November 9, 2017

The House Ways and Means Committee approved legislation (HR 1) to overhaul the nation’s tax code. At the heart of the Republican tax plan, known as the Tax Cuts and Jobs Act, is a proposal to shrink the current seven tax brackets into four – 12 percent, 25 percent, 35 percent, and 39.6 percent. (See the chart below for a comparison of the income thresholds for each of the marginal tax brackets).

CSAC and several partners issued a joint statement today detailing many of the problems with the current tax overhaul plan. 

Of additional note, income levels for each bracket are currently indexed annually based on increases in the Consumer Price Index (CPI). Pursuant to HR 1, the new income levels would be indexed for chained CPI, which is a slightly different measure of inflation. While a number of economists consider the chained CPI to be more accurate, it generally results in lower estimates of inflation than traditional CPI.

In addition, the measure would nearly double the standard deduction and expand the Child Tax Credit. However, it also proposes to eliminate the personal exemption, which is currently valued at $4,050 per person. Furthermore, in an effort to simplify the code and increase revenues, HR 1 would eliminate or cap a number of tax deductions and credits.

With regard to businesses, the measure would reduce the corporate tax rate from 35 percent to 20 percent. While there was some discussion about phasing in the cut or making it temporary, the legislation would immediately and permanently lower the rate. However, negotiators could still seek changes to this provision to bring down the overall cost of the package. In addition, the House GOP proposal would lower the tax rate to 25 percent on small businesses that file as individuals (often referred to as “pass through” businesses). The legislation includes several guardrails to ensure that wealthy individuals do not unfairly game the system to take advantage of this change.

The reaction to the proposal on Capitol Hill was very much as expected. House Republicans generally praised the bill for providing tax relief for middle-class families and businesses, while Democrats have criticized the measure for adding to the national debt, disproportionately benefiting the wealthy, and being drafted without their input. Democrats were also critical of the hurried pace, as well as the budget reconciliation process that GOP leaders will utilize to advance the legislation.

The budget instructions for the tax overhaul allow the measure to increase the deficit by $1.5 trillion over the next decade. As initially drafted, the nonpartisan Joint Committee on Taxation estimates that the House bill would increase the deficit by $1.4 trillion over the ten-year budget window. However, an amended version of the bill is now projected to increase budget deficits by $1.7 trillion. Therefore, GOP leaders may need to identify additional revenue sources before moving forward. For the most part, Republicans, while cautious about adding to the growing national debt, believe that increased economic growth will ultimately offset any static revenue losses.

Across Capitol Hill, Senate Republicans are poised to unveil their own tax plan this week. Like its House counterpart, the Senate measure will largely adhere to the tax framework that President Trump and GOP leaders released in September. However, it is also expected to include some distinct differences. For starters, the Senate proposal will likely increase the size of the child tax credit even further and could also include changes to the tax rates for both individuals and businesses. It is also expected to delay a cut in the corporate tax rate until 2019. As of this writing, a number of key details are still being finalized.

Both chambers of Congress intend to move quickly on their respective bills, aiming to send a final bill to the president’s desk by Christmas. The full House chamber is expected to consider HR 1 next week, while the Senate tax writing committee could begin consideration of its proposal as early as November 13. As the bill moves through the legislative process, House GOP leaders can only afford to lose 22 votes and still pass the bill without Democratic support. In the Senate, the budget reconciliation process allows Republicans to clear a tax-code rewrite with a simple majority vote, rather than the 60 votes that are typically required to pass most legislation. Senate Republicans can only afford to lose two votes on their side of the aisle, unless they receive some support from Democrats. Another key consideration is that each chamber must ultimately agree on the same package before taking a final vote.

Below are several key provisions that would negatively impact California’s counties:

State and Local Tax Deduction

Under current law, taxpayers can deduct their state and local property taxes, as well as their state income taxes or sales tax. This benefit, which has been in place since 1913, provides counties with some measure of autonomy over their own tax systems and also incentivizes local investment in long-term infrastructure projects and various county services. The proposed House bill would eliminate the deduction for income and sales taxes, and would cap the deduction for property taxes at $10,000. It should be noted that corporations would still be able to fully claim the SALT deduction.

California has the highest top income tax rate in the nation, but it also has one of the lowest personal property tax rates. Therefore, the loss of the SALT deduction would be particularly detrimental to taxpayers in the Golden State, where more than 5 million households were able to deduct nearly $80 million for local income taxes in 2015. In fact, the average deduction for state and local income taxes alone is nearly $16,000 per return, while state and local property taxes average less than $6,000 per return. Furthermore, 79 percent of California taxpayers who received a benefit from the state and local income tax deduction were families earning less than $200,000 in annual household income.

During committee consideration, Congressman Bill Pascrell (D-NJ) offered an amendment that would have fully restored the SALT deduction, but the amendment failed on a straight party line vote. In an effort to provide equity between the individual and business side of the tax code, Congressman Ron Kind (D-WI) introduced an amendment that would repeal the SALT deduction for businesses. However, the Kind amendment was also defeated.

The partial elimination of SALT has emerged as a key sticking point during negotiations, particularly for Republicans from higher-tax states. In fact, Several GOP lawmakers, primarily those from New York and New Jersey, have even threatened to oppose the bill on the House floor unless the bill is amended. Up until now, Republican members of the California congressional delegation have largely remained quiet on the issue. However, Congressman Darrell Issa (R-CA) was the first to break his silence and declare that he would vote no on the current tax reform package, citing concerns about SALT.

Municipal Bonds

Municipal bonds are the single most important tool for financing public capital improvements and critical infrastructure projects such as roads, bridges, schools and hospitals. Under current law, investors are not required to pay federal income tax on interest earned from most bonds issued by state and local governments. The effect of this tax exemption is that local governments receive a lower interest rate on their borrowing than they would if their interest was taxable to investors. As the nation’s largest issuer of municipal bonds, any changes to the tax exemption would have a disproportionate impact on local governments in California.

The tax reform package would generally retain the tax exemption for municipal bond interest, but it would eliminate the exemption for bonds used to finance professional sports stadiums. While this would only apply to a small number of counties, the larger concern is that changing the scope of tax-exempt municipal bonds opens the door to future changes that could further restrict which projects can be supported by municipal bonds.

Advance Refunding Bonds

Under current law, advance refunding allows counties to refinance outstanding bonds to take advantage of better terms and rates. Additionally, counties are only able to engage in a tax-exempt advance refunding once over the life of the bond. However, the House GOP tax plan would eliminate the tax exemption for advance refunding bonds. Alabama Democratic Representative Terri Sewell offered an amendment to restore the exemption, but it was defeated along party lines.

Private Activity Bonds

Private Activity Bonds (PAB) are widely used to attract private investment for projects that have some public benefit. Under current law, the interest earned on PABs is tax exempt. However, HR 1 would eliminate the exemption on newly issued PABs. An amendment offered by Representative Bill Pascrell (D-NJ) to preserve the exemption was not adopted.

Disaster Deduction

Under current law, individuals and businesses can claim casualty losses on personal property as itemized deductions. Casualty losses can occur as a result of natural disasters, which includes wildfires, earthquakes, and floods, among other things. The House bill would eliminate the deduction for personal losses from wildfires, earthquakes and other natural disasters, but it would preserve the benefit for victims of recent hurricanes. Representative Bill Pascrell (D-NJ) offered an amendment that would preserve the tax benefit for all victims of natural disasters, but it was defeated along party lines.

Mortgage Interest Deduction

Under current law, homeowners can deduct up to $1 million in mortgage interest. HR 1 would retain the deduction for existing mortgages, but it would reduce the cap to $500,000 for future home purchases. It also would eliminate the deduction for a second home. This would be a significant blow to California homeowners, as mortgages throughout the state routinely exceed the proposed $500,000 threshold. It should also be noted that the $500,000 threshold is not indexed to inflation, so as home prices rise, more and more homes will not fall under the cap.

Charitable Deduction

Under current law, taxpayers who itemize their returns may deduct their charitable contributions from their federally taxable income. While HR 1 would largely keep the charitable deduction intact, the JCT estimates that the number of itemizers would be substantially reduced, which could ultimately create a disincentive for giving. A projected decline in public giving for charitable services could increase demand and costs for county government services.

Estate Tax

Under current law, the estate tax applies to assets, mostly real estate and stocks, passed on after death following a $5.5 million exemption per individual ($11 million exemption per couple). This means that the first $5.5 million of assets is not subject to a tax, but everything above that level would incur a 40 percent tax. HR 1 would immediately double the exemption to $11 million per individual ($22 million per couple), until the estate tax is completely repealed in 2024.

Adoption Tax Credit

Under current law, taxpayers can claim an adoption credit of as much as $13,750 per eligible child. The House bill calls for full repeal of the adoption credit. An amendment offered by Representative Danny Davis (D-IL) to reinstate the Adoption Tax Credit was defeated along party lines. However, a manager’s amendment sponsored by Chairman Brady included a provision to reinstate the credit.

Medical Expense Deduction

Under current law, medical expenses that exceed 10 percent of an individual’s adjusted gross income (AGI) may be deducted from federal taxes. This deduction assists filers with significant out-of-pocket medical costs, including nursing home care, long term care insurance premiums, and other medical bills.The GOP tax proposal would eliminate this deduction, which could potentially shift costs from private insurers to public sector programs like Medicaid, emergency room care and uncompensated care in county-owned nursing homes. Congressman John Larson (D-CT) offered an amendment that would have restored the medical expense deduction, but it was defeated along party lines.

Cadillac Tax

The Affordable Care Act (ACA) levied a 40 percent excise tax on high-cost employer-sponsored health coverage. However, given widespread opposition to the tax, Congress delayed its implementation to 2020. Prior to the release of HR 1, there were rumors that House Republicans would further delay, or possibly repeal, the Cadillac Tax. However, the legislation does not currently address the Cadillac Tax in any manner. For her part, Representative Suzan DelBene (D-WA) offered an amendment to repeal the tax, but it was rejected by a vote of 16 yeas to 24 nays.

We hope this information is useful to you. Please do not hesitate to contact us if you have any questions.