Tax Reform: Lawmaking Process Explained

Tax reform is the process of changing the way taxes are collected or managed by the government, often to improve tax administration or to provide economic or social benefits. In the United States, tax reform has been a significant issue, with movements to reform the collection and management of taxes dating back to the 19th century. The Tax Cuts and Jobs Act (TCJA), signed into law by President Donald Trump in 2018, was a major overhaul of the tax code, impacting taxpayers and business owners through tax cuts and other changes. The process of tax reform can be complex and involves various factors, such as political negotiations and budgetary considerations.

The role of the Senate and the House of Representatives

The process of tax reform involves changing the way taxes are collected or managed by the government, with the aim of improving tax administration or providing economic or social benefits. In the United States, tax reform laws are passed by Congress and signed into law by the President. The role of the Senate and the House of Representatives in this process is crucial, as they are responsible for drafting, debating, and voting on the proposed tax reform legislation.

In the case of the Tax Cuts and Jobs Act (TCJA), which was signed into law by President Trump in 2018, the House of Representatives and the Senate played a significant role in shaping the final legislation. The TCJA was an amalgam of two competing tax reform measures—one approved by the House and the other by the Senate. The legislation moved through Congress under budget reconciliation protections, which allowed it to clear the Senate with a simple majority vote, rather than the usual three-fifths supermajority required. This was due to the GOP’s narrow margin of control in the Senate at the time.

The Senate passed the TCJA on December 2, 2017, by a party-line vote of 51-49. The House passed its version of the bill by a vote of 224-201, with no support from House Democrats and 12 Republicans voting against it. The differences between the House and Senate versions of the bill were then reconciled, resulting in a final piece of legislation that more closely tracked the Senate bill in some significant ways.

The House of Representatives and the Senate also played a crucial role in the passage of the Tax Reform Act of 1986, which was signed into law by President Ronald Reagan. The Act lowered federal income tax rates, decreased the number of tax brackets, and expanded the earned income tax credit, the standard deduction, and the personal exemption. It received majority support in both the House and the Senate, with votes from both Republican and Democratic members.

In both the TCJA and the Tax Reform Act of 1986, the House and the Senate were responsible for drafting and debating the legislation, as well as negotiating and voting on the final version of the bill. Their role in the tax reform process is critical in shaping the ultimate form of the legislation and ensuring its passage into law.

The impact of tax reform on businesses

The Tax Cuts and Jobs Act (TCJA) was a major overhaul of the US tax code, signed into law by President Donald Trump in 2018. The reform impacted taxpayers and business owners, particularly through tax cuts. The law created a single flat corporate tax rate of 21%, down from 35%. This is expected to increase company profits and give a boost to the US economy.

The TCJA also repealed the corporate alternative minimum tax (AMT) and introduced immediate expensing of short-lived capital investments, rather than requiring them to be depreciated over time. The section 179 deduction cap was doubled to $1 million, and phase-out begins after $2.5 million of equipment spending.

Owners of pass-through businesses (including sole proprietorships, partnerships, and S-corporations) gained a 20% deduction for pass-through income. To discourage high earners from recharacterizing regular wages as pass-through income, the deduction is capped at 50% of wage income or 25% of wage income plus 2.5% of the cost of qualifying property.

The net interest deduction is capped at 30% of earnings before interest and taxes (EBIT). Businesses with up to $25 million in average annual gross receipts over the preceding three years can use cash accounting, up from the previous limit of $5 million.

The law also eliminated the section 199 deduction for businesses engaged in domestic manufacturing and other production work. It introduced a territorial tax system, under which only domestic earnings are subject to tax. Companies with over $500 million in annual gross receipts are subject to the base erosion anti-abuse tax, designed to counteract profit-shifting to low- or no-tax countries.

The impact of the TCJA on businesses is expected to be significant, with many provisions altering the valuation landscape. While the reduction in corporate tax rates will generally increase profitability and overall value, the changes to interest deductions and cost of capital may decrease the value of some businesses.

The impact of tax reform on individuals

Income and Tax Burden

The Tax Cuts and Jobs Act (TCJA) of 2017, a major tax code overhaul, impacted individuals based on their income level, filing status, and deductions. The reform retained the seven individual income tax brackets but lowered the top tax rates. The highest earners were expected to benefit the most from the law, while the lowest earners were predicted to pay more in taxes after individual tax provisions expire in 2025. The standard deduction was raised, benefiting those who don't itemize their deductions. However, the personal exemption was suspended through 2025.

Health Coverage

The TCJA also had an impact on health coverage. It ended the individual mandate, a key provision of the Affordable Care Act (ACA), which required individuals to purchase health insurance or face tax penalties.

Child Tax Credit and Education

The law raised the child tax credit and created a non-refundable credit for non-child dependents, providing some financial relief for families. Additionally, it allowed for 529 plans to fund K-12 private school tuition, and the SECURE Act of 2019 expanded these benefits, allowing plan holders to withdraw funds penalty-free to pay down qualified student debt.

Retirement Savings

Retirement savings were also impacted by the TCJA. The law changed the rules for designating Roth and traditional contributions and allowed individuals to contribute to Individual Retirement Accounts (IRAs) past the age of 70½.

State and Local Taxes

The TCJA capped the deduction for state and local taxes at $10,000, increasing the incentives for individuals to move from high-tax states to lower-tax states.

Economic Decisions and Behaviour

Tax reforms can influence economic decisions and behaviours. For example, the Earned Income Tax Credit (EITC) encourages labour force participation, especially among low-wage families and single parents. Tax policies can also affect decisions about retirement savings, with individuals weighing the benefits of pre-tax and post-tax retirement accounts.

The impact of tax reform on estates

The US federal government has imposed a tax on the estates of the wealthiest individuals since 1916. This tax, known as the estate tax, plays an important role in the economy and society. While it has been subject to reform and temporary repeal in the past, it currently applies to net estates worth more than $1 million. The estate tax is progressive, with marginal rates ranging from 41% to 49% as wealth increases.

The Tax Cuts and Jobs Act (TCJA), signed into law by President Trump in 2018, included a temporary increase in the estate tax exemption. For 2024, the exemption for single filers is $13.6 million, and for 2025, it will be $13.99 million. These exemptions will be reversed after 2025. The TCJA also changed the way inflation is calculated for these exemptions, using the Chained-CPI instead of the traditional Consumer Price Index, which generally yields a lower rate of inflation.

The impact of the increased exemption limits is that more people will be able to pass on larger amounts of their estates to their heirs without paying estate taxes. This change benefits beneficiaries but does not eliminate the need for estate and tax planning. It is still important for individuals to review their estate planning documents to ensure they are taking full advantage of any opportunities under tax reform.

One consequence of the higher exemption limits is that some heirs may unintentionally be disinherited. This could occur if an estate plan is set up to use a bypass trust, which directs a trustee to fund the trust with any remaining estate tax exemption amount before distributing the remaining assets to the intended heirs. If the bypass trust is large enough, there may be insufficient assets left to distribute to the heirs.

Another impact of the tax reform is on charitable giving. The estate tax encourages charitable bequests by allowing a deduction for these bequests. While the tax reform may reduce charitable gifts by lowering the amount of wealth that can be allocated, it is unclear what the net impact will be. Some studies suggest that repealing the estate tax would lead to a significant reduction in charitable bequests and giving during life.

In conclusion, while the tax reform's impact on estates is mostly positive, with increased exemption limits, it is important to consider potential unintended consequences and the impact on charitable giving. Individuals should stay informed about any changes to the tax code and review their estate planning documents regularly to ensure their intentions are carried out.

The role of the President

The President plays a crucial role in the process of tax reform. In the United States, tax reform is a complex legislative process that requires the collaboration of Congress and the President. Here is an overview of the President's role in tax reform:

Proposal and Advocacy: The President has the power to propose tax reform as part of their legislative agenda. They can put forward their tax policy ideas and recommendations, which are often included in the annual budget proposal presented to Congress. The President can advocate for specific tax changes, such as reducing tax rates, modifying tax brackets, or introducing tax credits and deductions. During this stage, the President may work with their party members in Congress to develop and refine the tax reform proposal.

Negotiation and Compromise: The President engages in negotiations with Congress, particularly the leadership of both the House of Representatives and the Senate. This process involves bargaining, compromise, and consensus-building to shape the final tax reform legislation. The President's role is crucial in securing support from members of their own party and persuading members of the opposition party to get on board with the tax reform package.

Approval and Signature: Once Congress passes a tax reform bill through both chambers, it is sent to the President for approval. The President has the power to sign the bill into law, officially enacting the tax reform. This signature signifies the President's support for the legislation and their agreement with the contents of the bill.

Veto and Amendments: If the President disagrees with the tax reform bill passed by Congress, they have the power to veto it. A presidential veto sends the bill back to Congress, which then needs a two-thirds majority in both chambers to override the veto and enact the law without the President's signature. Alternatively, the President may propose amendments to the bill and request Congress to make specific changes before they consider passing it again.

Communication and Public Outreach: Throughout the tax reform process, the President plays a vital role in communicating with the public. They can use their position to explain the proposed tax changes, highlight their benefits, and address concerns raised by citizens. The President's ability to shape public opinion can influence Congress's decisions and increase support for the tax reform agenda.

Implementation and Enforcement: After signing the tax reform bill into law, the President, through the relevant government agencies, is responsible for ensuring its effective implementation and enforcement. This includes providing clear guidance to taxpayers, businesses, and tax administrators on how to comply with the new tax rules. The President also ensures that the necessary resources and infrastructure are in place to facilitate the smooth administration of the reformed tax system.

In conclusion, the President's role in tax reform is multifaceted and influential. They initiate the process by proposing tax changes, negotiate with Congress to shape the legislation, approve or veto the final bill, communicate the benefits to the public, and ensure effective implementation and enforcement of the new tax laws.

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