By Anthony Michael
Since taking office in November, tax reform has been a top legislative item for the Trump administration. After missing out on repealing and replacing the Affordable Care Act, the administration does not want to miss its chance to make lasting change to the current tax system. Using details released during the presidential campaign, along with additional details provided by the White House in April, AE has examined the effects of the administration’s proposed tax reform on households in Texas. There are numerous provisions that will impact businesses in Texas, but these provisions have been excluded from this analysis. However, stay tuned as they will be analyzed at a later date.
To understand its effects, AE examined the Trump administration’s proposal from three different perspectives. The first two perspective include the proposal’s fiscal impact to household tax bills, and the subsequent economic impact of these changes to after tax income. These two perspectives are related to one another, since changes tax bills will subsequently alter household spending habits on goods and services throughout the economy.
Additionally, AE examined the impact that the proposal will have on home buying in Texas – an economic activity that is incentivized in the current tax system and under the Trump administration’s proposal. Given the likely provisions included in the proposal, tax incentives for home buying will be less accessible for households in the medium and low-income brackets.
The Need for Tax Reform
Before digging into the weeds of the administration’s tax reform proposal, it’s worth noting that tax reform is something that has plenty of bipartisan support. Of course, the means in which tax reform is achieved will be hotly contested, but both republicans and democrats agree that our current system is in desperate need of an update. Currently, our federal tax code is over 75,000 pages long – which is three times larger than it was 40 years ago. Having a long and complicated tax system subsequently created many negative and unintended economic consequences for our country.
First, the complicated nature of our tax code has fostered a system of avoidance and evasion. Each year, billions of dollars are lost to fraudulent tax returns. Businesses and households regularly file fraudulent tax returns, hide income in tax havens, and create shell companies to take advantage of various tax loop hole incentives. To add insult to injury, the government spends incredible amounts of money to enforce and investigate tax fraud – a bill that is ultimately paid by tax payers.
Second, our complicated tax code undermines what should be simple financial decisions for businesses and households. The federal tax code complicates decisions related to life events such as retirement, home buying, and paying for education due to the numerous credits and deductions associated with each.
Finally, the tax code fosters a system of “horizontal inequality” – or a system in which two seemingly identical households can pay different amounts in taxes due to the numerous circumstances that alter tax bills. For example, homeowners may have significantly lighter tax burdens than renter’s due to deductions that can be taken for home mortgage interest, even though they may earn the same exact salary.
Altogether, it shouldn’t come as a surprise that 59% of Americans believe that the tax code is in need of a complete change. Eager to take advantage of this popular sentiment, the Trump administration released its tax reform proposal on April 20th. Although the proposal is light on details, it takes a clear approach: simplify the tax code, lighten tax burdens, and widen the tax base.
To estimate the impact of this proposal on the state of Texas, AE has analyzed the following provisions that are related to household tax returns:
Tax Relief Provisions:
- Consolidate income tax rates to 10%, 25%, and 35%
- Double the standard deduction
- Repeal the alternative minimum tax
Federal Revenue Raising Provisions
- Repeal all itemized deductions except for the home mortgage interest deduction and deductions for charitable contributions
- Repeal the head of household filing status
- Repeal personal exemptions
In total, Texas households will save roughly $830.4 million annually should the reform become law. Below is a detailed breakdown of the net impacts of the Trump administration’s proposal on the state of Texas.
Tax Proposal Net Impacts by Provision
Net Tax Impact
Tax Relief Provision 1: Consolidate Income Tax Rates
Tax Relief Provision 2: Double the Standard Deduction
Tax Relief Provision 3: Repeal the Alternative Minimum Tax
Revenue Raising Provision 1: Repeal Select Itemized Deductions
Revenue Raising Provision 2: Remove Head of Household Filing Status
Revenue Raising Provision 3: Repeal Personal Exemptions
Net Tax Impact
While these provisions will provide net tax relief across the entire state, a closer examination of the distribution of tax relief across income brackets tells a much different story. In aggregate, all tax relief comes to those at the top of the income distribution – specifically those with adjusted gross incomes above $200,000.
Fiscal Impacts by Income Distribution
Net Fiscal Impact
Less than $10K
$10 – 25K
$25 – 50K
$50 – 75K
$75 – 100K
$100 – 200K
More than $200K
Certainly, there will be many individual households with incomes above $200,000 that will pay higher taxes, and plenty of individual households with incomes below $200,000 that will pay less taxes under the administration’s proposal. However, when taken together, households with incomes above $200,000 will be receiving net tax breaks that will be partially offset by net tax hikes for those with incomes below $200,000.
Changes to after tax household income will subsequently impact consumption, investment, and saving behavior throughout Texas’ economy. Quite simply, if individuals or households are forced to pay more taxes, they will have less income available to spend throughout the economy. Household spending adjustments are translated into increased or decreased revenue for local businesses, who subsequently adjust their spending on goods or employees in response to household demand.
In total, the Trump administration’s proposal will have a negative economic impact on Texas – to the tune of -$3.4 billion. There are approximately 8.4 million households with incomes below $200,000 – compared to just 419,000 households with income above $200,000. While there may be a net positive fiscal impact to taxpayers, this policy will have an overwhelming negative impact on the majority of households in Texas, and subsequently the Texas economy.
Impact on Home Buying
Home ownership is an economic activity that is incentivized by our current tax system. Rather than selecting the standard deduction, households may elect to itemize pre-determined deductions if the sum of these deductions are greater than the standard deduction amount.
Currently, there are two itemized deductions that benefit homeowners:
- Mortgage interest deduction
- State property tax deduction
In the Trump administration’s tax proposal, there are two provisions that would impact the incentives available for home buying: doubling the standard deduction and repealing the state property tax deduction.
Together, these provisions will raise the “break-even home price” for Texas households. The break-even home price refers to a specific home price for each filing status (single, married, head of household), that reflects the minimum price of a home needed to receive tax relief via itemized deductions. For any home above this price, home ownership is incentivized, since homeowners can deduct a greater amount from their taxes than the standard deduction would allow.
However, doubling the standard deduction will increase the break-even point for tax payers as they weigh the itemized vs. standard deduction. Further, eliminating the deduction for state property taxes will limit the amount of funds available for homeowners to count towards reaching the standard deduction. Together, these provisions will price many households out of the benefits associated with purchasing a home. Below is a before (2017) and after (Trump Administration Proposal) snapshot of the break-even home price by filing status specific to Texas.
Break Even Home Price by Filing Type
Head of Household
Across each filing type, the break-even home price will increase significantly under the Trump administration’s proposal. For married filers, this increase will be the most drastic – increasing by over $400,000.
Increasing the break-even home price will limit home buying incentives available to Texas households. Essentially, many households will no longer be able to afford homes that allow them to take advantage of this incentive.
To understand this, consider the current distribution of Texas households by home value. Roughly 54% of households currently qualify for the home ownership tax incentives available under the single filing status – which would be a home value of $110,627. Under the Trump administration’s proposal, the break-even home price jumps to $331,579 – only 14% of households are currently eligible at this home value. For married households under the Trump administration’s proposal, just 5% of households would qualify for the new break-even home price of $631,579.
Home ownership tax incentives will be available to fewer Texas households under the proposal, namely those towards the top of the income bracket. The proposal will subsequently price would-be buyers out of the market, and limit home buying activity throughout the state.
The proposed tax reform – as it stands now, is bad for Texas. In its current form, these provisions will place a burden on lower and middle-income families, while providing tax relief to Texas’ wealthiest households. The economic impact of such changes will cost Texas’ economy -$3.4 billion dollars in 2018 alone. Further, these provisions will raise the break-even home price throughout the state – effectively pricing many would-be home buyers out of the market. In its current form, the Trump administration’s tax proposal is simply too costly for the state of Texas and its constituents.