Simple Explanation of the New Tax Reform

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After spending the first nine months of the year trying futilely to overturn President Barack Obama’s healthcare reform, Trump seems to have his first big success with the biggest tax cut since the Ronald Reagan era (1986 reform).

The Tax Cuts and Employment Act was approved in the Senate last Saturday with an adjusted vote of 51 versus 49 votes. It is proposed to reduce the corporate tax to 20%, while changing the income tax brackets and significantly reducing exemptions.

Presently, there is the stumbling block of the lower House, for there are slight differences with the Senate bill. But everything seems to indicate that they can be overcome before the end of the year.

The exempt minimum would almost double to $24,000 a year for married taxpayers and $12,000 for single filers. Currently, the exempt minimum is $12,700 for married couples filing jointly and $6,350 for single taxpayers.

It seeks to benefit large companies with a single tax on the repatriation of around $2.6 trillion of assets that are currently outside the US.

One of the most controversial issues of Obamacare is the so-called individual mandate. Now, the penalty that had been established for those who do not purchase health insurance from the Obamacare insurance market would be eliminated.

The main differences between the Senate and the House

Trump’s tac reform is not yet underway because it must also be approved in the lower house, so that finally both chambers will give the green light to the tax reduction. Until then, both chambers have differences that must be adjusted in the coming weeks to reach a final agreement.

If we focus on the differences, the Senate proposes that the reduction of the corporate tax from 35% to 20% be made one year late, that is 2019. On the contrary, the House of Representatives wants them to take effect next year.

The current draft law in the Senate maintains up to seven tax brackets in the income tax that would expire in 2025. In comparison, the House of Representatives reduces these seven brackets down to four: 12%, 25%, 35% finally, 39.6% and they would be permanent.

Consequences on the deficit and public debt

Current estimates on the reform are that only 44% of Americans will see an annual reduction of more than $500. However, the Speaker of the House of Representatives, Paul Ryan, indicated that the reform will allow a savings to the average families of up to $1,182.

The Joint Tax Committee of the non-partisan Congress has calculated that the Senate bill would add 1 trillion dollars to the public deficit during the next decade, even when taking into account the economic growth that would contribute 0.8 percentage points of annual GDP.

The government’s estimates, which projected an additional $1.4 trillion added to the current public debt, did not take into account a boom in economic growth that the tax package would cause.

The economic growth resulting from the tax reduction would only contribute $408 billion dollars to the public coffers, leaving a huge hole of 1 trillion dollars to fill.

That means that, unless there is a commitment to control federal spending or tax increases, the government debt will continue to advance in the coming years to levels not seen since the end of the Second World War.

Tax competition does not tend to please countries, since it means seeing which country is capable of being the most competitive with a lower fiscal burden, which leads to reducing budgetary control by the public sector. In other words, a pseudo race to the bottom.

On this occasion, the European Union and China have expressed their concern that the current bill does not comply with international regulations and stress that there may be adverse consequences in local markets.

Therefore, Germany and France initiated an investigation, through the European Commission and the legal service of the European Union, to verify if the tax legislation approved by the US Senate violates international trade and tax laws.

From China, there is a nervousness about focusing on the decrease of the corporate tax rate since it could negatively impact the Chinese domestic markets and create serious internal imbalances. Stay tuned for more analysis on the global and domestic economic consequences of this new tax reform.

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