federal government should encourage home ownership. Why? There is no clear answer except perhaps that homeownership is part of the American dream and that social problems like crime, drug use, teenage pregnancy and elevated high school drop out rates tend to be lower in communities where residents own homes rather than rent.
But the federal income tax code should not be geared to solve social problems. Rather it should be geared to equitably raise sufficient revenue. Besides the federal government trying to encourage home ownership was the real cause of the financial crisis.
Keeping control of state and local taxes.
The taxpayers in the states with high SALT often agree to allow those states to increase spending and raise taxes partly because the residents know they can write off those taxes so that their federal tax bill is reduced. As the above example shows, if SALT increases then federal income tax decreases under the current law. With the new law, there will finally be pressure to control spending in those states where taxes and spending are so high.
Additionally, those households paying high SALT, probably have substantial investments in the stock market. The value of those investments increased by about 25% since Trump’s election and will probably increase much more as the tax cut pushes economic growth above 4% annually and corporate profits increase.
Despite the rhetoric, virtually all Americans will benefit from the new tax law.