Tax Cuts and Jobs Act: A Year in Review
As the tax season came to a close, many Americans scrambled to file their returns in advance of the April 15th deadline. I myself am often part of this financial frenzy. Having been an accountant, my lack of appreciation for the time value of money is perplexing. Rather than getting ahead of the filing process, I instead chose to write this article on the Tax Cut and Jobs Act (TCJA). While I find the annual reconciliation of my finances tedious, I find tax policy and the economic implications fascinating.
Politicians campaigning for the passage of the TCJA wrote some pretty big checks that the bill has struggled to cash, both metaphorically and literally. Supporters argued that the bill would raise wages, create jobs, spur business investment, and put more money into the pockets of middle and low income earners.
Putting aside the fact that many of these objectives have inherently countervailing effects, the fact of the matter is that the bill was simply not written in a way that could make good on these promises over time. What the bill has managed to accomplish for the individual tax filer has in greater magnitude accrued to the wealthy. Furthermore, current projections by the CBO estimate the bill’s impact on the corporate sector to be more of a sugar rush than a catalyst for lasting structural change.
While there are many promises that deserve to be compared to their actual outcomes, this article will focus on three primary arguments fundamental to the justification of the bill’s passing.
- Lower taxes for individuals and families
- Increased business investment
- Increased job opportunities and pay
Individual Taxation Reform: A Confusing Christmas Gift
When the Tax Cut and Jobs Act was announced, President Trump spoke to the reform as a Christmas gift from the administration to the general public. He promised higher take home income and increased tax refunds for all. A year after peeling back the wrapping paper, the question must be asked: Did the act successfully put money back into the pockets of every day Americans? Typical of most political reforms the answer is, it depends. It depends on where you look, it depends on your measure of success, and it depends on the timeline over which you make your evaluation.
Taxation Basics — Before launching into a discussion of how the TCJA impacted the tax liabilities of individuals and families, a quick refresher on a few key taxation basics is required. Specifically, it is important to understand the difference between above the line deductions, itemized deductions, standard deductions, and tax credits.
TCJA Adjustments to Available Deductions — The TCJA made a handful of changes to the deductions claimed by individual tax payers. See below for a summary of the bill’s most notable changes to the tax laws applicable to individuals and families.
We will begin by evaluating the mixed results emanating from changes made to the standard deduction and personal exemption provisions. Consider the three following examples of how these changes could impact filers in 2017 versus 2018.
The change in the standard deduction and elimination of personal exemptions was the most harmful for families with children. The above example shows the impact to a family with two parents and three children. Overall, the family of 5 lost close to $10,000 worth of deductions. Even for parents with only one child, the change in available deductions is still net negative.
For those families meeting the income restrictions required to qualify for the child tax credit, the elimination of the personal exemption may have been partially or completely offset by the increase in the credit. The tradeoff is largely dependent on number of children and the household’s income.
TCJA Adjustments to Tax Rates and Brackets — In addition to changing the deduction structure for individual tax payers, the bill also made many tweaks to tax brackets and rates. You can find a comprehensive summary of changes to each filing status at the end of this article. But as an illustration we will look at the changes made for taxpayers filing as single.
To give context to the below graphic, green arrows indicate changes working in favor of the tax payer, while red arrows indicate changes working against the taxpayer.
TCJA Alternative Minimum Tax — The Alternative Minimum Tax (AMT) is a more involved tax provision that will not be explained in detail here. Nevertheless, a loose understanding of changes to the AMT under the TCJA is important. These adjustments represent a major way in which the bill did more to ease the tax burden of those in the highest income brackets relative to those more typically identifying as “middle America.”
In short, filers with certain kinds of available deductions and adjusted gross incomes over a specified threshold must follow a separate formula to calculate their tax burden. This “alternative” calculation limits the types and dollar amount of available deductions.
The bill was derived from the minimum tax enacted in 1969. The minimum tax sought to reduce deductions and “loopholes” in the system that had allowed high income earners to pay little if any taxes. In its early form the AMT was an additional tax paid by high income earners. After Reagan era tax reforms it became essentially a higher effective tax for more wealthy filers.
Ultimately the reforms enacted under the TCJA changed the income levels over which deductions were phased out. It significantly reduced the number of individuals paying the tax.
This is not to say the AMT was not in need of reform. It is only to say that the method of executing the reform reduced revenues and lightened the tax burdens of top wage earners. Prior to the TCJA high income earners had become extremely adept at avoiding the tax. The Tax Policy Center found that less than 1 in 5 taxpayers with incomes over $1M paid the tax. This is in comparison to nearly 3 in 5 tax filers with incomes between $500k to $1M and nearly 1.5 in 5 for filers with incomes between $200k and $500k.[i]
Future State — Upon evaluation it feels aspirational to say these provisions benefit middle to low income taxpayers in any kind of revolutionary way. Even for those tax payers that come out ahead under the new system, the timeline of these reforms does not look good. While bipartisan agreement remains hard to come by as it relates to the TCJA, a common criticism heard on both sides of the aisle relates to the limited life span of the individual tax cut provisions.
While most corporate provisions are permanent, most individual and family income tax provisions will expire in 2025. This includes cuts related to pass through entities. Pass through entities include businesses set up as LLC’s, S Corps, and sole proprietorships. This is important as these types of businesses are typically small to medium sized companies and startups. These companies consistently contribute the greatest number of new jobs created on an annual basis.
Business Investment
One of the most crucial assumptions when arguing in favor of tax cuts and their long-term viability as a solution to slowing growth, is that businesses will use that money to reinvest in the American economy. Reinvestment expectations generally take two forms:
- Increased domestic investment in things like technology, new facilities, and better infrastructure that boost the country’s output per worker and potential GDP, and
- Increased employee pay and benefits for workers
The first point addresses the supply side of the economy by increasing the potential output per person. The second point addresses the demand side of the equation by giving consumers more discretionary funds to buy goods and invest.
The supply side of the equation has been of increasing concern for many first world countries as birth rates have generally fallen and more workers continue to retire. Output can only grow through:
- An increase in the working age population or
- An increase in the amount of output a single individual is able to produce.
For example, to grow his business a farmer needs either an increased work force to plant and harvest his crops, or a new technology that allows the same number of people to plant and harvest more output.
Addressing the supply side of the equation has captured the minds of policy makers as they attempt to craft policies that encourage investment. Increased government spending and decreased taxation have often been the default strategies. Historically these policies are implemented most dramatically in recessionary periods to prevent severe depressions or damage that could prove permanently harmful to the economy’s ability to grow in the future.
While having money in the economy is certainly an important part of spurring investment, it is far from a comprehensive strategy and has often failed to meet its intended objectives. This is especially true of governments that struggle to channel funds strategically towards efforts that increase long term productivity.
Part of what made the government stimulus program and tax cuts last year perplexing is that they were sold on the premise that the increased money supply would be invested and contribute to long term GDP growth. However, the bill was passed during a time of economic expansion and extremely low interest rates. Most large companies already had considerable cash on hand, and those who didn’t generally had ample access to debt and investor capital. This premise thus felt overly optimistic, and, as will be discussed next, has not panned out quite as promised.
Nevertheless, corporate entities saw their tax rates lessened and were granted tax holidays if they repatriated money back to the United States.
Stock Buy Backs and Dividend Payments — In an environment where cash was already readily available, the additional cash added to corporate balance sheets in the form of reduced taxes and repatriated money had to go somewhere. We have seen a significant portion of that money directed towards stock buy backs and dividend payments.
Stock buy backs occur when a company uses corporate money to buy back their own stock. This behavior decreases the supply of the company’s stock on the market. The decreased supply then increases the dollar value of remaining stock held by investors. Dividends are payments made to shareholders from a company’s after-tax income.
Certainly, there is nothing wrong with returning value to shareholders as it is one of the primary responsibilities of a corporation. Nevertheless, tax savings diverted to these purposes represent money not being invested in future productivity or increased wages.
Corporate money diverted to stock buy backs and dividend payments work in direct contradiction to promises made by promoters of the TCJA. First, stock returns generally accumulate to wealthier individuals rather than middle America. Second, by accumulating to wealthier individuals this money fails to address the consumer demand side of the GDP equation.
Money accumulating to wealthier individuals generally does less to spur demand for domestic goods and services. This is driven by the fact that wealthier individuals generally have a lower propensity to spend marginal dollars earned. For example, someone making $50,000 is far more likely to spend additional money earned on things like housing, transportation, clothing, education, and entertainment. In contrast, an individual making $500,000 generally has these needs fulfilled by their existing income. Thus, this individual is more likely to save that money or reinvest it to further extend his or her capital earnings.
There are certainly many caveats to this assertion, including the fact that propensity to spend is generally sinusoidal rather than linear. Nevertheless, the fact remains that money back in the pockets of individuals in lower income brackets does more to spur demand for goods and services that contribute to the output of the economy. Furthermore, money back in the pockets of these individuals expands their access to education, increases economic mobility, and ultimately helps build the middle class.
Again, this is not to say that investment is wrong. It is to point out how the bill failed to deliver on promises of increased investment and private sector productivity. It also touches on how the bill failed to deliver on promises of benefitting middle America and how it instead created an environment where increased income inequality is likely. This outcome is disturbing in light of a ballooning national debt and a rate of income inequality described by hedge fund founder Ray Dalio as a national emergency.
ISM Manufacturing Index — The ISM Manufacturing index is a measure of manufacturing activity in the US economy. It is a composite score derived from data related to manufacturing orders, employment, production, deliveries, inventories, and other key indicators of the manufacturing sector’s performance. Increases in the index indicate a thriving manufacturing sector, while decreases indicate shrinking production and potential recession. Not only is manufacturing sector performance an important marker of economic health, it is also an industry that proponents of the TCJA claim will benefit significantly from the tax reform.
The 12 months preceding the tax cuts corresponded with an overall decrease in the ISM Manufacturing Index.
Future State — It is undeniable that tax reform boosted economic activity above the 2% growth rate characteristic of the preceding years. In 2018 real GDP grew by 2.9% compared to 2.2% in 2017, 1.6% in 2016, and 2.9% in 2015.[i] While 2.9% is certainly not a figure to discount, based on current projections, it does not appear to be the start of a new trend towards faster growth. The Congressional Budget Office has published the below projections assuming the continuation of current law:
Jobs, Wages, and Worker Benefits
In addition to increased business investment, drafters of the bill asserted that a decrease in the corporate tax rate would trickle down to workers in the form of more and better paying jobs. The article Jobs, Jobs, Jobs…Jobs? takes a deeper dive into the mixed bag of American job performance. In contrast, this article will look at a select number of economic indicators that will help us assess if corporate profits have been returned to employees.
Increased Worker Pay — After the bill’s passing, a handful of prominent companies announced one-time bonuses they claimed were the direct result of decreased corporate taxes. Unsurprisingly, many on this list were those companies who lobbied hardest for the proposed legislation (more on that in an upcoming article). Putting aside catchy headlines, one must look at the actual wage growth precipitating the bill’s passing.
Wage growth has picked up slightly but at the same time so has inflation. The below graphic from the Bureau of Labor Statistics shows that wage growth has been near zero after accounting for inflation. Given the historically low unemployment rate this phenomenon is even more surprising.
Not only are wages flat, but part time and contractor work has continued to grow as a percentage of the total workforce. This trend significantly impacts household wealth. Part time and contracted workers are far more expendable and do not profit from basic employee benefits such as healthcare and retirement savings.
Employee Benefits — Employer benefits are a significant source of employee short term and long-term wealth. They offer vital support systems in the short term by offering health benefits to keep the workforce healthy and employed. Over the long term, employer benefits help employees prepare for retirement. Benefits earned through employment also reduce government spending on healthcare and social insurance programs. To be both beneficial to employees and the long-term economic outlook, savings from the TCJA need to be invested in employees not only in wages but in benefits.
In its 2018 Employer Health Benefits survey, the Kaiser Family Foundation found that accessibility of employer provided healthcare remained virtually unchanged year over year. Furthermore, the levels of employee contributions to those plans increased or remained unchanged. This indicates that the quality of health benefits offered to workers with insurance has not improved. These trends are especially concerning as the cost of premiums have significantly outstripped increases in real wages.[i]
Beyond not accomplishing the objective of providing workers with better jobs, the bill may have made obtaining affordable benefits more difficult through the repeal of the individual mandate. The obvious impact emanating from the repeal is the prospect that premiums will rise as younger and healthier individuals opt out of the insurance pool. The secondary effect is that workers are now less incentivized to exert pressure on employers to provide health benefits.
Are We Better Off?
In a time where income inequality is reaching historic levels and interest on the national debt continues to crowd out strategic government spending, it is difficult to see how the American public could be better off. As has been true with the many tax cuts before it, the TCJA will not pay itself back. We are not growing out of this national debt. We are not methodically investing in our people and the technology of the future.
Tax policy requires a vision of where we want the United States to be in 10, 20, and even 30 years. It requires an evaluation of the values we espouse related to opportunity and innovation. It requires thoughtful planning and experimentation. It requires the consultation of experts, not special interest groups and lobbyists. Tax policy is a key component of the strategic plan our country needs if it is to grow its people and compete globally.
Addendum: As this article is being posted after the April 15th filing deadline, I would like to assure readers that I did in fact file my taxes on time and am anxiously awaiting my $10 return.
[i] https://www.kff.org/report-section/2018-employer-health-benefits-survey-summary-of-findings/
[i] https://www.bea.gov/news/2019/gross-domestic-product-industry-fourth-quarter-and-annual-2018
[i] https://www.taxpolicycenter.org/model-estimates/baseline-alternative-minimum-tax-amt-tables-april-2017/t17-0149-characteristics
