President Trump has revealed his proposed tax plan, which involves, among other things, cutting the corporate tax rate and reducing tax brackets to three, down from seven.

What do the proposed changes mean? Here Adam Rosenzweig, professor of law at Washington University in St. Louis and expert on federal income tax and international tax law, discusses some of Trump’s proposed changes.
Reduce the number of tax brackets

“The proposal reduces the top individual rate to 35 percent from 39.6 percent and contracts the number of brackets from seven to three. At each bracket there is potentially an incentive for a taxpayer to stop working rather than ‘move up’ a bracket. The evidence is mixed, at best, whether people in fact do stop earning income for this reason. For the same reason, lowering the overall top rate is intended to increase the incentive to earn income at higher amounts, but according to critics, this comes at the expense of progressivity.”

Double the standard deduction

“A double standard deduction would have the effect of significantly increasing the number of taxpayers who pay no federal income tax at all. This has been criticized by a number of people in the past, most notably by Mitt Romney in 2012 with his ‘47 percent’ comment.”

Repeal the alternative minimum tax

“Since Trump’s proposal keeps the mortgage interest deduction and the personal exemption for children, taken together the proposal would most likely harm taxpayers living in high-tax states such as California and New York, while benefiting high-income taxpayers in other states who currently pay alternative minimum tax.”

Repeal the estate and gift tax

“The estate and gift tax represents a small percentage of overall federal revenue, but is one of the only taxes targeted directly at wealth transfer and income inequality.  Proponents of repeal note that the money in the estate has already been subject to income tax, while opponents note the risk of dynastic concentrations of wealth without the tax.”

Reduce the corporate tax rate to 15 percent

“This proposal is aggressively supply-side based, with the theory being that any additional money businesses do not pay in taxes will be invested in productive use, which will lead to job growth.  For example, Treasury Secretary Steven Mnuchin speculated 3 percent annual growth due to this cut in marginal rate.  By contrast, opponents note that any growth would be speculative while revenue loss could be significant and immediate.  Ultimately, the issue comes down to whether one believes that the amount of growth will be sufficient to offset the loss in revenue.”

Introduce a territorial tax

“The United States currently taxes the worldwide income of U.S. persons, including corporations formed under U.S. law, and provides a credit for foreign taxes paid to mitigate so-called ‘double’ tax on cross-border income. A territorial regime only taxes income earned ‘inside’ the United States and exempts income from U.S. tax earned ‘outside’ the United States. As is apparent from this description, a territorial system places pressure on the definition of what is ‘in’ and ‘out’ of the United States for these purposes. Economists criticize this concept as having no meaning, but, that said, most developed countries other than the United States have moved to territorial systems within the last 20 years or so.

“In some ways, this would be a conforming move to match the rest of the world. In other ways, this would be a radical shift in the policy basis underlying U.S. international income taxation. Of note, however, is that both the U.S. worldwide system and the territorial system used in much of the world in practice look quite similar due to the use of anti-abuse rules and other regimes, so perhaps this would be less radical than initially perceived.”

One time tax holiday on unrepatriated earnings

“Under current law, active earnings of U.S. companies earned through foreign subsidiaries are not taxed in the United States until repatriated by a dividend or similar transaction. The result is a vast amount of untaxed income ‘outside’ the United States. A territorial tax would no longer tax foreign earnings when paid back to the United States, so the question is what to do about these ‘old’ foreign earnings.  Exempting the earnings from tax can be seen as a giveaway to the ‘bad’ U.S. companies, while imposing full U.S. tax can be seen as punitive and could prevent the money from being reinvested for productive use in the United States. The proposal could be seen as a compromise between these two positions, offering a low rate for a short period of time as a transition. Critics could see it as a giveaway to corporations that acted in bad faith.”

Professor Rosenzweig is available for media interviews at [email protected].