WASHINGTON – The coming cut in the state and local tax deduction comes with a marriage penalty.
That's what tax experts said Saturday after studying the final language of the tax reform bill that Republicans in Congress plan to pass this week.
And that marriage penalty, they say, is just one of several family-unfriendly elements in a tax package that will, at first, lead to a tax break for most Americans and a 40 percent tax cut for corporations.
Republicans reveled in the fact that they were nearing passage of the most comprehensive tax package in 31 years.
"It means relief for hardworking families and a jumpstart for our economy," said House Speaker Paul S. Ryan, a Wisconsin Republican.
The nonpartisan Tax Policy Center said the measure would mean a tax cut for Americans in all income brackets in 2019, although wealthier Americans will get a proportionally bigger break and the bill's benefits will diminish over time for most Americans.
The outlook is much darker for residents of high-tax states such as New York, for large families and for anyone who thinks these tax cuts will last forever. That's because:
- The bill includes a new $10,000 limit on the deduction of state and local taxes – which will have a huge impact in New York – and that limit is the same for single people and married couples.
- The loss of the personal exemption will hit families with children especially hard, meaning those with more than three children could end up paying higher taxes
- And the tax bill is structured in such a way that families may get a tax break up front, only to pay more over time.
The marriage penalty
Federal figures show that slightly more than a quarter of the taxpayers in Western New York take the so-called "SALT" deduction for state and local taxes. The rest don't itemize their deductions, and even more will stop itemizing under the GOP tax plan, given that it nearly doubles the standard deduction, to $12,000 for singles and to $24,000 for married couples.
But the tax bill also comes with a built-in disadvantage for married couples who, between paying $10,000 in state and local taxes and having other write-offs, will still find it worthwhile to itemize their deductions after the 2018 tax year.
When they do, they'll encounter a marriage penalty.
Why? Because it doesn't matter if your household consists of two highly paid professionals with children or if you're a high-income bachelor: the $10,000 tax write-off cap is the same for the family and the bachelor.
"Why is it fair that a couple can receive a doubling of the standard deduction yet doesn't receive a doubling in the state and local interest deduction?" asked Anthony Ogorek, a Williamsville financial planner.
In practical terms, the change means that proportionately more single New Yorkers likely will continue to itemize their taxes, just because a $10,000 SALT deduction and a few other write-offs will easily get them over the $12,000 standard deduction. Couples, in contrast, would have a much harder time clearing a $24,000 hurdle.
The marriage penalty emerged in the last iteration of the tax bill. Earlier versions restricted the $10,000 deduction to property taxes. But when House-Senate negotiators heeded the wishes of California lawmakers who wanted state income taxes included in the SALT cap, they did so – without making any adjustment for dual-income couples.
"We were glad to protect as many people as possible, whether single or married," said Rep. Tom Reed, a Corning Republican.
Republicans stress that the SALT cap and the marriage penalty will affect very few taxpayers. Reed has been citing three examples of taxpayers in his district who would save under the tax plan: a single filer who would get a $649 tax cut and two families that would get tax cuts of up to $1,699.
But none of the taxpayers in those examples itemize on their returns, meaning the new limits on the SALT deduction would be meaningless to them, noted Anthony S. Illos, who runs B&I Tax Center in Amherst and who has been preparing tax returns for 50 years.
Shown Reed's examples, Illos said: "It is obvious that all three scenarios are cherry-picked."
Personal exemption ending
It's almost impossible to know exactly how the tax bill will affect any one family, because each family's income and deductions differ so much, Illos and other tax experts said.
Generally speaking, though, according to Reed, "If you look at this package in its entirety, the hard-working families in my district are going to get a tax cut."
There will be exceptions who end up paying more, though. And Illos and other tax experts said that any family with more than three children might end up paying more under the Republican tax reform plan.
That's because the bill makes a little-noticed but seismic change in the tax code: eliminating the personal exemption, a longstanding tax break that currently allows taxpayers to reduce their taxable income by $4,050 for each dependent in the family.
Republicans argue that by doubling the standard deduction and boosting the child tax credit from $1,000 to $1,400, the GOP tax plan ends up saving families money even without the personal exemption. (Credits, unlike exemptions, are essentially subtractions from a family's tax bill.)
"It does nothing for big families," said Illos,
Also, Ogorek said, the tax bill eliminates the Affordable Care Act's mandate that all Americans buy health insurance, which means more young, healthy people may choose to go without insurance. That would make the overall pool of people who buy insurance older and sicker, thereby driving up the cost of insurance for everyone else.
Considering the cumulative effect of the tax bill, Ogorek said, "There are people who are definitely going to be negatively affected."
An exploding cigar?
Democrats have long portrayed this year's GOP reform effort as the exploding cigar of tax cuts, one that might seem good at first only to blow up in the face of taxpayers later.
In fact, the personal tax cuts in the bill are designed to blow up. They end in 2025, while the cut in the corporate tax rate from 35 percent to 21 percent is permanent.
Republicans argue that a future Congress can always extend those personal tax cuts. But, considering that the bill is projected to increase the federal deficit by $1.5 trillion over 10 years, Democrats such as Rep. Brian Higgins of Buffalo wonder if any future Congress will ever be able to renew those tax cuts on the personal side.
"They're creating a budget deficit to justify going after Social Security, Medicare and Medicaid," Higgins added.
Republicans argue that the tax cuts will unleash a wave of economic growth that will result in tax revenue growth that will wipe away the projected debt.
While leaving Americans with more money in their pockets, "this legislation will also grow our economy, make our companies of all sizes more competitive, and help prevent more American jobs from continuing to go overseas," said Rep. Kevin Brady of Texas, chairman of the tax-writing Ways and Means Committee.
At the same time, the tax bill is designed to eat away at the very tax cuts it provides people over time.
It does that by changing the inflation measure used to tie income levels to federal tax brackets. Unlike the current tax code, the bill uses a figure called the "chained consumer price index" to calculate inflation. Economists consider it a more accurate measure of increasing costs, but it's also a more conservative one, meaning the income levels tied to each tax bracket will go up more slowly under the reform bill.
Many taxpayers will get an immediate tax break because the bill lowers rates overall, with the top rate cut to 37 percent from the current 39.6 percent and many taxpayers targeted to move into a lower tax bracket.
But because of the way the bill measures inflation, those people who move into a lower bracket now likely will move into a higher bracket sooner as their income rises.
"It's an accounting scheme to push people into a higher level of taxation," Higgins said.
For his part, Reed accentuated the positive.
"Overall, we are simplifying the code and increasing the standard deduction, which will mean tax cuts for hardworking New Yorkers," he said.
Tax experts worry that any such gains will be short-lived.
Ogorek said, "This bill has the potential to be a real Trojan horse," with higher taxes hidden inside.