A Review on The 2017 Tax Reform

The biggest year-end news is that Congress passes tax reform. I found that the tax statistics cited in many news articles are misleading or incorrect, which motivates me to do an in-depth survey. In this analysis I examined carefully the before-and-after tax reductions for the income tax rates. The massive tax bill reduces the tax rates for almost all income brackets, with the middle class the most reduced. I also point out the news inaccuracy due to the confusion before the statutory tax rate and the effective corporate tax rate. Overall, I conclude the tax bill will enable U.S. corporations to gain the competitive edge over foreign competition. Some economists argue the tax reduction will result in short-term federal budget deficit. However, those economists also agree the long-term stimulative effect. In this article I demonstrate that historically lowering tax rates has increased the federal tax income, both in economic theory and empirical analysis.

The tax reductions benefit the middle class the most

The tax bill benefits the middle class. First, the standard deduction has nearly doubled from $12,700 to $24,000. This will simplify the tax filing for millions of mid-income taxpayers. I then examined carefully the old tax plan and the new tax bill in Figure I. The tax reductions range from 13% to 1% for the low-income to ultra-high-income married taxpayers. The largest reduction applies to the $75,901 - $77,400 bracket. Some news have criticized the tax reform benefits the rich people. In fact, the tax percentages for some high-income range ($400,001 - $416,700) do not decrease but rather increase.

In U.S. the top 1% taxpayers pay 39% of the total income taxes

It is not correct to assert the new tax bill moves U.S. into more income inequality. Remember, in U.S. the top 1% taxpayers already pay 39% of the total income taxes. The table to the right summarizes the share of the federal tax by income level. The top 1 % of the taxpayers paid 39% of all individual income taxes. The top 5 % of the taxpayers paid 60% of the income taxes. Overall, 97% of the taxes come from the top 50% taxpayers. Most economics textbooks report the same statistics on U.S. federal income taxes and income inequality.

What are the statutory tax rate and the effective corporate tax?

The U.S. has the highest top statutory rate (39.1%) among all the G20 countries, reported by the Congressional Budget Office (CBO). The 2017 tax reform cuts the top statutory rate to 20%. But the statutory rate isn't the rate that corporations actually pay. The U.S. corporate tax code, as well as corporate tax codes throughout the worlds, are filled with credits, accelerated depreciations and deductions. After applying various credits and deductions, corporations pay the effective actual corporate tax rate (ATR).

The U.S. average effective tax rate is 29.1%, ranking the third place among the G20 countries. The tax reform will reduce the tax burden on U.S. corporations to be competitive with following countries including Japan, Italy, India, South Korea and France. The U.S. Tax Reform has European large economies worried. Their anxiety is manifested by the article "Germany Loses Out in U.S. Tax Reform" released by Germany's Center for European Economic Research.

U.S. corporations become more competitive

According to the poll of the Heritage Foundation in April 2017, most Americans—58 percent—agree that the corporate tax rate is too high and concern the competitiveness of U.S. corporations. The reduction in the corporate tax puts U.S. corporations in more competitive edge, and is welcome by most of the corporations in the U.S. "Overall, the business community is very pleased with the bill," said Neil Bradley, chief policy officer at the U.S. Chamber of Commerce.

Lowering taxes increases federal tax revenue

Most economics learners know the "Laffer Curve" from Macroeconomics 101. The idea that lowering taxes can raise revenue is not new, but has become popular since the 1980s by the supply-side economics. The argument is that the tax rate is so high that lowering the taxes allows the economy to grow fast enough to generate extra revenue. The "Laffer Curve" was created by the economist Arthur Laffer, who was a member of Reagan's Economic Policy Advisory Board. Lower taxes can stimulate productivity, create new businesses and new investments that otherwise higher taxes do not.

That's all theory. Are there any empirical evidences for lower tax rates and higher taxable federal income? Yes, many empirical studies have confirmed this point. In a significant study on the 1986 tax reform, Feldstein documents the taxable income is very responsible to a reduction in the marginal tax rate. In other words, lower marginal tax rate results in higher taxable income. This study "do tax cuts increase government revenue?" shows there is a very strong negative correlation between the top marginal tax rates and the government revenue in 1931 to 2011. As the tax rates declined, government revenue increased.