Old Tax Law Progressive, New Tax Law Progressive
There seems to be a substantial amount of confusion as to what effect the newly enacted Federal Tax bill will have on residents of New York state. The confusion stems from the fact that (i) taxes are complicated, (ii) what people pay in taxes depends on individual circumstances, and (iii) the political rhetoric about the tax bill and its effects has been misleading and in certain cases inaccurate. In order to understand the effects the federal tax legislation will have on New Yorkers, there needs to be a general understanding of how the federal income tax system works. Accordingly, in this column I attempt to provide a simple primer on federal tax law and set forth some of the changes that were enacted at the end of last year. In future columns I will tackle the effects the new tax law will have on New York state as best as can be predicted. Finally, in the future I also plan to discuss proposals being made in Albany in reaction to the new federal tax legislation.
First, it should be noted that individual income taxes are the federal government’s biggest revenue source accounting for over $1.6 trillion dollars or 48% of all federal revenue. Corporate income tax by way of comparison account for approximately 9% of total federal revenue. The remainder of federal government revenue comes from sources such as payroll taxes, excise fees, and estate taxes.
Second, in our country we have a progressive income tax system—that is, those who have higher incomes pay at higher tax rates. The IRS taxes income at different rates at different levels. The rates are set forth in seven different income brackets. For example, under the old law, for someone filing taxes as a single person, their first $9,275 of income was taxed at 10%, earnings over $9,526 up to $37,650 were taxed at 15%, earnings over $37,651 up to $91,150 were taxed at 25% and so on. Earnings over $415,050 were the top income bracket and that income was taxed at a rate of 39.6%. Because of the progressiveness of the tax code, the top 20% of American households pay almost 70% of federal taxes. Interestingly, in 1979 the top 20% shouldered 56% of the federal tax burden—so over the last almost 30 years our income tax system has become more progressive. On the flipside, those on the lower end of the income scale pay little or no income tax. In fact, two-thirds of the almost 66 million tax returns filed by people in the lowest income tier pay no income tax at all. However, they do contribute to federal revenue when you factor in payroll taxes and excise taxes.
Against this backdrop, the new federal tax bill continues to be progressive. It retains the seven income brackets but reduces rates for almost every level of income. While it has been misrepresented by those who oppose the tax bill, under the new law people with the highest incomes will continue to pay the highest income taxes.
If this progressive income tax system was all there was to the federal tax code, we would have a relatively simply system. However, as anyone who pays taxes knows, it is much more complicated because the government has tinkered with the system over the years to encourage certain behaviors from taxpayers. For instance, because the federal government deems home ownership important, it allows taxpayers to deduct mortgage expenses from their federal taxes. Because it believes taxpayers should contribute to charity, it allows for charitable deductions. Under the old law, a taxpayer could either itemize these deductions or take a standard deduction which was $6,500 for a single filer and $13,000 for a joint filer. The new law also allows taxpayers to either itemize or take a standard deduction, but it increases the amount of the standard deduction for a single filer to $12,000 and $24,000 for joint filers. While most Americans take the standard deduction (approximately 70% of taxpayers), high-income taxpayer under the old law tended to itemize their deductions. In one of the most talked about provisions of the new law, the amount of a deduction that taxpayers can take for state and local taxes is capped at $10,000 (under the old law, there was no cap). This provision will likely negatively affect high income earners the most because they are the most likely to itemize their deductions and generally pay the most in state and local taxes.
The new tax bill also increases the child tax credit from $1,000 to $2,000, cuts the corporate tax rate from approximately 35% to 21%, doubles the estate tax exemption in 2018 and eliminates the individual mandate penalty that had been imposed as part of Obamacare. All of these changes will impact individual taxpayers differently based on individual circumstances. And if that doesn’t complicate matters enough, because states tax their citizens in different ways, these changes will have a different effect on citizens of different states. I will discuss that in next week’s column.
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