Extending Trump-era tax-code overhaul could stick these 6 groups with a big bill

10/05/2024

Many Americans have little experience with tax increases at the federal level. Beginning in the 1980s, Congress has been in the habit of lowering tax rates for individuals and corporations with only brief tax-hike detours during Washington’s occasional bouts of fiscal discipline.

These trends may have run their course as the U.S. confronts rising healthcare costs — which lead to greater spending on health programs and lower tax revenue from heftier business deductions — as well as larger projected outlays for Social Security as the population ages.

Rising healthcare costs and an aging population are nothing new, but a third factor — rising interest rates and the recent inflation that necessitated them — represents a twin problem that hasn’t been faced head-on in more than a generation.

That’s why the looming expiration of much of the 2017 tax-rate reduction enacted under Donald Trump — notably the lower income-tax rates for individuals, whose sunsetting allowed the legislation to pass by a simple majority in the Senate — is such a big deal. In the past, there was always the option of paying for lower taxes with debt. But there is now a reasonable fear that another round of stimulative tax cuts would stoke a politically toxic episode of rising prices.

Video (December 2017): Trump, GOP lawmakers celebrate passage of tax plan

In One Chart (December 2016): How Trump’s tax cuts (and hikes) will impact you, explained in one simple chart

Nevertheless, President Joe Biden and White House predecessor and presumptive November foe Trump both want to make most of the cuts permanent. Biden would extend individual cuts to all but the top 2% of earners, and Trump has said he wants to make the entire package permanent.

“When President Trump is back in the White House, he will advocate for more tax cuts for workers, families and all Americans and reinvigorate America’s energy industry to bring down inflation, lower the cost of living and pay down our debt,” Karoline Leavitt, a Trump campaign spokeswoman, told MarketWatch in a statement.

“The deficit problem is why there’s going to be greater pressure next year to find pay-fors,” Erica York, senior economist and research director at the Tax Foundation told MarketWatch, using a D.C. euphemism for tax hikes and budget cuts.

In other words: It’s time to pay the piper. So who’s going to foot the bill?

Wealthy taxpayers

Republicans have long resisted tax increases of any kind, and Biden, a Democrat, has pledged not to raise taxes on families making less than $400,000, meaning roughly 98% of American taxpayers.

Biden’s recent budget would go after the highest-earning 2% aggressively, proposing to increase the rate paid on every dollar earned above $400,000 to 39.6% from the current 37%; increase the Medicare surcharge tax for those earners from 0.9% to 2.1%; and significantly hike various capital-gains taxes, as well, to name just a few of the proposed budget’s provisions.

All told, Biden wants to tax this group — which comprises 3 million households out of about 130 million total in the U.S. — to the tune of $1.4 trillion over the next 10 years, according to a Tax Foundation analysis.

Large corporations

The large corporations that make up the S&P 500 are in a relatively enviable situation because the 2017 tax overhaul made the corporate-tax cut, from 35% to 21%, permanent.

The measure helped reduce the tax burden for American owners of businesses large and small but was particularly generous — by design, critics said — to the large multinational firms that compose the S&P 500, given their outsized profits.

The median effective tax rate for S&P 500 companies fell from 31.2% in 2017 to just 20% in 2018, according to John Butters, senior earnings analyst at FactSet.

In the first quarter that the new tax law was effective, the changes saved S&P 500 companies $12.8 billion in taxes, according to a 2018 Bloomberg analysis.

The political unpopularity of corporations among swaths of voters, however, means these generous cuts are likely on the table as a means to pay for extending some of the $3.2 trillion in individual tax cuts set to expire after 2025.

Biden has proposed increasing the corporate rate to 28%, and even Republican House Ways and Means Committee Chairman Jason Smith of Missouri said Wednesday that some on his side of the aisle think the corporate rate will have to be raised to get a deal done.

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Pass-through business owners

The 2017 tax-code revamp was a big win for owners of pass-through businesses including partnerships, S corporations and sole proprietorships, which had long paid taxes on their profits as if it were ordinary wages.

Republicans fought for a provision to enable pass-through business owners to deduct up to 20% of their business profits from their taxable income to cut taxes for smaller businesses at the same rate that they were cut for big corporations.

The provision is expensive, however, and more than 50% of the benefits end up accruing to the top 1% of earners.

Even organizations like the Tax Foundation, which advocate for lower taxes, argue that the pass-through deduction distorts the economy by encouraging owners to reclassify their businesses as well as how they distribute profits, draining tax revenues without significantly boosting economic activity.

With a cost of $700 billion over 10 years, allowing this deduction to expire would enable lawmakers to extend more popular and economically sound provisions of the 2017 law.

Stock-market investors

In addition to higher taxes on wealthy earners, Democrats will push hard to boost taxes on a variety of sources of investment income, including taxing capital gains at the same rate as income from labor.

Biden proposed increasing the top capital-gains tax rate to 39.6% from 20% today as well as boosting an excise tax on stock buybacks to 4%.

According to the Penn Wharton Budget Model, this would come close to eliminating the tax advantage of share buybacks relative to dividends and raise $265 billion over 10 years.

For stock-market investors, however, it could dissuade public companies from distributing cash to shareholders and keep it on their balance sheets.

A spike in corporate share buybacks, according to Democrats and other critics, was among the Trump-era tax overhaul’s most salient effects. That, these critics say, suggested the tax cut had done nothing to encourage companies to invest in business expansion or employee hiring.

Social Security and Medicare recipients

Republicans paid a steep political price last decade for advocating cuts to Social Security and Medicare for future recipients, and this has made Trump and other GOP elected officials wary of advocating for reductions in future benefits as a means to put these programs on a more sustainable path.

Current law, however, requires a 21% benefit cut to Social Security in 2033, when the program’s trust fund is projected to become insolvent, and Medicare’s hospital insurance fund is projected to become insolvent in 2036, after which medical benefits to seniors will be curtailed.

Absent tax increases, which Republicans oppose, it’s difficult to see how these programs will be maintained at their current spending levels.

Bondholders and consumers

Given the reluctance to raise taxes or cut benefits, Congress could decide to continue to increase the federal budget deficit.

Henrietta Treyz, director of economic policy at Veda Partners, wrote in a recent note to clients that, no matter what happens in November, Congress and the president will pay for extending some of the 2017 tax cuts with additional deficit spending.

If Trump were to win the White House but Democrats control the House of Representatives, then “deficit increases will likely be orders of magnitude higher than any other electoral outcome,” she wrote, estimating that “deficit increases in the $3.5 trillion range are distinctly possible, and that’s only when we incorporate $2 trillion worth of revenue from across-the-board tariffs.”

She argued that if Biden wins the White House and Republicans hold the House, in which their current majority has dwindled to the extent that Minority Leader Hakeem Jeffries recently said Democrats are operating as if they owned a majority, Republican “efforts at deficit reduction will re-emerge and dominate at least 2025” if not the entirety of Biden’s second term, but still lead to upwards of $1.2 trillion in new debt.

Unified control of government by either party, she said, would fall somewhere in between.

Any additional deficit spending will make it harder for the Fed to lower interest rates, according to an April report from the International Monetary Fund, which argued that America’s budget deficits, unprecedented in a peacetime expansion, are fueling inflation and higher interest rates.

Further deficit spending risks exacerbating these trends, which would hit consumers and holders of U.S. Treasury bonds most.