By Robert Duquette, CPA

This is part two of a five-part blog series analyzing what was promised when the Tax Cuts and Jobs Act (TCJA) was enacted compared with what has actually happened to date. To make your reading and consumption of all this information easier, this analysis covers 13 topics and is presented in five separate blogs.

In my previous blog I covered …

• Protecting American jobs
• Making taxes fairer
• Making taxes simpler

In this blog I address …

• Making individual tax rates lower
• Tax relief for small businesses so they can better compete
• Tax relief for multinational businesses so they can better compete

Each issue will be reviewed with independent data, and I will conclude with my own personal verdict and opinion (not that of the PICPA) as to whether that goal was achieved and if the TCJA has been successful so far.

Make Individual Tax Rates Lower (Especially for middle class taxpayers)

As discussed in part 1 of this analysis, the TCJA did cut the average individual tax rate two to three points for most income brackets, doubled everyone’s standard deduction, doubled the child tax credit, raised the threshold before alternative minimum tax (AMT) is triggered, and provided a 20% exemption on most pass-through income. But it also eliminated personal exemptions, many adjusted gross income (AGI) factors, and several itemized deductions, and capped state and local deductions. As a result, most Americans’ tax bills were scheduled to decrease, but it was not planned to be as dramatic as the rate cuts suggested. Many taxpayers, in fact, found themselves with higher tax liabilities due to the cap on certain itemized deductions.

The Tax Policy Center (TPC) originally predicted, after all TCJA provisions were considered: “In general, higher income households would receive larger average tax cuts as a percentage of after-tax income, with the largest cuts as a share of income going to taxpayers in the 95th to 99th percentiles of the income distribution,” and “In total, for 2018, the average tax cut would be $1,600, with 80% of taxpayers receiving a tax cut averaging $2,100, but with 5% experiencing a tax increase averaging $2,800.” Here is what TPC expected by income group:

• Taxes would decline on average across all income groups.
• Taxpayers in the bottom quintile (those with income less than $25,000) would see an average tax cut of $60 (or 0.4%) of after-tax income.
• Taxpayers in the middle income quintile (those with income between about $49,000 and $86,000) would receive an average tax cut of about $900 (or 1.6%) of after-tax income.
• Taxpayers in the 95th to 99th income percentiles (those with income between about $308,000 and $733,000) would benefit the most as a share of after-tax income, with an average tax cut of about $13,500 (or 4.1%) of after-tax income.
• Taxpayers in the top 1% of income distribution (those with income more than $733,000) would receive an average cut of $51,000 (or 3.4%) of after-tax income.

IRS preliminary data for the 2018 tax return filing season for returns filed through May (after about 90% of returns have been filed, representing about 80% of taxable income) provides a sense of what actually happened:

• Aggregate total individual tax receipts came down about 6% from 2017 returns filed through the same period (May 2018) – $1,049 trillion and $1,114 trillion, respectively.
• The average tax per return (before payments) for 2018 (with or without any tax owed before payments) came down about 6% compared with 2017 returns filed through the same period – $7,780 and $ $8,304, respectively.
• The aggregate tax receipts as a percentage of aggregate AGI reported on 2018 returns filed through May 2019 came down 1.4 percentage points compared with 2017 returns filed through the same period – 11.9% of AGI for 2018 returns and 13.3% of AGI for 2017 returns).
• The average tax per return (before payments) for all 2018 returns filed through May that showed tax owed before payments came down by only $250 (or 2.3%) compared with 2017 returns filed through the same period – $10,684 and $10,934, respectively.
• The average tax (before payments) for taxpayers in the middle quintile ($50,000 to $100,000 of AGI) dropped $963 (or 13.7%) for 2018 returns filed through May 2019 compared with 2017 returns for the same period for an average tax of $6,044 on 2018 returns vs. $7,007 on 2017 returns.
• The average tax before payments for taxpayers in the lowest quintile ($1 to $25,000 of AGI) appears to have dropped only $6 for 2018 filings through May 2019 (less than 1%) when compared to 2017 returns of the same period: average tax of $890 for 2018 vs. $896 for 2017). When the lowest quintile for 2018 return filings through May 2019 was compared to all 2017 returns filed in this group through October 2018 (after extensions), the average 2017 tax for the group was actually $926, which would suggest the average 2018 tax for this group will fall by about $36 in the end. (This comparison still excludes the as yet unknown impact of potentially millions of lowest quintile taxpayers who filed a 2017 tax return but who no longer have to file.)
• Reliable data regarding the top 1% or top 20% for 2018 is not yet available due to the fact that most of the tax returns from these top income groups are under extension through October 2019. This could also impact the preliminary results for all quintile groups referenced above.

The above discussion regarding how much tax savings individuals experienced in 2018 as a result of tax reform ignores any offsetting impact of newly enacted and pending tariffs. Several nonpartisan authorities, such as Penn-Wharton and the Tax Foundation, estimate that over the next 10 years, the effect of tariffs will consume a significant portion of the tax savings as a best case, to almost all or more than the savings as a worst case. This was corroborated by the Federal Reserve Bank of New York in a May 2019 report, which estimated the total annual 2018 household cost of the current 10% tariffs on Chinese goods, ignoring other countries, was as high as $400. This could double to $800 per year if a proposed additional 15% on Chinese goods is enacted.

Make Taxes Lower Goal Achieved?

Yes. Every taxpayer knows the statutory rates were cut as well as the effective rate on pass-through business income of most taxpayers. However, the expected average savings may not come in as high as originally promised for many taxpayers due to other provisions that broadened the base of taxable income, and for some taxpayers, their taxes actually increased. Of course, any savings from tax reform is at risk of being offset by tariff costs that will be passed on to consumers. (Tariffs placed on products from a country of origin are not paid by that country. They are paid by the purchaser.)

Tax Relief for Small Businesses (So they can compete with larger ones)

As discussed in part 1, the TCJA simplified small-business taxation. It expands qualifying small businesses’ ability to use simpler accounting methods; allows 100% immediate expensing on all new or used machinery and equipment; reduces the C corporation rate from 35% to 21% (applicable to all businesses, regardless of size); and adds a new deduction of up to 20% of qualifying pass-through business income, lowering the effective rate on such income down to as low as 29.6%.

Tax Relief for Small Businesses Goal Achieved?

Yes.

Tax Relief for Multinational Businesses (So they can better compete with foreign ones)

The cut in the C corporation rate from 35% to 21% is a huge benefit to C corporations, as is the low-to-zero rate on offshore income earned. As a result, the new U.S. combined federal and state income tax burden after the TCJA has fallen from about 40% – highest among countries in the Organisation for Economic Co-operation and Development (OECD) and third-highest in the world – to about 25%. Compare this to the average statutory national and provincial rate for OECD countries of 28% (weighted for GDP), or 25% (nonweighted for GDP). The United States is no longer the highest in the OECD, but it is yet to be seen what impact this new rate will have in the long term as long as several developed countries still have a rate lower than the United States.

The effective tax rate – what is actually paid after using all available subsidies, credits, and loopholes in the code – is something else altogether. As a benchmark of what the effective rate was prior to the TCJA, a 2017 Congressional Budget Office (CBO) study found that the 2012 U.S. corporate marginal effective tax rate (federal and state rates on new investments) was only about 19%. It has been argued that this low rate shows that the United States’ high statutory rates among OECD countries was not that much of a true disadvantage after considering all the loopholes. However, the same study concluded that the 19% marginal effective rate was still fourth highest among the G20 countries because they too have built-in subsidies and “loopholes” that serve to lower statutory rates.

More recently, the Congressional Research Service (CRS) reported that the C corporation effective federal tax rate for 2017, the year before tax reform, was 17.2%. It turned out, based on Securities and Exchange Commission (SEC) filings for 2018, the effective C corporation federal rate came in at just 8.8%. Even when CRS backed out an estimate for foreign income, it calculated an effective U.S. federal tax rate of 23.4% for 2017 and 12.1% for 2018. This is almost a 50% decline in the effective rate, despite the statutory rate being cut by 40% and other base-broadening measures put in place to prevent this.

Readers may have come across the headline this past April, “Not Just Amazon: 60 Big Companies Paid $0 in Taxes under Trump Law.” According to this story in Yahoo Finance, which based its story on data from Fortune 500 public filings as reported by the Institute on Taxation and Economic Policy (ITEP), “In 2017, the effective corporate tax rate (for Fortune 500 companies) was 13.6%. In 2018, corporations paid just 7% of their profits as federal taxes. That’s the lowest effective tax rate since at least 1947.”

A separate analysis conducted by the Wall Street Journal published in July 2019 discovered that the median effective global tax rate for S&P 500 companies declined to 19.8% in the first quarter of 2019, compared with 25.5% two years earlier, and it was the third consecutive quarter below 20%. Although this reflects a higher effective rate than the other studies, it still represents an even lower rate than 21%.

This appears to have happened for several reasons. The TCJA continued many of the subsidies and loopholes that existed before tax reform (including base erosion loopholes, deductibility of stock options, 50% bonus expensing, and accelerated depreciation); it created additional subsidies, such as eliminating U.S. federal taxes on most post-2017 foreign profits; it increased bonus expensing to 100% and expanded it to include used personal property; and it provided for a low-to-no U.S. tax on foreign profits.

Therefore, it should not be a surprise that, according to the Peter G. Peterson Foundation, corporate tax receipts fell 31% in 2018, from $297 billion in fiscal year 2017 to $205 billion in fiscal year 2018, using U.S. Treasury available data. This data was also corroborated by the CRS.

Multinational Tax Relief Goal Achieved?

Yes, both from a statutory (stated) rate perspective and an effective rate perspective after continuing to take advantage of built-in subsidies and loopholes.

In my next blog, I continue with discussions on the TCJA goals of …

• Businesses to share tax savings with workers through increased wages
• Allow unprecedented capital expensing to stimulate new investment
• Establish more permanence in our tax code

In subsequent blogs I will cover the following:

• Encourage companies to bring back jobs from overseas
• Discourage inversions
• Encourage companies to repatriate about $3 trillion in profits “trapped” overseas
• Stimulate additional economic growth so tax cuts pay for themselves over the long term

Robert Duquette, CPA, is Professor of Practice in the College of Business at Lehigh University, a member of the Griffin/Stevens & Lee Tax and Consulting Network, and a retired EY tax partner. He has served on PICPA’s Federal Taxation Committee for over 25 years, focusing on federal tax reform and the national debt.

Sign up for weekly professional and technical updates in PICPA's blogs, podcasts, and discussion board topics by completing the form here.