Keith Mack
The tax landscape is ever-changing, and with the recent Republican win in the U.S. presidential election, the tax law is expected to undergo significant modifications. The TCJA of 2017, for example, altered business expensing and deduction tax codes, increasing the maximum expensing allowance and bonus depreciation percentage. It also reduced individual, corporate, and estate tax rates, with the latter affecting shareholders and those with stocks, mutual funds, or ETFs. The 2017 law also capped the SALT deduction at $10,000 and weakened the Alternative Minimum Tax (AMT). The upcoming One Big Beautiful Bill for 2025 and beyond promises further changes, including repealing energy-efficient credits and extending deductions for qualified business income. With so many potential adjustments, individuals and businesses seek clarity and strategic guidance on how these changes will impact their tax liabilities and overall financial planning.
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What You'll Learn
- Tax laws affect economic decision-making on work, savings, migration, investment and business organisation
- Tax laws influence the type and amount of income taxed and the rate at which it is taxed
- Tax laws affect how entrepreneurs organise their businesses, how much they borrow and invest, and their location
- Tax laws can incentivise businesses to invest and create jobs
- Tax laws can disproportionately benefit the wealthy
Tax laws affect economic decision-making on work, savings, migration, investment and business organisation
Tax laws have a significant impact on economic decision-making, influencing individuals and businesses in various ways. Here are some key aspects:
Work
Payroll taxes, for instance, can influence a company's hiring decisions. When payroll taxes increase, employers may pass the cost to workers through lower wages, or they may choose to hire fewer people. Tax policies can also create incentives for people to switch from employees to contractors to benefit from certain deductions.
Savings
Tax policies can affect people's savings plans, particularly for retirement. Changes in tax codes, such as lowering contribution limits on retirement plans or restricting withdrawals from tax-deferred plans, can reduce people's inclination to save through certain vehicles like IRAs.
Migration
Taxes are one factor influencing the location decisions of individuals and businesses. While it may not be the primary reason for interstate or international moves, tax differentials are often considered alongside other cost-of-living factors. Changes in tax rates and policies can impact the net inflow or outflow of taxpayers in a particular state or country.
Investment
Tax policies can affect investment decisions by individuals and businesses. Taxes on investment income, capital gains, and interest income influence the overall return on investments. Long-term investments often benefit from lower tax rates, and certain types of investments, like municipal bonds, may offer tax advantages. Tax reforms that incentivize investment, such as increasing expensing allowances and bonus depreciation, can lead to increased business investment, as seen with the TCJA of 2017.
Business Organisation
Entrepreneurs choose business structures that optimise their tax liability, and tax policies can influence these decisions. For example, the distinction between C-corporations and pass-through entities (like LLCs and partnerships) carries different tax implications. Taxation also influences how businesses borrow, invest, and choose their locations.
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Tax laws influence the type and amount of income taxed and the rate at which it is taxed
Tax laws have a significant influence on the type and amount of income that is taxed, as well as the rate at which taxation occurs. The impact of tax laws is evident in the differences between progressive, regressive, and flat tax systems.
Progressive tax systems, such as the US federal income tax, impose higher tax rates on higher incomes and lower rates on lower incomes. The progressive structure is designed to reduce the tax burden on those with lower incomes, ensuring that they retain more of their earnings. This system is based on the concept of ability-to-pay taxation, where the highest earners contribute more to government services, oversight, and infrastructure. Progressive taxes are structured with tax brackets, where income ranges correspond to specific tax rates. These brackets are adjusted annually to account for inflation and ensure that taxpayers are not pushed into higher brackets without a real increase in their purchasing power.
On the other hand, regressive tax systems have the opposite effect, imposing higher tax rates on lower incomes. This can disproportionately impact low-income individuals as sales taxes, for example, are applied uniformly regardless of the buyer's income. Proportional or flat tax systems are also considered regressive as they apply a single tax rate to all taxpayers, regardless of income level. While this approach aims for equality between marginal and average tax rates, it can place a greater burden on those with lower incomes.
The type of tax system implemented is influenced by the prevailing tax laws and policies. For example, the Tax Cuts and Jobs Act (TCJA) of 2017 in the US made changes to tax codes, impacting business expensing, deductions, and depreciation. The TCJA also adjusted the way the IRS measures inflation, using the Chained Consumer Price Index (C-CPI) to determine income thresholds, deductions, and credits. Additionally, the TCJA increased the cap on state and local tax deductions, benefiting high-income individuals.
Tax laws can also influence the tax liabilities of specific groups, such as families with lower incomes or entrepreneurs. For instance, certain tax policies may restrict the maximum credit available to low-income families, impacting their overall tax burden. Entrepreneurs' business decisions, including borrowing, investing, and business location, are also shaped by tax laws and their implications.
In summary, tax laws play a crucial role in determining the type and amount of income that is subject to taxation, as well as the applicable tax rates. Progressive, regressive, and flat tax systems each have distinct effects on taxpayers, and the choice of system is influenced by the prevailing tax laws and policies. These laws can further introduce adjustments to account for inflation and can target specific groups with varying impacts.
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Tax laws affect how entrepreneurs organise their businesses, how much they borrow and invest, and their location
Tax laws have a significant impact on how entrepreneurs structure their businesses, the amount they borrow and invest, and the location of their operations. They influence the economic decision-making of individuals and businesses, encompassing factors such as work, savings, interstate migration, investment patterns, and business organization.
The Tax Cuts and Jobs Act (TCJA) of 2017 is a notable example of how tax policies can shape entrepreneurial endeavours. This legislation modified the tax codes governing business expensing and deductions, raising the maximum expensing allowance to $1 million and broadening the definition of qualified properties. Additionally, the TCJA increased the bonus depreciation percentage from 50% to 100% for assets purchased and put into service between 2017 and 2023. These changes were expected to stimulate business investment, and there is supporting data to validate this expectation. For instance, the real nonresidential fixed investment in the US rose by 5.9% in 2018, surpassing the 2017 forecast of 2.7%. While some researchers attribute this investment growth to factors like oil prices, others have observed significant investment increases in sectors unrelated to oil, such as equipment, software, and intellectual property.
The TCJA also reduced the corporate tax rate, which was considered a pivotal factor in boosting corporate profits and creating jobs. The top marginal tax rate for US corporations under the previous law was 35%, significantly higher than the global average of 25.44% weighted for gross domestic product (GDP). Critics argued that such high corporate tax rates put American businesses at a competitive disadvantage, prompting them to shift profits overseas. By lowering the corporate tax rate, the TCJA aimed to encourage companies to retain more profits domestically and allocate resources to improving their products and services rather than lobbying for lower tax rates.
Moreover, the TCJA brought changes to individual finances, such as eliminating the taxation of discharged federal and private student loan debt due to death or disability between 2018 and 2025. It also increased the federal estate tax exemption threshold, providing relief to individuals with assets below a certain value.
In summary, tax laws have far-reaching consequences for entrepreneurs, influencing their business structures, investment strategies, borrowing decisions, and location choices. The TCJA of 2017 serves as a prominent example of how tax policies can incentivize business investment, enhance corporate competitiveness, and alleviate tax burdens on individuals.
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Tax laws can incentivise businesses to invest and create jobs
Tax laws can have a significant impact on businesses, influencing their investment decisions, organisational structure, and overall economic competitiveness. The Tax Cuts and Jobs Act of 2017 (TCJA) is a notable example of how tax policies can incentivise businesses to invest and create jobs.
The TCJA introduced changes to the tax codes governing business expensing and deductions, raising the maximum expensing allowance and expanding the definition of qualified properties. These changes were designed to encourage businesses to invest more. Indeed, data shows that US business investment grew strongly following the TCJA, with the real nonresidential fixed investment rising 5.9% in 2018, exceeding the forecast of 2.7% made in 2017.
Bonus depreciation, which allows firms to fully expense or depreciate capital investments, is another tool used by governments to incentivise business investment. Studies have shown that bonus depreciation stimulates investment, particularly in smaller firms and those facing financial challenges. Additionally, lowering corporate tax rates through policies like the Domestic Production Activities Deduction has been found to increase average wages in firms claiming these deductions.
Tax incentives can also play a role in promoting inclusive growth and enhancing local governments' ability to fund critical public services and investments. For example, property tax stabilisation agreements in Providence, RI, contributed to the city's fiscal health by incentivising new development and stabilising tax rates. Tax incentives can be designed to encourage specific behaviours, such as job creation, retention of jobs, and investment in skills development, leading to more equitable growth.
However, it is important to note that the effectiveness of tax incentives in creating jobs can vary. While they can attract businesses to specific jurisdictions, they may also lead to a zero-sum game where jobs are simply reshuffled rather than newly created. Additionally, regulatory burdens, laws favouring incumbent firms, and tax complexity can hinder the effectiveness of tax incentives in promoting entrepreneurship and job creation.
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Tax laws can disproportionately benefit the wealthy
The US tax system has been criticised for disproportionately benefiting the wealthy, with tax policies having a significant impact on economic inequality. The 2017 Trump Tax Law, for example, was skewed in favour of the rich, offering large tax breaks for corporations and high-income households, while failing to deliver promised economic gains for working people.
The law included permanent corporate tax cuts, which disproportionately benefited the wealthy as they own the majority of stock. In 2018, the first year the law was in effect, the top 5% of households received 40% of the individual tax cuts and over half of the corporate tax cuts. The top 1% received 36.2% of the corporate provisions, compared to 16.8% of the individual provisions. The law also doubled the standard deduction for married couples and doubled the Child Tax Credit for many families. While these changes provided modest tax cuts for most families, they were outweighed by the net tax cuts for the wealthy.
The Tax Cuts and Jobs Act (TCJA) of 2017 also dramatically weakened the estate tax and cut the corporate tax rate from 35% to 21%, benefiting the wealthy. The TCJA further expanded tax-sheltering opportunities through health savings accounts and new corporate tax breaks. The Tax Policy Centre estimated that the TCJA increased after-tax incomes for those earning over $1 million by 3.3%, compared to 1.3% or less for those earning under $100,000. The average tax cut for millionaires was $69,840, while those earning less than $100,000 received an average cut of only $453.
The House Republican Tax Bill has also been criticised for being skewed towards the wealthy, with tax cuts three times larger for the top 1% than for the bottom 60%. The bill's revisions focused on allowing high-income earners to deduct more of their state and local taxes, rather than limiting harm to low- and moderate-income families. The bill also retained smaller maximum credits for lower-income families and failed to address issues such as the "refundability cap".
The US tax code has been described as favouring income from wealth over income from work, allowing the richest Americans to pay a smaller percentage of their income in taxes than most working families. For example, a 2021 White House study found that the wealthiest 400 billionaire families in the US paid an average federal individual tax rate of just 8.2%, compared to 13% for the average American taxpayer.
The impact of tax laws on economic inequality is a significant issue, with potential consequences for democracy and the global competitiveness of American corporations. To address this, some have proposed raising tax rates for billionaires, closing tax loopholes, and ending special tax treatments for the wealthy.
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Frequently asked questions
The TCJA of 2017 changed the tax codes governing business expensing and deductions. The new law raised the maximum expensing allowance to $1 million and expanded the definition of qualified properties. The law also incentivizes business investment, with the real non-residential fixed investment rising by 5.9% in 2018, exceeding the 2017 forecast of 2.7%. The law also affects individuals' economic decision-making on work, savings, inter-state migration, investment, and business organization.
The way corporate profits are taxed affects everyone who owns shares of a corporation through stocks, mutual funds, or ETFs. The reduced corporate tax rate was one of the key components of the 2017 Act, which was considered a major factor in corporate profits and job creation. The top marginal tax rate for U.S. corporations under the former law was 35%, which critics argued put the country at a competitive disadvantage.
Families with lower incomes are restricted to a smaller maximum credit: $1,700 per child for tax year 2025. Families also receive no credit for their first $2,500 of earnings, which lessens the credit amount for which lower-income families are eligible.
