What is good tax law? Taxpayers have their own thoughts on this. As a tax advisor, I certainly have my own opinion. We can refer to a number of sources for a researched and far-reaching direction on this, including guidelines from the American Institute of CPAs. The AICPA describes an effective tax system as one that is fair / equitable, neutral, simple / safe and economically efficient:
1. Fair: Compare the tax returns of two taxpayers with the same income. Would they have the same tax liability? In fairness, it could be argued that they should. If one taxpayer's income is higher than that of another, does that taxpayer pay more tax? Even if the applicable tax rules are fair, this would be expected.
2. Neutral: Ideally, taxes should be neutral, which means that they distort behavior as little as possible. Do tax laws affect your decision to donate to charity or buy a new home? Are you moving to a new country for tax reasons? In this case, these tax laws are not neutral.
3. Easy / Safe: For most people, US tax law is a foreign language. The concepts of simplicity and security state that taxpayers should be able to easily understand tax rules and apply them consistently. Taxpayers should have a clear idea of how and when a tax is paid. You should be confident that a tax has been calculated correctly. The more complicated and vague the tax laws, the less certain taxpayers are that their tax liabilities are correct.
4. Economically efficient: Effective tax systems do not hinder economic growth. This concept can be more difficult to pin down than the others. It is easy to measure whether a tax law is fair, neutral or simple. Just ask your tax advisor! However, it needs to be modeled and guessed whether a new tax law will allow business to "do its thing". Since nothing happens in a vacuum, the historical impact of a particular tax policy may not always be clear either.
This article looks at some of the key components of President Donald Trump's and former Vice President Joe Biden's tax positions in terms of whether their ideas meet the test of "good tax law" of being fair, neutral, simple, and economically efficient. (The libertarians and the greens have their taxes too, but I had to stop somewhere.)
Individual tax rates
Currently, the top tax rate for ordinary incomes such as wages is 37 percent. Biden would like to increase this rate back to its pre-2018 rate of 39.6 percent and apply that rate to those with taxable income above $ 400,000. Trump wants to keep the tax rate at 37 percent and has hinted at lowering the tax rate from 22 percent for middle-income taxpayers to 15 percent or restructuring the tax brackets so that more taxpayers fall into the lower brackets.
President Donald Trump (left) and Democratic presidential candidate Joe Biden
Morry Gash / Bloomberg
Biden's plan prioritizes fairness. This justifies a rate hike for people with high incomes due to their solvency. However, this can skew behavior as those in the upper tax bracket look for other ways to lower their tax burdens. Since we don't have many details for Trump's ideas on this, it may or may not be fair to put more taxpayers in lower brackets, depending on the definition of the term “middle income”.
Under current law, certain dividends and long-term capital gains from investments held for more than a year are taxed at lower rates than ordinary income. The top tax rate for long-term capital gains is 23.8 percent, including net investment income tax. Trump has expressed interest in lowering the key rate to 15 percent or indexing the inflation rate. Biden, on the other hand, seeks to tax long-term capital gains at normal income rates for those whose taxable income is more than $ 1 million.
To many, Trump's ideas seem unfair because they can result in a taxpayer with higher investment-related income paying less federal taxes than a taxpayer with lower non-investment income, such as B. Wages. Biden's plan tries to address this, at least with high earners, by touching on the good tax law components of neutrality and simplicity. It is important to note, however, that the original intention of taxing this type of income at lower levels, dividends at least, is that that income has already been taxed at the corporate level before it gets to shareholders. In other words, the lower tax rate helps minimize double taxation – a potential hindrance to profitability.
The 2017 Tax Reduction and Jobs Act significantly increased the standard deduction while limiting certain individual deductions. These changes are currently expected to expire at the end of 2025. In the event of re-election, Trump would like to make them permanent. Under Biden's tax plan, the value of the individual deductions would be capped at 28 percent for taxpayers with incomes greater than $ 400,000.
The increased standard deduction was a step towards a simpler tax system. Many taxpayers no longer had to calculate different individual deductions. On the other hand, many individuals with large mortgages and significant charitable donations continue to benefit from the breakdown of their deductions. In other words, since the standard deduction is so much higher, the continued retention of individual deductions in the tax code will disproportionately benefit those who have higher deductions. Between the pre-TCJA law and the TCJA, the percentage of people listing their deductions dropped from 31 percent to 14 percent, with almost all higher earners continuing to list while many middle earners quit. This situation contradicts the effective tax principles of equity and partly the neutrality. Biden's plan seems to recognize this by capping the value of individual deductions for higher earners at 28 percent.
Child tax credit
Under applicable federal tax law, many taxpayers have a tax credit of $ 2,000 for children under the age of 17 and a tax credit of $ 500 for certain other dependents. Biden supports the expansion of the child tax credit, as outlined in the recently revised original version of the HEROES Act, which the House passed earlier this year. This would increase the child tax credit to $ 3,000 per child for children ages 6-17 and $ 3,600 for children under 6. Biden would also like to fully refund the credit. Trump has not proposed any material changes to the current child tax credit rules.
Some argue that the child tax credit is unfair as it treats taxpayers with children differently than those without children. From that perspective, Biden's plan would be lower on the fairness scale. Note, however, that this loan is a significant benefit for lower-income families, whose ability to pay taxes is disproportionately reduced by the cost of raising children compared to higher-income families. In other words, the child tax credit could instead be seen as a way to remove some of the costs associated with raising children from the equation and make families more tax-equal than taxpayers with no young children. Whether this loan and its extension are considered fair depends on your perspective.
Deduction for pass-through income
If you own a pass-through business like a partnership or an S company, you can benefit from the 20 percent Qualified Business Income (QBI) deduction that was part of the TCJA. This deduction, along with other components of the TCJA, expires in late 2025. Trump's plans regarding the withdrawal are not clear right now. Biden would like to phase out the credit for those earning more than $ 400,000. Based on the mechanisms of withdrawal, many passthrough business owners already have an income threshold in place.
Qualified business income deduction is one of the more complicated provisions of US tax law, and its various limitations make it difficult for taxpayers to predict how much their deduction will be. For the most part, it doesn't match the good fiscal security / simplicity component. In addition, companies in different industries are not treated equally and entrepreneurs are treated differently than employees in the same industry. For these and other reasons, the QBI deduction is neither fair nor neutral. While Biden's plan to phase out the deduction for certain high earners could potentially increase fairness, it would add another component to the calculation of an already confusing deduction.
In an August 2020 presidential memorandum, Trump instructed the U.S. Treasury Department to postpone the tax obligations of certain American social security workers for September through December 2020. If re-elected, Trump would like to eliminate those deferred taxes by providing a temporary vacation for payroll taxes. Biden wants to expand the social security tax by applying it to wages over $ 400,000. Currently, this tax is limited to wages around $ 137,000. As soon as an employee exceeds this amount at any point in a calendar year, social security taxes no longer apply to further income for the remainder of the year.
Due to this upper wage limit, social security taxes are falling. In the tax world, regressive means that the more money you make or have, the less percentage of your income or assets will be spent on tax. To illustrate, those who are below the Social Security wage line and earn $ 30,000 per year pay about $ 1,900 in Social Security tax, while those who are above Social Security wage and earn $ 300,000 pay about $ 8,500 in Social Security tax. The first person pays a little more than 6 percent of their income in social security taxes, while the second person pays a little less than 3 percent of their income in social security taxes. We see a similar situation with some consumption-based taxes, such as B. Sales Taxes. Compare a low-income family to a high-income family of the same size and their food bills are likely to be about the same. However, the percentage of sales tax that the low-income family pays relative to their income is higher than that of the high-income family.
As you can see, regressive taxes like social security taxes have a greater impact on lower-income taxpayers than higher-income taxpayers, thus violating the solid tax principle of fairness. In theory, Trump's wage tax deferral was a way to temporarily make payroll tax a little less regressive, as the deferral only applied to people earning less than $ 100,000 a year. However, to be effective, the postponement would have to become permanent, which would require the approval of Congress. Without such an agreement, workers who defer their taxes now will have their deferred taxes paid back in 2021, which not only brings back the regressive nature of the tax, but also puts these individuals in a difficult cash flow position. If this move is to create more economic dynamism by putting more money in workers' wallets, those without jobs will not be targeted. TheU.S. The unemployment rate in September 2020 was around 8 percent compared to 3.5 percent in the same period of the previous year. Many employers, including the US House of Representatives, have so far refused to attend because this provision will ultimately have an impact.
Biden's proposal takes a different, more permanent approach to making wage taxes less regressive and fairer. His stance improves the security aspect of wage tax adjustments due to a temporary deferral, but could create other problems as higher-income workers and entrepreneurs prepare for a potentially significant impact on their income. In addition to the tax side, we also need to consider how adjustments to social security tax withholding will affect the solvency of the social security system itself.
C companies are currently taxed at a flat rate of 21 percent. Before the 2017 Tax Cuts and Jobs Act, corporate tax rates for C were between 15 and 35 percent. Trump has stated that he prefers a 20 percent rate, but a formal proposal has not been made public. Biden wants a corporate tax rate of 28 percent. He has also proposed a minimum tax of 15 percent on "book" income, which may make it difficult for large corporations to report little to no income for tax purposes.
Biden's proposal is primarily motivated by fairness. Many US taxpayers are concerned that big corporations are not paying their "fair share". While this position is understandable, it ignores the belief of many tax and economic policy experts that a significant portion of corporate taxes are ultimately paid by employees, shareholders and consumers as opposed to companies themselves. For example, the Council of Economic Advisers – the agency within the executive that advises the president on economic policy issues – published a study in October 2017 that found that lower corporate tax rates would both increase real wages for workers and increase GDP on sound tax policies Components for fairness and economy. In addition, changes in the taxation of C companies can affect a company's choice of tax unit. New or existing companies may be able to adjust their tax structure to either switch to or from C corporate tax systems, whichever is more favorable at the time. After all, given the myriad of estimates and complicated calculations that go into the financial statements of many larger corporations, an income tax levied on a corporation's book income would not be simple or neutral.
There you have it: Republican and Democratic candidates' ideas on several key tax issues. So who does the grade? While I'll leave you to make this call for yourself, here are some general observations:
- None of the candidates presented a detailed, formal tax plan. As a tax advisor, I would certainly welcome that.
- Understanding the implications of changes in tax law can be difficult and potentially impossible. As I said, nothing happens in a vacuum.
- Overall, Biden's ideas focus on being fair, while Trump's plans focus more on promoting economic growth – hardly surprising given her party affiliation. As a tax advisor who has helped clients tackle numerous complicated and vague tax law changes over the years, I'd love to see tax platforms that focus on neutrality and simplicity.
While tax policy isn't the only thing you think about when you vote, it is likely to play an important role. If you have any questions about candidates' tax positions, please contact us.