Trump’s Tax Plan – A tale of expectations vs reality

23 November 2017

The US tax plan proposed by Trump’s administration looks like the biggest tax overhaul in the US since President Reagan in 1986.  Simplifying tax law has remained a priority for Trump since the campaign.  Nevertheless, there have been doubts about how they will successfully pass anything, despite Congress and the White House being under Republican control.  Recent positive developments have however reignited GOP hopes that longed-for tax reform is on track, and so the party can accomplish its first major legislative success of the year.   After much discussion, both House and the Senate Republicans passed their respective tax plans earlier this month, thereby taking a significant step forward.

Proposals made in the GOP Tax Plan

Individual and Corporate Taxes: The bill seeks to slash the federal Corporate Tax rate from 35% to 20%. For individual tax payers, House Republicans have proposed cutting the number of income tax bands from seven down to four (12%, 25%, 35% and 39.6%). On the other hand, the Senate version maintains current tax brackets but calls for lower tax rates. The Senate also wants to delay any cuts to Corporate Tax for a year, whilst reductions in individual tax would only be temporary.

One-time Repatriation Tax Rate: A 12% repatriation rate would be imposed on offshore earnings of US companies, while non-liquid assets would be taxed at a rate of 5%.

Increase in Standard Deductions: The GOP tax plan proposes a rise in the available standard deduction from $12,700 to $24,400 for married couples and from $6,350 to $12,200 for single individuals.

Rise in Child Tax Credit: The existing Child Tax Credit will be raised from $1,000 to $1,600. Also, a new $300 credit for every parent and non-child dependent has been proposed, a concession that would expire by the end of 2022. The Senate plan raises Child Tax Credits from $1,000 to $2,000. However, both plans preserve Adoption Tax credits.

Repeal of the Alternative Minimum Tax: The bill has proposed eliminating the Alternative Minimum Tax.

Limit on Mortgage Interest Deduction: The tax plan allows homeowners to deduct interest on mortgages up to $500,000 from $1 million. The Senate plan allows the deduction to remain up to $1 million, nut eliminates it for home equity loans.

No Change in the Retirement Savings Plan: The Republicans have left 401(k) contributions unchanged in the new tax bill.

Itemised Deductions to be Slashed: This would add new limits to itemised deductions for charitable contributions, medical expenses and student loan interest. Additionally, deductions for alimony, losses from theft or natural calamity, moving expenses and tax preparation fees would be removed.

Repeal of the Estate Tax: Under the new tax plan, the Estate Tax exemption would be doubled and then repealed in 2024.

No Repeal of Obamacare’s Individual Mandate: While the Senate prefers repealing the tax penalty for not having an insurance plan, there is no such provision in the House Republicans’ tax bill.

Tax for Pass-through Businesses: This is a planned 25% tax rate on qualifying business income from pass-through entities like partnerships, S corporations, trusts or sole proprietorships.

Possible impact on the Economy

As it stands, low and middle-income people stand to gain the most from the current tax plan. Doubling the standard deduction and raising child tax credits would lead to more disposable income, thus boosting consumption.  For US businesses, a massive cut in the Corporate Tax rate would be highly beneficial.  The one-time Repatriation Tax could encourage several companies to bring back their stockpiles of cash held overseas, to help in future expansion.  This would likely boost R&D activity, M&A deals and create new jobs.  Lower business taxes would ensure the US is more competitive globally, and would draw in more MNCs.  Republicans are arguing that the proposed reduction in taxes for individuals and businesses would boost consumer spending and business investment, driving US economic growth to about 3%.

On the negative side, a report by the Congressional Joint Committee on Taxation (JCT), suggests that the current proposition would lead to a 13% increase in individual taxation for those earning between $20,000 and $30,000 per year by 2021.  They would thereafter experience continuous hikes, reaching 25% by 2027.

Regarding the contentious issue of healthcare, repealing the individual mandate clause in the Affordable Health Care Act would increase insurance premiums by 10% in 2019, resulting in 13 million more uninsured by 2025.  If the proposed tax bill is signed into law, the Federal Medicare programme for seniors would see a $25 billion cut in funding next year and there would be automatic spending cuts thereafter.

Fiscal impact

Republicans have stuck with their argument that tax cuts will bolster the economy, and increased taxable income from higher growth will compensate for the proposed cuts.  Top rating agencies, including Moody’s Investors’ Service, and Fitch do not buy this view point.  Their expectation is that these plans will increase the budget deficit, and therefore US Federal debt.  According to a number of major think tanks, the proposed tax bill would increase the Federal deficit by $1.4 trillion over next 10 years.  The bill is poised to cut $5.9 trillion in taxes, while generating $4.5 trillion.

Even more worryingly, the CBO analysis predicts and increase of $1.7 trillion to the deficit over 10 years.  Subsequently, US public debt is estimated to stand at 97.1% of GDP by 2027.  This is up from their previous estimate of 91.2%.  To fast-track their tax bill and avoid roadblocks, Republicans will likely look to use the controversial “reconciliation process”, requiring only a simple-majority vote to pass the Senate.  In order to use this tactic, the revenue cost of the bill must remain below $1.5 trillion.  Furthermore, it cannot add any further burden to the long-term deficit.

US Government shutdown still looms

In September, Trump and Congressional Democrats reached a temporary agreement to raise the federal debt limit and fund the government through early December.  Beyond this however, the possibility of a government shutdown is looms large again, if GOP leaders cannot strike a deal with their Democratic counterparts on spending and other major issues.  If they cannot conform their bill to fit within the reconciliation process, Republicans will need Democratic support to pass a major spending bill through the Senate.  In return, they are likely to demand protection for Obamacare and The Deferred Action for Childhood Arrivals (DACA), as well as the reauthorisation of the Children’s Health Insurance Programme.  While Republicans are determined to pass tax cuts before the year-end, it is becoming more likely that US lawmakers could pass a stopgap spending bill to prevent a government shutdown for now.  This would also require Democratic votes and only a compromise between the two parties can avert a major government shutdown.


The lightning speed at which the current tax bill has moved through Congress in the last couple of weeks has raised its odds of passing and ultimately becoming law.  Nevertheless, this kind of ‘unorthodox’ legislative process has been criticized by many, including some of their own allies.  Most notably, Senator John McCain has stated he won’t support legislation that Majority Leader, Mitch McConnell, attempts to pass in this way.  With his desire for normal legislative procedure, the demands of Republican deficit hawks, and disagreements about Obamacare’s Individual Mandate, it’s a very narrow tightrope Trump will need to walk to avoid another setback.