The Tax Cut and Jobs Act of 2017 — commonly known as the Republican tax reform bill — has a number of good things in it.
The corporate tax rate cut was something that needed to happen for a long time, and mainly just follows the example set by other developed nations. Limits on the mortgage-interest deduction and the tax deductibility of interest payments will discourage companies and households from taking on too much debt. The limiting of deductions for state and local income taxes could also be progressive in its impact.
But overall, it’s a mess. Because it was rushed through Congress without extensive debate, there are probably tons of loopholes and perverse incentives in the law that will be discovered by clever accountants and lawyers.
Because the GOP Congress knew about many likely problems in advance, and yet chose to pass them anyway, it’s likely that the task of fixing them will fall to the Democrats. In other words, Democratic politicians and policy advisers should already be thinking about tax repair.
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The biggest problem with the bill is also one of its centerpieces — a 20 percent deduction for pass-through business income. S corporations, limited-liability corporations, partnerships and sole proprietorships will now be taxed at a much lower rate than ordinary personal income. That opens the door for all kinds of tax avoidance. Instead of having a job, just set up a shell company and become an independent contractor. Your income will now flow through the shell company, instantly lowering your tax rate without any substantive change in what you do. Already, less than half of pass-through income comes from traditional business activities, and this fraction can be expected to decrease.
Not only will it make the tax system less progressive, but it will create large deficits — high earners pay an outsized share of the income taxes that make up the government’s main revenue source. Instead of focusing on cutting the top income tax rate, as in previous tax cut plans, Republicans have simply offered rich people a way around it. Big deficits will put pressure on the Federal Reserve to keep interest rates very low, in order to save the government from having to make large interest payments on its debt. That could distort the economy in ways that are poorly understood, or — in the most extreme case — even put the country in danger of a hyperinflation.
A second problem involves the shift to a territorial tax system for corporations. Under the previous system, companies had an incentive to use various accounting tricks to shift profits to overseas subsidiaries in low-tax nations and hold them there for long periods of time. For a while, Congress flirted with an idea to tax profits based on where actual sales were located, which would have put an end to many such shenanigans. But instead, the final bill switched the U.S. to a system that makes the shenanigans even more harmful.
Some experts believe a company will be able to move its operations — factories, offices and research centers — to another country, then book the profits in a tax haven, and end up paying almost no taxes. It will probably result in the offshoring of more U.S. jobs — exactly the kind of thing President Donald Trump promised to halt.
A third big problem with the bill is a big cut to the estate tax. That’s exactly the opposite of the direction that the country needs to go. The staggering rise in wealth inequality means the country needs more inheritance taxation, not less.
The final big problem with the tax reform bill is the repeal of the individual health-insurance mandate, a key part of the Obamacare system that has substantially increased the number of Americans with health insurance. The mandate imposed a penalty on those who failed to buy insurance, helping to bring down premium costs for those with coverage. Ending this will allow more healthy people to exit the health insurance market entirely, raising prices for everyone else.
Tax reform is a reality, but the quest for tax repair has just begun.