|Type of paper:||Term paper|
President Trump approved the comprehensive tax reform bill into law on 22nd December 2017 after the Congress had passed it two days earlier. This bill (Act) signified the weightiest reform witnessed in the country for more than three decades. The Act integrates provisions released by the House of Representatives and the Senate on 2nd and 14th November respectively, with most of these provisions translating into taxation changes that will be active for years to come.
One of the provisions imposes State deductions for income and property taxes, whereby, people may reduce property, State and sales (income) taxes up to a total of $10,000 (Sahadi, 2017). Additionally, this provision prohibited prepayment of income and State taxes prior to January 2018 to evade the $10000 check for forthcoming taxable years. Another provision introduces several alterations to the individual income tax. These reforms include increasing family tax credits and standard deductions, reducing itemized deductions and personal exemptions, lowering tax rates, and shifting the income level of personal tax brackets to a maximum rate of 37% for individuals earning more than $500000 and married couples earning in excess of $600000 (Sahadi, 2017).
Thirdly, this Act endorses the reduction of the maximum corporate tax rate from 35% to 21% as from 2018. Moreover, this provision sees the US shifting from a global to a territorial tax regime, whereby, as opposed to paying a tax rate of 35% for revenues generated in any nation, each corporation will be levied according to the tax rate of the country where it is operating (Sahadi, 2017). Fourthly, in this Act, the deductibility of net business premium rates is capped at 30% of the Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA) up to January 2023 and thereafter at 30% of the Earnings Before Interest and Tax (Sahadi, 2017).
Another provision revolves around the endowment tax, which imposes a 1.4% excise tax of revenue generated from investments made by private universities having assets prized at $500000 for each regular student and having an enrolment of more than 500 students (Sahadi, 2017). Also, under this law, estates that are valued at $5.6million are required to pay a 40% levy in addition to doubling the tax exemption amount to $11.2million (Sahadi, 2017). Finally, this legislation lowers the pass-through taxes by 20%, which sees a minimum rate of 30% being imposed on limited liability companies (Sahadi, 2017).
Likely Effects of the Bill on Aggregate Demand
The aggregate demand is taken to be the total revenue exchanged for services and goods produced in the country. This Act sees the reduction of individual income tax of most people as well as sales taxes for the next 7years. From these deductions, the income effects are one of the likely outcomes whereby more individuals will be discouraged to invest, work and save due to an increase in their after-tax income (Burton, 2017). This translates into lower economic activity among most people since most of them will tend to be more content with their current earnings and thus see no reason to venture into more businesses or service provisions (Burton, 2017).
The eventual impact is that the aggregate demand will be reduced due to the low level of commercial activity i.e. low production and provision of goods and services (Burton, 2017). Additionally, in such an unproductive State, if the deficit incurred from these reductions is not financed by immediate expenditure cuts, the federal budget deficit will possibly increase thereby raise premium rates and national savings (Burton, 2017). However, on a positive note, these tax reforms would induce growth in aggregate demand if they involve substitution effects that subdue the income effects. This would entail a meticulous aiming of tax deductions towards other manufacturing and production activities as opposed to providing payouts for preceding activities (Burton, 2017).
Likely Effects on the Aggregate Supply and Longer Run Economic Growth
The reduction in business and maximum corporate taxes is likely to create a trade deficit, whereby, there will be a surge in both limited liability businesses and foreign investors (Burton, 2017). Hypothetically, the US will offer a more attractive investment environment for most of its citizens and foreigners. This influx, especially from foreign corporations will increase the price of goods within the country, as well as exports, due to an increase in the value of the dollar (Burton, 2017). The resultant effect on the aggregate supply is that the rising prices of goods will create an insatiable demand although the supply of these goods may remain constant due to the high competition for the available goods.
According to Burton (2017), with the increased prices of goods, businesses are prompted to increase their production levels to meet the high aggregate demand. Therefore, all competing corporations will have to augment their output to sell more products and services. The ensuing increase in supply will eventually normalize the prices albeit the aggregate supply will remain high.
The short-term effect of this elevated aggregate supply is that the consumption of current inputs into the manufacturing and production phases will increase. The capital levels will remain fixed and thus most of the companies will be unable to establish new plants or incorporate new technological innovations that would spur production efficacy (Burton, 2017). Therefore, businesses will be compelled to ramp up their output by maximizing their factors of production, for example, exploiting existing technologies or assigning more working time to their employees (Burton, 2017).
In terms of economic growth, lower income and corporate tax rates would temporarily increase the country's economic growth due to a stable financial scene characterized by a higher GDP. These benefits will be expected to accumulate annually for an indefinite period after which the economic growth will stagnate. According to Samwick (2016), since only technology, labour and capital affect the aggregate supply in the long-term, a slow shift in economic growth will be witnessed. This is in line with the assumption that a case of optimal consumption of these inputs ensues due to the increased demand for the existing labour and technology.
Likely Effects on the After-tax Distribution of Income
The diagram below illustrates the distributional effects of the Tax Cuts and Jobs Act on the after-tax income of Americans for the year 2018, 2025 and 2027.
Source: (Tax Policy Center, 2017)
In 2018, there will be an average tax reduction of $1600 thereby increasing the after-tax revenue by about 2.2%. According to the Tax Policy Center (2017), taxpayers in the lower quintile, that is, those earning not more than $25000 annually, will have their taxes reduced by about $60 representing a 0.4% cut. Taxpayers in the middle quintile, that is, those with an annual income between $49000 and $86000, will receive a tax reduction of about $900 representing a 1.6% cut. Individuals earning between $308000 and $733000 annually, that is, those in the 95th and 99th percentiles will receive a tax cut of about $13500, which represents 4.1%. Finally, individuals earning more than $733000 will have their taxes reduced by $51000, which translates into a 3.4% reduction. Therefore, in 2018, taxpayers between the 95th and 99th percentiles will be the greatest beneficiaries of this Tax Cut.
(Tax Policy Center, 2017) continues to stipulate that in 2025, there will be an average tax cut of 1.7%, which translates to about $1600. As a share, this figure would be lesser than that reported in 2018 for the majority of the income groups since the tax regime will be indexed to the consumer price index witnessing slow growth in addition to the phasing out of several corporate tax deductions and the introduction of other corporate tax increases. Individuals in the lower quintile will have their taxes reduced by $70, representing 0.4%. Those in the middle quintile will see a reduction of about $900, representing 1.3%. Conversely, individuals between the 95th and 99th percentiles will receive a $13000 cut, which represents 3.2% while the top 1% will receive a $61000, representing 2.9% of the income after tax.
Finally, in 2027, the Tax Policy Center (2017) argues that the average tax deduction will be $160, which translates to 0.2% mainly due to the culmination of the personal income tax provisions as from 2025. The tax rates will be slightly changed for individuals in the lower 95% of the income distribution, whereby those in the lower two quintiles will receive a percentage increase of 0.1%, a 0.2% deduction for those between the 95th and 99th percentiles while no change will be reported for individuals in the middle quintile.
Likely Effect on the Behavior of businesses and the Kind of Businesses that are Likely to Get Particular Benefits
The highlight of the new Tax Cuts and Jobs Act, that is, the reduced corporate tax rate and the substantial deduction for the pass-through businesses, without a doubt, will affect the activities of both small and large business. Essentially, the country will become a tax haven for businesses and this will not only attract global companies to set up shops in the US but also make the existing businesses even more competitive. Moving to regions with lower tax rates is always a profitability strategy for corporates and therefore a slash of the corporate tax rate, for many large establishments, will be great incentive to bring their headquarters into the country.
One of the key components of the new legislation is the change of the tax structure for the pass-through enterprises, which according to Looney (2018) accounts to about 95% of the total businesses in the US. For this category of businesses which primarily consists of S corporations, partnerships and sole proprietorships, a 20 percent deduction will not only give these premises a financial breathing room but also, it will encourage the owners to reinvest the saved money by hiring new employees, increasing operations and even buy more equipment. This, in the long run, will increase production output and consequently affordable prices for the products in the market.
An interesting dynamic of the pass-through tax cut is likely to emerge. According to the Treasury analysis, only less than half of the people claiming pass-through businesses involvement actually conduct the traditional business activities (Parlapiano, 2018). This means they could be claiming to be getting their income from vacation house rentals or even hobbies. Additionally, the report shows that some deduct just small expenses meaning that they likely to be independent contractors providing sole labour services. With the new Act which allows for lower tax rates for pass-through establishment compared to individual taxable income rates, there is a likelihood that more people will try to find ways of fitting their business activity to this classification. For instance, an employed journalist could quit employment terms and contract as a sole proprietor and benefit from pass-through tax cuts.
With a tax slash of about 14% to bring the corporate tax at 21%, a big step closer to countries like Canada that has 15% corporate tax, more jobs, competitive wages, and generally unprecedented growth of the economy will be registered as a result of increased investment by foreign corporates encouraged by this cut. Moreover, the bill also scrubs out taxes on foreign earnings by the American firms conducting businesses outside the country. This move will encourage home corporates to bring in the foreign earnings into the country, assisting the growth of the economy since only an 8% and 15%, instead of the 35%, the tax will be imposed on these earnin...
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