Middle Class Miracle? Or Repaying the Donors? Whose Side is Your Congress On?

The house tax bill labeled by the president of the United states the, “middle class miracle”, or my favorite cut cut cut, cleared the Ways and Means Committee this week. However, the question remains, whose taxes will be cut? If the house bill were to pass today, as is, there would be marginal increases and decreases to how your taxable income is calculated, and in turn a marginal change in how much tax you pay. In the following article I will discuss in detail how a few of those items actually impact you, and how the numbers really work.

Before we talk about the miracle, lets briefly go over how your taxes are calculated. Starting with all of the income you earned during the year, for most people this includes, your W-2 wages, interest and dividends, for some it also includes business income. This is income earned as a sole proprietor, or from a business that you formed as a partnership, LLC or S-corporation. These are forms of “flow-through” income, you’ve likely heard this term lately. This simply means that the income from these forms of entities “flow-through” to your individual tax return rather than being taxed separately, as in a corporation. After calculating the amount of gross income earned, you then reduce this amount by various deductions, starting with personal exemptions, then EITHER your standard deduction OR your itemized deductions, whichever is higher. The resulting number is your taxable income which is multiplied by a blended tax rate, resulting in your tax. Your tax is then reduced by credits, including the child tax credit, you then factor in how much you paid during the year through withholding or estimated tax payments and voila, tax due or refund.

So, starting with this framework, one of the biggest impacts from the Middle Class Miracle, will be the loss of your personal exemptions. Personal exemptions are a deduction that reduces your gross income. For 2016, you likely deducted $4,050 for each person in your family (whom you claimed as a dependent). So, a family of 4 received deductions for exemptions from their gross income of $16,200. If your taxable income was in the 25% marginal rate (taxable income starting at $75K for married couples), then this reduced your tax by $4,050, if you pay state taxes which normally start with federal taxable income, then you will lose that deduction for state tax purposes as well. In the great state of Colorado where we pay a ~5% tax rate it will cost us an additional $810 (16,200 x 5%). The loss of personal exemptions will be a significant negative impact on almost everyone the files an individual tax return. The miracle is looking a little less mliracleish…

Another issue is the interplay between the standard deduction and itemized deductions, as I mentioned previously you get the higher of the two. In my opinion the press has blown it on discussing this issue, probably because it’s a little complicated. Under the proposed bill you would receive an enhanced standard deduction, roughly double the current standard deduction. For people that don’t have enough deductions to itemize, and therefore use the standard deduction, the enhanced standard deduction may be a great thing. However, for those of us that currently have enough deductions to itemize it gets complicated. For example, hypothetically lets say you’re married and have a house in a quiet suburb in any state that has a personal income tax (most states). Lets say together you and your spouse make about $100K a year and pay state income tax of 5%, or $5K. you pay a perfectly average amount of mortgage interest on your home of about $15K per year, and your property taxes are $2K per year. So, your itemized deductions are are roughly (15+5+2) $22K per year. This means under current law you reduce your taxable income by you itemized deductions of $22K, and you therefore do not use the standard deduction. Under the proposed bill, you would lose your state income tax deduction, but it doesn’t matter because the enhanced standard deduction is $24K for married couples. So, the enhanced standard deduction results in a $24K deduction under the proposed bill rather than a $22K deduction under current law. As you see, it is very dependent upon your individual situation whether or not the middle class miracle is a net small gain or a net small loss. Factor in the loss of exemptions above and the miracle’s looking grim.

The final item that I’m going to discuss here is the reduced number of tax brackets. Below I’ve calculated this change at a variety of income levels up to $200K. As you move into higher income levels the trend continues, the higher the income level the larger the tax cut. However, keep in mind the impact from the loss of personal exemptions and the increase or decrease from he standard deduction, and frankly for families making $200K or less, for all the talk, this just doesn’t impact most families much.

Taxable Income 100,000 150,000 200,000
Current 16,478 28,978 42,884
Proposed 13,300 25,800 38,300
Change 3,178 3,178 4,584
Current 20,982 34,982 49,399
Proposed 19,150 31,650 44,150
Change 1,832 3,332 5,249

Bottom line, the proposed tax bill is NOT a middle class tax cut, some will pay more, some will pay less. It’s certainly not a middle class miracle. This bill will increase the national debt by roughly 1.5 Trillion dollars over the next 10 years. Nearly the entire benefit of which will go to large corporations and high net worth families. But, we the people will pay for it through higher inflation as deficits pile up. Deficits by the way are now paid for through increasing the money supply, devaluing your current assets. look for my next post where I will go into a detailed discussion of the economics of wealth redistribution from the middle class to the wealthy. Also, please read my prior post, for a discussion on wealth inequality which will be significantly enhanced by the proposed tax bill. Which, I believe is the true goal of this bill.

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