What defines good tax law? Taxpayers have their own thoughts on this. As a tax professional, I certainly have my own opinions. For researched and broad-reaching direction on this, we can look to a few sources, including the American Institute of CPAs
1. Fair/equitable: Compare the tax returns of two taxpayers with the same income. Would they show the same tax liability? From a fairness standpoint, one could argue they should. If one taxpayer’s income is higher than another’s, does that taxpayer pay more taxes? Again, if the tax rules in place are equitable, one would expect so.
2. Neutral: Ideally, taxes should be neutral, meaning they distort behavior as little as possible. Are tax laws influencing your decision to donate to charity or buy a new home? Are you moving to a new state for tax reasons? If so, these tax laws aren’t neutral.
3. Simple/certain: For most people, the U.S. Tax Code is a foreign language. The concepts of simplicity and certainty assert that taxpayers should be able to easily understand tax rules and apply them consistently. Taxpayers should have a clear idea of how and when a tax is paid. They should have confidence that a tax has been calculated correctly. The more complicated and vague tax laws are, the less certainty taxpayers have that their tax liabilities are accurate.
4. Economically efficient: Effective taxing regimes don’t obstruct economic growth. This concept can be harder than the others to pin down. Whether a tax law is fair, neutral or simple is fairly easy to measure. Just ask your tax advisor! However, whether a new tax law will allow for the economy to “do its thing” must be modeled and, well, guessed. Furthermore, because nothing happens in a vacuum, the historic impact of a particular tax policy may not always be clear either.
This article looks at a few key components of President Donald Trump and former Vice President Joe Biden’s tax positions from the perspective of whether their ideas meet the “good tax law” tests of being fair, neutral, simple and economically efficient. (The
Individual tax rates
Currently, the top tax rate for ordinary income, such as wages, is 37 percent. Biden would like to increase that back to the pre-2018 rate of
Biden’s plan prioritizes fairness. It justifies a rate hike for high income earners based on their ability to pay. This can distort behavior, however, as those in the top tax bracket look for other ways to lower their tax bills. As we don’t have much detail for Trump’s ideas on this, moving more taxpayers into lower brackets may or may not demonstrate fairness depending on how “middle-income” is defined.
Capital gains
Under current law, certain dividends and long-term capital gains from investments held for more than one year are taxed at lower rates than ordinary income. The top tax rate for long-term capital gains is 23.8 percent when including the net investment income tax. Trump has
For many, Trump’s ideas seem unfair because they can result in situations in which a taxpayer with higher investment-related income is paying less federal taxes than a taxpayer with lower non-investment income, such as wages. Biden’s plan tries to address this, at least with high income earners, touching on the good tax law components of neutrality and simplicity. However, it’s important to note the original intention of taxing this type of income at lower levels, dividends at least, is because this income has already been taxed at the corporate level before it makes its way to shareholders. In other words, the lower rate
Itemized deductions
The Tax Cuts and Jobs Act of 2017 significantly increased the standard deduction while limiting certain itemized deductions. These changes are currently scheduled to expire at the end of 2025. If re-elected, Trump would like to make them permanent. Under Biden’s tax plan, the value of itemized deductions would be capped at 28 percent for taxpayers with incomes over $400,000.
The increased standard deduction was a step toward a simpler tax system. It eliminated the need for many taxpayers to calculate various itemized deductions. On the other hand, many individuals with large mortgages and significant charitable giving continue to benefit from itemizing their deductions. In other words, with the standard deduction so much higher, continuing to keep itemized deductions in the Tax Code disproportionately benefits those who have higher levels of deductions to itemize. Between pre-TCJA law and TCJA, the percentage of individuals itemizing their deductions dropped from
Child tax credit
Under current federal tax law, a $2,000 child tax credit for children under age 17, plus a $500 credit for certain other dependents, are available for many taxpayers. Biden
Some argue that the child tax credit is unfair since it treats taxpayers with children differently than those without children. From that perspective, Biden’s plan would be lower on the fairness scale. However, note that this credit is a
Deduction for pass-through income
If you own a pass-through business such as a partnership or S corporation, you may benefit from the 20 percent qualified business income (QBI) deduction that was part of the TCJA. This deduction is set to expire at the end of 2025 along with other components of the TCJA. Trump’s plans regarding the deduction aren’t clear at this time. Biden would like to
The qualified business income deduction is one of the more complicated provisions of U.S. tax law, and its various limitations make it challenging for taxpayers to predict what their deduction will be. For the most part, it does not meet the good tax policy component of certainty/simplicity. Also, it does not treat businesses in different industries equally and treats business owners differently from employees in the same line of work. For these and other reasons, the QBI deduction is neither fair nor neutral. Although Biden’s plan of phasing out the deduction for certain high earners could possibly increase fairness, doing so would add yet another component to calculating an already confusing deduction.
Payroll taxes
In an August 2020
Because of this wage cap, Social Security taxes are regressive. In the tax world, regressive means that the more money you make or have, the less percentage of your income or wealth is spent on the tax. To illustrate, someone who is under the Social Security wage threshold earning $30,000 per year will pay about $1,900 of Social Security tax while someone overthe Social Security wage who makes $300,000 will pay about $8,500 of Social Security tax. The first person pays a little over 6 percent of their earnings in Social Security taxes while the second person pays a little less than 3 percent of their earnings in Social Security taxes. We see a similar situation with some consumption-based taxes, such as sales taxes. Compare a low-earning family to a high-earning family of the same size and their grocery bills are likely to be about the same. However, the percentage of sales tax the low-earning family pays relative to their earnings will be higher than the high-earning family.
As you can see, regressive taxes such as Social Security taxes impact lower-earning taxpayers more than higher-earning taxpayers, and thus run counter to the sound tax policy principle of fairness. In theory, Trump’s payroll tax deferral was a way to temporarily make the payroll tax somewhat less regressive, as the deferral only applied to individuals earning around less than $100,000 per year. To be effective, however, the deferral would need to become permanent, which would take congressional approval. Without such an agreement, workers deferring their taxes now will pay back the deferred taxes in 2021, which not only brings back the regressive nature of the tax but puts such individuals in a tough cash flow position. Further, if this move was meant to provide greater economic momentum by putting more cash into workers’ wallets, it doesn’t address those without jobs. The
Biden’s proposal takes a different, more permanent, approach to making payroll taxes less regressive and more equitable. His stance improves the certainty aspect of payroll tax adjustments from a temporary deferral but could generate other issues as higher-earning workers and business owners adjust for a potentially significant hit to their earned income. In addition to the tax side of this, we must also consider how adjustments to Social Security tax withholdings impact the solvency of the Social Security system itself.
Corporate taxes
Currently, C corporations are taxed at a flat rate of 21 percent. Before the Tax Cuts and Jobs Act of 2017, C corporation tax rates ranged from 15 percent to 35 percent. Trump has stated that he prefers a
Biden’s proposal is primarily motivated by fairness. Many U.S. taxpayers are concerned that large corporations aren’t paying their “fair share.” While understandable, this position ignores the belief among many tax and economic policy experts that a significant portion of corporate taxes are ultimately paid by workers, shareholders, and consumers as opposed to companies themselves. For example, the Council of Economic Advisors — the agency within the executive branch that advises the president on economic policy — published a
There you have it: the Republican and Democratic candidates’ ideas on several key tax issues. So, who makes the grade? While I’ll leave it up to you to make that call for yourself, here are some general observations:
- Neither candidate has put forth a detailed, formal tax plan. As a tax professional, I would certainly appreciate that.
- Understanding the impact of changes to tax law can be challenging and potentially impossible. As I’ve said earlier, nothing happens in a vacuum.
- Overall, Biden’s ideas concentrate on being fair/equitable, while Trump’s plans are more focused on encouraging economic growth — hardly surprising given their party allegiances. As a tax advisor who’s helped clients navigate numerous convoluted and vague changes to tax law over the years, I would like to see tax platforms that focus on neutrality and simplicity.
Although tax policy won’t be the only thing on your mind as you cast your ballot, it probably will play an important role. If you have any questions about the candidates’ tax positions, please don’t hesitate to reach out.