A Year After the Middle Class Tax Cut, the Rich Are Winning

When President Donald Trump and the Republican Congress set out to re-write the tax code, their goals were simple enough: Lower tax rates, juice the economy, reward some taxpayers while punishing others. The price tag, though, was enormous: by some estimates, as much as $1.9 trillion over 10 years.

And their tool—an enormously complex, 186-page piece of legislation—still puzzles tax experts a year later. While offering most individuals an initial tax break, and many businesses with large windfalls, the law uses methods that would make Rube Goldberg proud. It takes away as many perks as it provides, and opens as many loopholes as it closes.

To figure out how the law affects you, you’ll need an accountant, or at least some powerful software. To gauge how Trump’s tax overhaul affects the country, though, you can compare the many promises Republicans made for the law and their real-world results.

Filing taxes will be simpler for millions of Americans next year, thanks an almost doubling of the standard deduction to $24,000 for married couples. But some top earners might not be happy about it. The tax law limits or eliminates dozens of itemized deductions, including for SALT, mortgage interest, home office expenses and fund management fees. As a result, far fewer taxpayers will itemize their deductions at tax time. The overall effect is modest, though: The U.S. Treasury estimated that individuals overall will spend 4 to 7 percent less time filing their 2018 taxes next year.

For high-earning businesses, the tax code has become a lot more complex. The main culprit is the 20-percent tax break for owners of pass-through businesses, which report their income on owners’ tax returns. To limit its cost, the law makes business owners jump through hoops to qualify. Above income limits, certain industries—generally health care, accounting, law, and other professional fields—are completely barred from the break. Others must use complicated formulas to calculate the size of their benefit.

Corporations are facing even more complexity, especially if they do business overseas. While winning a cut in their tax rate, multinational firms must navigate new taxes and other rules—including the Gilti, a levy on global intangible low-tax income, and the BEAT, a base-erosion and anti-abuse tax—that are still creating confusion for companies and their tax pros.

The good news for middle-income business owners: The complicated limits on the pass-through break only apply to those earning more than $157,500, or $315,000 for a married couple. Under those thresholds, business owners, and even independent contractors, can take the full break without restrictions.

But a 20-percent tax cut is far more lucrative if you’re in a higher tax bracket, where it effectively cuts the top rate from 37 percent to below 30 percent in one fell swoop. That’s why the vast majority of the tax break goes to the biggest businesses. The Joint Committee on Taxation found almost half the benefit flows to businesses making $1 million and up.

Workers are still waiting for their raises as inflation eats into modest increases. Hourly wages, adjusted for inflation, were up 0.8 percent in November, according to the Labor Department. While the number has been steadily rising for the last few months, it’s still significantly lower than real wage increases in 2015 and early 2016, when inflation-adjusted raises occasionally topped 2 percent. Even then, economists worried that the strong economy wasn’t helping the average worker.

After the tax law passed, prominent companies made a splash by promising to pass their savings onto employees. According to an analysis of 145 of those company announcements by nonprofit Just Capital, however, just 6 percent of tax cuts were allocated to workers. Most of that windfall went into one-time bonuses rather than a permanent wage hike. Another 18 percent of savings was allocated to job growth.

How Companies Are Distributing Their Tax Savings

How Companies Are Distributing Their Tax Savings

Shareholders

Jobs

Customers

Products

Workers

Communities

56%

18%

9%

8%

6%

3%

56%

Shareholders

Jobs

Customers

Products

Workers

Communities

Source: Just Capital

18%

9%

8%

6%

3%

56%

Shareholders

Jobs

Customers

Products

Workers

Communities

18%

9%

8%

6%

3%

There’s no sign of a corporate spending spree. Nonresidential business investment rose 2.5 percent in the third quarter, the smallest increase since the final three months of 2016. While such spending picked up in early 2018 after plodding along for years, a string of weak reports raises questions about the outlook.

Earnings reports suggest big companies have mostly used their tax savings to protect profit margins squeezed by tariff-related uncertainty and cooling global demand. Other firms may be confused about the impact of the BEAT tax and other international provisions. Some of the law’s new rules may even end up providing some incentives to keep or move operations overseas.

So far the trillions haven’t materialized. The tax law requires corporations to pay a one-time tax on profits that they’ve stowed abroad. But they’re not required to bring the money back home, and many aren’t. While estimates suggest there’s more than $3 trillion in corporate profits overseas, U.S. Commerce Department data show companies have repatriated about $464 billion in the first half of the year. A recent report from Morgan Stanley estimates companies brought back from $50 to $100 billion in the third quarter—which would bring the total to just a fraction of what Trump promised.

Companies such as Johnson & Johnson, EBay Inc. and Cigna Corp. have disclosed in regulatory filings that they plan to keep their foreign profits offshore.

A corporate tax rate of 21 percent does bring the U.S. much closer to its international peers than the old 35 percent rate. But focusing just on the rate can be misleading: The overall amount of taxes paid by U.S. corporations was already pretty low compared to other countries.

The conservative Tax Foundation ranks 35 countries every year based on their tax environments. This year, the U.S. moved up on the international tax competitiveness index, to 24th place from 28th.

Most firms are continuing with business as usual when it comes to their coveted intellectual property since the law’s provisions aren’t enticing enough for them to keep it at home, tax experts who advise large public corporations have said.

Many Republicans rejected the nonpartisan Congressional Budget Office’s estimate that the law would add $1.9 trillion to the federal debt through 2027. They insisted extra economic growth would generate enough revenue to offset the tax cuts. Initial tax receipts suggest the CBO had it right, and other independent experts say the agency may have been too optimistic.

Along with the tax cut, Congress and Trump have approved billions of dollars in new spending. Bloomberg Economics estimates the U.S.’s annual budget deficit will exceed $1 trillion in fiscal 2019, a year earlier than CBO predicts.

The tax cuts probably gave the economy a boost. The question is whether it amounts to a sugar high that will fade with time. The second and third quarters of 2018 were the best back-to-back quarters since 2014, with inflation-adjusted U.S. gross domestic product growing 4.2 percent in the second quarter and 3.5 percent in the third quarter.

But there are signs of slowdown. One estimate, from the Federal Reserve Bank of New York’s GDP Nowcast, pegs fourth-quarter GDP growth at 2.4 percent. Economists surveyed by Bloomberg expect the economy to grow 2.6 percent in 2019.

The tax overhaul eliminated several provisions that have been called loopholes, like a deduction for lobbying expenses and a credit for drugs that treat rare diseases. But special-interest lobbyists still have plenty to celebrate: The law opened up Alaskan Arctic wilderness to drilling, cut excise taxes on alcoholic beverages and was especially friendly to Trump’s home industry, real estate. While the president promised to end the carried interest tax break for investment managers, the law merely requires managers to hold assets for three years—up from one year—to get a lower rate.

Writers of the tax law drew lines between taxpayers, handling various groups in vastly different, contradictory and complex ways. The pass-through break is the clearest example: It means employees can now end up paying higher tax rates than their employers, or than independent contractors working alongside them. It also penalizes business owners who rely on skills and education to do their jobs.

The Internal Revenue Service is issuing hundreds of pages of regulations clarifying how the hastily passed law will be implemented—creating winners and losers in arcane areas like cross-border corporate taxation. The biggest winner of all may be the companies and wealthy individuals who can afford to wade through the law’s complexity—like Trump himself.