U.S. Budget and Economy

Wednesday, December 13, 2017

How Big of a Benefit is the Doubling of the Standard Deduction and Child Credit?

On December 8, the Senate Republican Conference House placed a post on their Facebook page that contains the following quote:

"Our plan will double the child tax credit to $2,000, double the standard deduction to $24,000 per family and lower tax rates for families across middle-class income brackets.” – Senator Rob Portman via Akron Beacon Journal

Similarly, a post was placed on Senator John Thune's Senate web site on December 12 contains the following statement:

Thune highlighted the fundamental principles of the bill, including doubling the standard deduction, doubling the child tax credit, and lowering rates.

The following tables show the decrease in the tax rates for single, head of household, and married couples filing jointly under the Senate bill:

          SINGLE FILER                    HEAD OF HOUSEHOLD FILER           MARRIED FILING JOINTLY FILER

    Bracket Current  Senate              Bracket Current  Senate              Bracket Current  Senate
 N   Start    2018    2018 Change     N   Start    2018    2018 Change     N   Start    2018    2018 Change
-- ------- ------- ------- ------    -- ------- ------- ------- ------    -- ------- ------- ------- ------
 1       0    10.0    10.0    0.0     1       0    10.0    10.0    0.0     1       0    10.0    10.0    0.0
 2    9525    15.0    12.0   -3.0     2   13600    15.0    12.0   -3.0     2   19050    15.0    12.0   -3.0
 3   38700    25.0    22.0   -3.0     3   51800    15.0    22.0    7.0     3   77400    25.0    22.0   -3.0
 4   70000    25.0    24.0   -1.0     4   51850    25.0    22.0   -3.0     4  140000    25.0    24.0   -1.0
 5   93700    28.0    24.0   -4.0     5   70000    25.0    24.0   -1.0     5  156150    28.0    24.0   -4.0
 6  160000    28.0    32.0    4.0     6  133850    28.0    24.0   -4.0     6  237950    33.0    24.0   -9.0
 7  195450    33.0    32.0   -1.0     7  160000    28.0    32.0    4.0     7  320000    33.0    32.0   -1.0
 8  200000    33.0    35.0    2.0     8  200000    28.0    35.0    7.0     8  400000    33.0    35.0    2.0
 9  424950    35.0    35.0    0.0     9  216700    33.0    35.0    2.0     9  424950    35.0    35.0    0.0
10  426700    39.6    35.0   -4.6    10  424950    35.0    35.0    0.0    10  480050    39.6    35.0   -4.6
11  500000    39.6    38.5   -1.1    11  453350    39.6    35.0   -4.6    11 1000000    39.6    38.5   -1.1
                                     12  500000    39.6    38.5   -1.1
The above tables were created by merging the brackets under current law and the Senate bill. The tables and following plots were generated by the interactive application at this link. As can be seen, the new rates are generally lower except for a few brackets (such as $160,000 to $195,449 for single filers) where the tax rate is slightly higher. These would seem to generally be more than compensated by lower rates in the brackets below them. However, the Senate plan does give single and head of household filers higher rates over all or most of the incomes from $160,000 to $424,950. This can be seen in the following plots (click on them to enlarge):

As can be seen, single and household filers actually see a tax increase in the area around $440,000 due to these higher rates. On the other hand, married filers tend to see progressively larger tax cuts over this entire range. Still, it does appear that single and head of household filers will likewise see gains (though somewhat smaller) up to $160,000.

As claimed in the initial quote above, the standard deduction will nearly double, climbing in 2018 from $6,500 under current law to $12,000 under the Senate bill for single taxpayers. For head of household filers in 2018, the standard deduction will similarly almost double, from $9,550 under current law to $18,000 under the Senate bill. Finally, for married couples filing jointly in 2018, the standard deduction will again almost double, from $13,000 under current law to $24,000 under the Senate bill. However, the quote above does not mention that personal exemptions are being eliminated. Factoring this in, a single taxpayer will lose $4,150 of the $5,500 increase in the standard deduction, resulting in a net gain of just $1,350. A head of household will lose $4,150 of the $8,450 increase in the standard deduction, resulting in a net gain of $4,300. Finally, a married couple will lose $8,300 (for 2 exemptions) of the $11,000 increase in the standard deduction, resulting in a net gain of just $2,700. Hence, the net gain in deductions will be about 20.7 percent (1350/6500 or 2700/13000) rather than the expected 84.6 percent (5500/6500 or 11000/13000) for single and married filers. For head of household filers, the net gain will be a bit larger 45 percent (4300/9550) rather than the expected 88.5 percent (8450/9550).

As mentioned above, the standard deduction will cause a net increase of $1,350, $4,300, and $2,700 for single, head of household, and married filers, respectively. However, this will be an increase in taxable income and will mean a larger dollar tax cut for taxpayers who have a higher top-marginal rate. This can be seen in the following plots:

The increase in the child tax credit has a similar problem due to the loss of the exemption for each child. For a taxpayer with a new top marginal rate of 22 percent, the loss of a $4,150 exemption will increase their taxes by $913 (4150*0.22), just $87 short of the increase in the child tax credit of $1,000. Hence, that taxpayer will gain just 87 dollars. For the new marginal rates of 10 and 12 percent, the gains will be $585 (1000-4150*0.10) and $502 (1000-4150*0.12), respectively. However, this only applies to single and head of household filers making up to $75,000 and married filers making up to $110,000. Above that, the child credit starts to phase out under current law but not under the Senate bill. This can be seen in the following plots:

The loss of the exemption creates an even bigger problem for dependents who are not children. For each of these dependents, the Senate bill provides a $500 credit. This means that a taxpayer will experience a loss of $500 greater than they would if that dependent were a child. Hence, a taxpayer with a top marginal rate of 22 percent will see a tax increase of $413 (87-500) for each non-child dependent over what they would have seen otherwise. A taxpayer with a top marginal rate of 10 and 12 percent will see small decreases in their taxes of $85 and $2, respectively. At the top marginal rates of 22, 24, 32, 35, and 38.5 percent, it causes tax increases of $413, $496, $828, $953, and $1,098, respectively. These changes in taxes due just to the loss of the exemption and the new $500 credit can be seen in the following plots:

In summary, the Senate bill causes the following changes:

  1. The change in the brackets cause a general increase in the tax cut except for incomes from $160,000 to $424,950 for single and head of household filers.

  2. The increase in the standard deduction (along with the loss of the taxpayer exemptions) causes net decreases of $1,350, $4,300, and $2,700 in taxable income for single, head of household, and married filers, respectively. This results in tax cuts ranging from $135, $430, and $270 for single, head of household, and married filers with a top marginal rate of 10 percent to about $520, $1,656, and $1,040 for those filers with top marginal rate of 38.5 percent.

  3. The increase in the child tax credit (along with the loss of the child exemption) causes tax cuts of $585, $502, and $87 for taxpayers with top marginal rates of 10, 12, and 22 percent, respectively. This jumps up to around the full $1,000 after $75,000 for single and head of household filers and after $110,000 for married filers due to the fact that the credit no longer phases out at that level under the Senate bill. However, this then declines to nearly a $1,600 tax increase at the top marginal rate of 38.5 percent where the credit phases out under the Senate bill.

  4. The new credit for nonchild dependents (along with the loss of the dependent exemption) causes tax cuts of $85, and $2 for taxpayers with top marginal rates of 10, 12 percent, respectively. At the top marginal rates of 22, 24, 32, 35, and 38.5 percent, it causes tax increases of $413, $496, $828, $953, and $1,098, respectively.
This last item suggests that dependents may cause many taxpayers to have their taxes increase under the Senate bill. The following plots show the effect of declaring one nonchild dependent on the taxes of head of household and married filers:

As can be seen, there are no tax increases except for head of household filers with incomes over $300,000 (caused by the increase in rates above $160,000). This is likely due to the benefit provided by the increase in the standard deduction. The following plots show the same filers with itemized deductions equal to the new standard deduction:

As can be seen, taxpayers now see an increase in taxes up to incomes of about $56,000 for head of household filers and $88,000 for married filers. This is as expected, given the preceding analysis of specific changes in Senate bill. Hence, this analysis aids in finding winners and losers that may not be apparent when simply looking at the assorted taxpayer examples that have been put out by various organizations. In addition, this analysis shows that the benefits of the doubling of the standard deduction and child tax credit is not as large as they appear once the loss of the taxpayer and child exemptions are included. Also, the benefit of the decrease in brackets reverses for incomes from $160,000 to $424,950 for single and head of household filers. Finally, it show that the benefit of the credit for nonchild dependents is more than offset by the loss of the dependent exemption.

Wednesday, December 6, 2017

The Problems with "Taxpayer Examples" (Part 3)

On December 4, the House debated and voted on the motion to go to conference with the Senate on the Republican tax reform bill. A transcript of the debate can be found in the Congressional Record and a video can be found at this link. As mentioned here, Kevin Brady had been named the conference chair by Paul Ryan and he spoke many times throughout the debate. In the process, he offered numerous examples of taxpayers who would get a tax cut from the bill. In fact, each example appeared to follow a Democrat speaker and show a family from their district that would get a tax cut. Following are the examples, taken from the Congressional Record. In addition, each example is preceded by the time that it occurred and can be found in the video. The list under the video allows the user to jump to the exact time desired.

1. (0:50:09) Mr. Speaker, I would point out that a family of four in Michigan’s Ninth District will save over $1,700 each and every year.

2. (0:55:31) Mr. Speaker, I would note that the average family of four making $59,000 a year in the 35th District of Texas will see a tax cut of over $1,100.

3. (1:00:20) Mr. Speaker, I would point out that the average family of four in the Fifth District of California will see a tax cut of over $2,370.

4. (1:06:03) Mr. Speaker, I am proud to remind the House that a family of four in Connecticut’s First District will see a tax cut of $3,858 each and every year.

5. (1:11:12) Mr. Speaker, I would note that a family of four in Oregon’s Third District will see tax savings of $2,256.

6. (1:12.53) Mr. Speaker, that family of four in New Jersey’s Ninth District making $90,000 a year, two workers, will see a tax cut of $2,044.

7. (1:14:52) Mr. Speaker, I am pleased to report that the median family of four in New York’s 14th District making $63,000 a year working hard will see a tax cut of $1,251.

8. (1:16:38) Mr. Speaker, I am proud to report that that median family of four with two kids in the Seventh District of Illinois making $73,000 really working hard where every dollar counts will see a tax cut of $1,546.

9. (1:18:31) Mr. Speaker, I am proud to report that that median family of four making $74,000, blue-collar workers in the 26th District of New York, will see a tax cut of $1,562.

10. (1:20:14) Mr. Speaker, I would point out that the median family of four making $65,000 in Alabama’s Seventh District would see a tax cut of $1,311.

11. (1:22:05) Mr. Speaker, I point out that a median family of four with two kids in Washington’s First District will see a tax cut of $5,008.

12. (1:23:43) Mr. Speaker, I would point out that that hardworking family of four in California’s 38th District would see a tax cut of $1,870.

13. (1:25:23) Mr. Speaker, I would point out that that hardworking family of four in the 27th District of California will see a tax cut of $2,249.

14. (1:30:19) Mr. Speaker, I point out that a middle class family making $74,000, in the Fifth District of South Carolina, will see a tax cut of $1,568.

15. (1:36:27) Mr. Speaker, I am proud to report that a median, hardworking, middle class family in the Fifth District of Maryland, will see a tax cut of $4,158.

16. (1:49:42) I would point out that a hardworking middle class family in the 12th District of California will see a tax cut of $5,508.

The following table summarizes these 16 examples:

                                                                                          HOUSE    DIFFERENCE     SENATE
 N          FAMILY DESCRIPTION  CONGRESSIONAL DISTRICT             INCOME      TAX CUT     2018  AMOUNT  PERCENT    2018 
--  --------------------------  --------------------------------  -------  ------------  ------  ------  -------  ------        
 1              family of four  Michigan’s Ninth District                  over $1,700*
 2      average family of four  35th District of Texas            $59,000  over $1,100   1105.5     5.5    0.500  1638.5
 3      average family of four  Fifth District of California               over $2,370
 4              family of four  Connecticut’s First District                    $3,858*
 5              family of four  Oregon’s Third District                         $2,256
 6              family of four  New Jersey’s Ninth District       $90,000       $2,044   2035.5    -8.5   -0.416  2568.5
 7       median family of four  New York’s 14th District          $63,000       $1,251   1225.5   -25.5   -2.038  1758.5
 8       median family of four  Seventh District of Illinois      $73,000       $1,546   1525.5   -20.5   -1.326  2058.5
 9       median family of four  26th District of New York         $74,000       $1,562   1555.5    -6.5   -0.416  2088.5
10       median family of four  Alabama’s Seventh District        $65,000       $1,311   1285.5   -25.5   -1.945  1818.5
11       median family of four  Washington’s First District                     $5,008
12              family of four  California’s 38th District                      $1,870
13              family of four  27th District of California                     $2,249
14         middle class family  Fifth District of South Carolina  $74,000       $1,568   1555.5   -12.5   -0.797  2088.5
15  median middle class family  Fifth District of Maryland                      $4,158
16         middle class family  12th District of California                     $5,508

* each and every year
The first four columns come from Brady's examples. As can be seen, every single one of the first 13 is a "family of four" though two are described as "average" and 5 are described as "median". The last 3 examples are described as "middle class family". It appears that Brady was likely referring to a family of four since the first of the three examples seem to match the numbers for a family of four under the House plan. The remainder of this analysis will assume that the last three examples are for a family of four but there's no way to be sure, especially for the last two.

The last four columns give the tax cuts according to the latest House and Senate plan according to this tax cut calculator. As can be seen, Brady only stated the income for 7 of his 16 examples. It's unclear whether this is an oversight or whether he attempted to use the median or average income for the districts in question. In any case, the tax cuts for the 7 examples for which he does give incomes appear to be much closer to those given by the House plan than the Senate plan. The largest discrepancy is $25.5 and 2.038 percent.

The following plot shows the dollar amount of all tax cuts under the current House plan for incomes under $300,000:

This plot was generated by going to the tax cut calculator, selecting "Example 1 - Family of Four (House)" for "Tax Examples", selecting "Current 2018" and "House 2018" for "Tax Plan 1" and "Tax Plan 2", and setting "Wage Maximum" to 300000. As can be seen, the plot shows tax cuts ranging from about $1,000 to $8,000. This can be used to estimate the incomes for the tax cuts for which Brady provided none. For example, the last tax cut of $5,508 appears to be for an income of about $250,000.

In fact, it happens that all of the tax cuts missing incomes in the table above are in the second and fifth segments of the above plot. For the second and fifth segments, the income can be calculated using the following two formulas, respectively:

2nd segment: income = (taxcut * 100/3) + 22150
5th segment: income = (taxcut * 100/3) + 68833.33
Using this second formula for the last tax cut of $5,508 gives (5508 * 100/3) + 68833 which equals $252,433. Using these formulas to fill in the above table gives the following:
                                                                                          HOUSE    DIFFERENCE     SENATE   HOUSEHOLD INCOME
 N          FAMILY DESCRIPTION  CONGRESSIONAL DISTRICT             INCOME      TAX CUT     2018  AMOUNT  PERCENT    2018    MEDIAN     MEAN
--  --------------------------  --------------------------------  -------  ------------  ------  ------  -------  ------  --------  --------
 1              family of four  Michigan’s Ninth District          80,000  over $1,700*  1735.5    35.5           2268.5   $56,582   $78,160
 2      average family of four  35th District of Texas            $59,000  over $1,100   1105.5     5.5    0.500  1638.5   $48,490   $61,107
 3      average family of four  Fifth District of California      101,200  over $2,370   2371.5     1.5           2904.5   $73,006   $94,695
 4              family of four  Connecticut’s First District      197,500       $3,858*  3860.0     2.0           4916.0   $70,215   $92,139
 5              family of four  Oregon’s Third District            97,350       $2,256   2256.0     0.0           2789.0   $63,231   $83,699
 6              family of four  New Jersey’s Ninth District       $90,000       $2,044   2035.5    -8.5   -0.416  2568.5   $64,964   $91,675
 7       median family of four  New York’s 14th District          $63,000       $1,251   1225.5   -25.5   -2.038  1758.5   $53,512   $70,658
 8       median family of four  Seventh District of Illinois      $73,000       $1,546   1525.5   -20.5   -1.326  2058.5   $54,147   $88,912
 9       median family of four  26th District of New York         $74,000       $1,562   1555.5    -6.5   -0.416  2088.5   $47,358   $64,320
10       median family of four  Alabama’s Seventh District        $65,000       $1,311   1285.5   -25.5   -1.945  1818.5   $34,664   $50,729
11       median family of four  Washington’s First District       235,770       $5,008   5008.1     0.1           6446.8   $91,018  $113,292
12              family of four  California’s 38th District         84,480       $1,870   1869.9    -0.1           2402.9   $66,421   $83,039
13              family of four  27th District of California        97,120       $2,249   2249.1     0.1           2782.1   $71,223   $99,899
14         middle class family  Fifth District of South Carolina  $74,000       $1,568   1555.5   -12.5   -0.797  2088.5   $48,743   $66,232
15  median middle class family  Fifth District of Maryland        207,430       $4,158   4157.9    -0.1           5313.2   $95,442  $109,200
16         middle class family  12th District of California       252,430       $5,508   5507.9    -0.1           7113.2  $105,918  $146,341

* each and every year
As can be seen, some of the calculated incomes are very high with 3 of them over $200,000 and one very nearly equal to it. The last example lists an income of $252,430 for the 12th District of California but the U.S. Census lists the median and mean household income to be $105,918 and $146,341, respectively, for this district. The following shows the corresponding incomes for all four of these high-income districts:
                                                                            HOUSEHOLD INCOME
 N          FAMILY DESCRIPTION  CONGRESSIONAL DISTRICT             INCOME    MEDIAN     MEAN
--  --------------------------  --------------------------------  -------  --------  --------
 4              family of four  Connecticut’s First District      197,500   $70,215   $92,139
11       median family of four  Washington’s First District       235,770   $91,018  $113,292
15  median middle class family  Fifth District of Maryland        207,430   $95,442  $109,200
16         middle class family  12th District of California       252,430  $105,918  $146,341
As can be seen, all four have median and mean incomes far, far less than those implied by Brady's tax cuts. It's therefore unclear why Brady chose them unless it was to increase the reported tax cut. In any event, the table showing all 16 examples above shows that all of the incomes stated or implied by Brady were greater than the median and all but 5 were greater than the mean income reported by the U.S Census for that district.

Likely much more important, however, is the fact all of the examples are for a family of four. Following are the calculation shown on the "Calculation of Taxes" tab for Example 2 above:

Example 1 - Family of Four Making $59,000 Per Year

                      Tax Plan     2018 House 2018   Change
1  --------------------------- --------   -------- --------
2  Wages, salaries, tips, etc.    59000      59000        0
3   Tax-deferred contributions        0          0        0
4                   Exemptions   -16600          0    16600
5          Standard deductions   -13000     -24400   -11400
6          Itemized deductions        0          0        0
7  --------------------------- --------   -------- --------
8                      Medical        0          0        0
9        State and local taxes        0          0        0
10           Real estate taxes        0          0        0
11      Home mortgage interest        0          0        0
12                     Charity        0          0        0
13   Misc. repealed deductions        0          0        0
14 --------------------------- --------   -------- --------
15              Taxable income    29400      34600     5200
16 --------------------------- --------   -------- --------
17       Tax on taxable income   3457.5       4152    694.5
18                Child credit    -2000      -3200    -1200
19      Other dependent credit        0          0        0
20               Parent credit        0       -600     -600
21    Earned income tax credit        0          0        0
22 --------------------------- --------   -------- --------
23                  Income tax   1457.5        352  -1105.5
As can be seen, the tax cut in this case is chiefly due to the increase in the child credit and the standard deduction. Hence, the families that will get the largest tax cuts will tend to be those which have children and which are currently using the standard deduction. It's likely no coincidence that this was the type of family used by Brady in every single one of this 16 examples. This is an obvious example of cherry-picking. To be consistent, Brady should propose that the tax bill be renamed "Tax Cut for the Family of Four using the Standard Deduction Act".

It's important that the Democratic party continue to point to distributional studies of the tax cut such as the recent CBO and JCT studies. However, it would seem that they also need to respond to the taxpayer examples that Republicans continue to mention, verifying that they are correct, calling out mistakes and/or cherry-picking, and coming up with reasonable counterexamples. The distributional studies may be more meaningful and complete in some ways but the taxpayer examples are easier to verify and understand by the media and the public. Hence, both need to be addressed.

The Problems with "Taxpayer Examples"

The Problems with "Taxpayer Examples" (Part 2)

Who Will See Their Taxes Go Up under the House and Senate Plans?

Sunday, November 26, 2017

The Problems with "Taxpayer Examples" (Part 2)

On November 16, the Senate Committee of Finance advanced the "Tax Cuts and Jobs Act" out of committee. Information on the plan is posted here, including a link to Taxpayer Examples. The first two of those examples are for a "Family of four earning $73,000" and a "Single parent with one child earning $41,000". I've created an R Shiny application which can interactively show the tax savings for these two examples and other variations. That application can be accessed at this link.

Selecting "Example 5 - Family of Four (Senate)" in the "Tax Examples" select list causes the following table and plot to be output:

Example 5 - Family of Four Earning $73,000 Per Year

         Names       Taxes          Released
1 Current 2017  3682.50000              3683
2  Senate 2018  1499.00000              1499
3       Change -2183.50000             -2184
4     % Change   -59.29396 nearly 60 percent

The "Taxes" column are the numbers calculated by the application and the "Released" column are the numbers released by the Senate committee for their first example. As can be seen, the numbers are identical (when rounded to the nearest dollar). The plot shows the calculated percent tax cut for this example for all incomes up to $200,000 which have tax cuts up to 100 percent. As can be seen, the tax cut is about 100 percent at about $60,000 (actually $60,509) but is still positive at $200,000 (at about 13 percent). The vertical red line is at $73,000, relatively close to the income with the maximum tax cut shown in the plot.

Selecting "Example 6 - Single Parent, One Child (Senate)" in the "Tax Examples" select list causes the following table and plot to be output:

Example 6 - Single Parent with One Child Earning $41,000 Per Year

         Names       Taxes          Released
1 Current 2017  1865.00000              1865
2  Senate 2018   488.00000               488
3       Change -1377.00000             -1377
4     % Change   -73.83378 nearly 75 percent

The columns are the same as before but now are for the Senate committee's second example. As can be seen, the calculated and released numbers in the table are identical. As before, the plot shows the calculated percent tax cut for this example for all incomes up to $200,000 which have tax cuts up to 100 percent. As can be seen, the tax cut is about 100 percent at about $40,000 (actually $38,915) but is still positive at $200,000 (at about 15 percent). The vertical red line is at $41,000, very close to the income with the maximum tax cut shown on the plot.

There's a problem with the above two examples, however. They are comparing the taxes in 2017 under current law with the taxes in 2018 under the Senate plan. Because certain items like the tax brackets and the standard deduction increase with inflation, taxes tend to go down on a salary which does not increase with inflation. For example, comparing taxes for the above two examples for 2017 and 2018 under current law results in an apparent tax cut of 3.39 and 3.89 percent respectively. This is relatively small but should be accounted for. Hence, following are the results for the two example comparing the taxes in 2018 under current law with the taxes in 2018 under the Senate plan.

Married, 2 children, 0 dependents, 73000 in wages        Household, 1 children, 0 dependents, 41000 in wages
                                                         
         Names       Taxes          Released                      Names       Taxes          Released
1 Current 2018  3557.50000              3683             1 Current 2018  1792.50000              1865
2  Senate 2018  1499.00000              1499             2  Senate 2018   488.00000               488
3       Change -2058.50000             -2184             3       Change -1304.50000             -1377
4     % Change   -57.86367 nearly 60 percent             4     % Change   -72.77545 nearly 75 percent

As can be seen, the change is not great but does make a difference. In any event, the above two plots show a problem with discrete taxpayer examples. Such examples don't show the variation of a tax cut across incomes, even when all of the other parameters are the same. Still, both of these two examples did seem to show tax cuts across incomes, even if the size of the tax cut may vary. Are there examples in which taxpayers don't get a tax cut?

To answer this question, it helps to look at exactly which changes in the law lead to the tax cuts. The "Calculation of Taxes" tab shows the actual calculation of taxes under the different plans. Following is the output for the two examples:

Example 5 - Family of Four Earning $73,000 Per Year             Example 6 - Single Parent with One Child Earning $41,000 Per Year
                                                                
                      Tax Plan     2018 Senate 2018   Change                          Tax Plan     2018 Senate 2018   Change
1  --------------------------- --------    -------- --------    1  --------------------------- --------    -------- --------
2  Wages, salaries, tips, etc.    73000       73000        0    2  Wages, salaries, tips, etc.    41000       41000        0
3                   Exemptions   -16600           0    16600    3                   Exemptions    -8300           0     8300
4          Standard deductions   -13000      -24000   -11000    4          Standard deductions    -9550      -18000    -8450
5          Itemized deductions        0           0        0    5          Itemized deductions        0           0        0
6  --------------------------- --------    -------- --------    6  --------------------------- --------    -------- --------
7                      Medical        0           0        0    7                      Medical        0           0        0
8        State and local taxes        0           0        0    8        State and local taxes        0           0        0
9            Real estate taxes        0           0        0    9            Real estate taxes        0           0        0
10      Home mortgage interest        0           0        0    10      Home mortgage interest        0           0        0
11                     Charity        0           0        0    11                     Charity        0           0        0
12   Misc. repealed deductions        0           0        0    12   Misc. repealed deductions        0           0        0
13 --------------------------- --------    -------- --------    13 --------------------------- --------    -------- --------
14              Taxable income    43400       49000     5600    14              Taxable income    23150       23000     -150
15 --------------------------- --------    -------- --------    15 --------------------------- --------    -------- --------
16       Tax on taxable income   5557.5        5499    -58.5    16       Tax on taxable income   2792.5        2488   -304.5
17                Child credit    -2000       -4000    -2000    17                Child credit    -1000       -2000    -1000
18      Other dependent credit        0           0        0    18      Other dependent credit        0           0        0
19               Parent credit        0           0        0    19               Parent credit        0           0        0
20    Earned income tax credit        0           0        0    20    Earned income tax credit        0           0        0
21 --------------------------- --------    -------- --------    21 --------------------------- --------    -------- --------
22                 Amount owed   3557.5        1499  -2058.5    22                 Amount owed   1792.5         488  -1304.5
As can be seen, the one increase in taxes is Exemptions. This is because the Senate bill eliminates the deduction for exemptions. The exemption amount in current 2018 law is $4,150. Hence, a family of four loses $16,600 (4 * $4,150) and a single parent with one child loses $8,300 (2 * $4,150) from the elimination of this deduction.

The two major decreases in taxes is Standardized deductions and the Child credit. This is because the former almost doubles and the latter does double. This leads naturally to the question of how taxpayers who don't benefit from these two changes in the tax law would do. The latter would obviously be taxpayers who have no eligible children and the former would be taxpayers who itemize deductions. In addition, taxpayers who have many non-child exemptions would seem to be worse off by the new tax law.

These cases are covered in my prior post. Examples A and B look at taxpayers who have no child credits and who itemize up to the approximate level of the new standard deduction. Examples C and D look at such taxpayers who also have an additional several thousand dollars of deductions which have been eliminated. Examples E and F look at taxpayers who pay 10 percent of their income in state and local taxes. Finally, Examples G through J look at taxpayers who have one or more non-child dependents.

As described there, Examples A through D show taxpayers with lower incomes who will end up paying higher taxes immediately whereas Examples E and F show taxpayers with higher income who will end up paying more. Examples G through J do not show any taxpayers with non-child dependents (but who use the standard deduction) who will pay higher taxes. This is likely because the Senate bill provides a credit of $500 for such dependents which appears to make up for the loss of the exemption.

As mentioned in my prior post, it should be noted that these examples don't include a number of major components that should greatly favor taxpayers with higher income. Those components include repeal of the alternative minimum tax, a large tax cut for some “pass-through” income of individual business owners, and the large corporate tax cut. There's also the repeal of the estate tax which will chiefly benefit taxpayers of great wealth, if not great income.

Still, the above information shows the severe limitations of the discrete examples released by the Senate Committee of Finance. It also shows how the examples can be examined over all incomes and additional examples can be found and examined to obtain a broader view of the effect of the Senate tax plan will have on taxpayers. Those who release discrete examples would do well to likewise broaden their analysis. At the very least, they would do well to show the calculations that lead to their results. This would serve to both verify the calculations and to show which tax measures are having the greatest effect on the results.

The Problems with "Taxpayer Examples"

The Problems with "Taxpayer Examples" (Part 3)

Who Will See Their Taxes Go Up under the House and Senate Plans?

Thursday, November 16, 2017

Who Will See Their Taxes Go Up under the House and Senate Plans?

As shown at the end of my last post, Example 4 released by the House Ways and Means Committee gives a tax increase if the wages are reduced to $45,000. This reveals an important point. It isn't just taxpayers who lose their deduction for medical or state and local taxes who can end up paying more in taxes. That appears to also occur for lower-wage workers who have no children but already have as many itemized deductions as the new standard deductions, even when they can still take those deductions. The following tables and plots show the change in taxes for such taxpayers, single and married, under the House and Senate tax bills. They were generated by selecting Examples A and B in the interactive application at this link.
Example A - Single Person Making $25,000 Per Year with $12,000 in Deductions             Example B - Married Couple Making $50,000 Per Year with $24,000 in Deductions

House                              Senate                                                House                              Senate
         Names      Taxes                   Names      Taxes                                      Names      Taxes                   Names       Taxes
1 Current 2018  885.00000          1 Current 2018  885.00000                             1 Current 2018 1770.00000          1 Current 2018 1770.00000
2   House 2018 1236.00000          2  Senate 2018 1369.50000                             2   House 2018 2472.00000          2  Senate 2018 2739.00000
3       Change  351.00000          3       Change  484.50000                             3       Change  702.00000          3       Change  969.00000
4     % Change   39.66102          4     % Change   54.74576                             4     % Change   39.66102          4     % Change   54.74576

As can be seen in the first table, a single person making $25,000 per year and having $12,000 in deductions (same as the new standard deduction in the Senate plan) will now have to pay nearly 40 percent more in taxes under the House plan. The result is the same however the $12,000 is divided up among deductions, regardless of whether or not those deductions are still allowed. As can be seen in the third table, a married couple making $50,000 per year and having $24,000 in deductions (same as the new standard deduction in the Senate plan) will now have to pay nearly 40 percent more in taxes under the House plan. As before, the result is the same however the $24,000 is divided up among deductions. In fact, it's interesting to note that the taxes in this table are exactly double the taxes in the prior table and the percent change in taxes is the same 39.66 percent increase. This is because a number of other key variables like income and standard deduction are also exactly double.

The second and fourth tables and the last two plots show the change in taxes under the Senate plan. As can be seen, both single and married taxpayers get an even larger tax increase of over 54 percent under this plan. The main reason for the difference is chiefly that the House plan has a family credit of $300 that applies to the parents whereas the Senate plan has a non-child dependent credit of $500 which does NOT apply to the parents. Hence, it's important to note that the $300 credit in the House plan covers the parents but the $500 credit in the Senate plan does not. An additional concern, however, is that the $300 House credit is currently scheduled to expire in 5 years. Selecting "House 2018 w/o Family Credits" for Tax Plan 2 shows that taxes increase over 73 percent for both Examples A and B in this case. The chief reason for this is likely that the Senate plan retains the 10 percent bracket while the House plan raises it to 12 percent.

What happens if the taxpayer currently has deductions that are higher than the new standard deduction? If the additional deductions have not been repealed, their should be little difference as the taxpayer can continue to deduct them. The result is very much different if those additional deductions have been repealed. The following tables and plots show the change in taxes for such taxpayers, single and married, under the House and Senate tax bills. For single taxpayers, they show the effect of $3,000 ($2,800 for the House) of additional repealed deduction and for married taxpayers, they show the effect of $6,000 ($5,600 for the House) in additional repealed deductions. The tables and plots were generated by selecting Examples C and D in the same interactive application.

Example C - Single Person Making $25,000 Per Year with $15,000 in Repealed Deductions    Example D - Married Couple Making $50,000 Per Year with $30,000 in Repealed Deductions

House                              Senate                                                House                              Senate
         Names     Taxes                    Names     Taxes                                       Names     Taxes                    Names      Taxes
1 Current 2018  585.0000           1 Current 2018  585.0000                              1 Current 2018 1170.0000           1 Current 2018 1170.0000
2   House 2018 1236.0000           2  Senate 2018 1369.5000                              2   House 2018 2472.0000           2  Senate 2018 2739.0000
3       Change  651.0000           3       Change  784.5000                              3       Change 1302.0000           3       Change 1569.0000
4     % Change  111.2821           4     % Change  134.1026                              4     % Change  111.2821           4     % Change  134.1026

As can be seen in the first table, a single person making $25,000 per year and having $15,000 in deductions ($2,800 more than the new standard deduction in the House plan) will now have to pay over 111 percent more in taxes under the House plan. The result is the same however the $15,000 is divided up among deductions, as long as they include at least $2,800 in deductions that are being repealed. As can be seen in the third table, a married couple making $50,000 per year and having $30,000 in deductions ($5,600 more than the new standard deduction in the House plan) will now have to pay over 111 percent more in taxes under the House plan. As before, the result is the same however the $30,000 is divided up among deductions, as long as they include at least $5,600 in deductions that are being repealed. As before, it's interesting to note that the taxes in the third table are exactly double the taxes in the first table and the percent change in taxes is the same 111.28 percent increase. Again, this is because a number of other key variables like income and standard deduction are also exactly double.

The second and fourth tables and the last two plots show the change in taxes under the Senate plan. As can be seen, both single and married taxpayers get a larger tax increase of over 134 percent under this plan. As before, the main reasons for the difference from the House plan is chiefly that the $300 Family Credit in the House applies to parents but the $500 Non-child Dependent Credit in the Senate does not.

The prior examples look at cases with the same deduction across all income levels. State and local taxes, of course, will be more related to a percentage of the taxpayer's income. The following tables and plots show the change in taxes for taxpayers paying 10 percent of their income in state and local taxes, under the House and Senate tax bills. The tables and plots were generated by selecting Examples E and F in the same interactive application. For these examples, the maximum wage is automatically increased from $200,000 to $2,000,000 since this negative effects of this change mainly effects taxpayers with higher incomes. Also, the specific wages for the tables were chosen to be close to local minimums shown in the plots.

Example E - Single Person with 10 Percent of Income in State and Local Taxes             Example F - Married Couple with 10 Percent of Income in State and Local Taxes
                     ($470,000 in wages)                                                                      ($530,000 in wages)
      
House                              Senate                                                House                              Senate
         Names        Taxes                 Names        Taxes                                    Names        Taxes                 Names        Taxes
1 Current 2018 121290.75000        1 Current 2018 121290.75000                           1 Current 2018 1.302715e+05        1 Current 2018 1.302715e+05
2   House 2018 134080.00000        2  Senate 2018 136796.00000                           2   House 2018 1.386600e+05        2  Senate 2018 1.340920e+05
3       Change  12789.25000        3       Change  15505.25000                           3       Change 8.388500e+03        3       Change 3.820500e+03
4     % Change     10.54429        4     % Change     12.78354                           4     % Change 6.439244e+00        4     % Change 2.932721e+00

As can be seen in the first table, a single person making $470,000 per year and paying 10 percent of their wages in state and local taxes will now have to pay 10.54 percent more in taxes under the House plan. The second table shows that this increases to be 12.78 percent under the Senate plan. The reason for the difference appears to be slightly more favorable tax brackets for a single taxpayer with those wages in the House bill. In any case, the first plot shows that the increase in taxes continues through a 2 million dollar income at about 10 percent under the House bill. The third plot shows that the increase in taxes through a 2 million dollar income becomes slightly smaller under the Senate bill. This appears to be due to the cut in rates from 39.6 to 38.5 percent under the Senate bill for incomes over $500,000.

As can be seen in the third table, a married couple making $530,000 per year and paying 10 percent of their wages in state and local taxes will now have to pay 6.44 percent more in taxes under the House plan. The fourth table shows that this decreases to 2.93 percent under the Senate plan. The reason for the difference appears to be slightly more favorable tax brackets for a married couple with those wages in the Senate bill. In any case, the increase in taxes is 6.79 and 4.45 percent at a 2 million dollar income under the House and Senate bills, respectively, according to the application. As can be seen in second and fourth plots, these increases become close to zero (a tax increase of 1.6 percent and a tax cut of 2.8 percent according to the application) at a 1 million dollar income. This upward bulge at 1 million dollars appears to be due to the fact that both plans increase the income at which the tax bracket starts from $470,700 to 1 million dollars.

A final concern is the effect of the tax plans on non-child dependents. Both plans benefit taxpayers with children in that the child credit is increasing under both. The effect on non-child dependents is less clear, however. This is because both plans eliminate the Exemptions but provide a credit to compensate. The following tables and plots show the change in taxes for single taxpayers with one non-child dependent and married couples with two non-child dependents, under the House and Senate tax bills. The tables and plots were generated by selecting Examples G and H in the same interactive application.

Example G - Single Person Making $25,000 Per Year with 1 Non-Child Dependent             Example H - Married Couple Making $50,000 Per Year with 2 Non-Child Dependents

House                              Senate                                                House                              Senate
         Names      Taxes                   Names      Taxes                                      Names      Taxes                   Names      Taxes
1 Current 2018 1053.75000          1 Current 2018 1053.75000                             1 Current 2018 2107.50000          1 Current 2018 2107.50000
2   House 2018  936.00000          2  Senate 2018  869.50000                             2   House 2018 1872.00000          2  Senate 2018 1739.00000
3       Change -117.75000          3       Change -184.25000                             3       Change -235.50000          3       Change -368.50000
4     % Change  -11.17438          4     % Change  -17.48517                             4     % Change  -11.17438          4     % Change  -17.48517

As can be seen from the plots, both tax plans provide tax cuts for these two cases for all incomes up through at least $200,0000. However, the Family Credit of $300 under the House plan is currently scheduled to expire in 5 years. For this reason, it makes sense to look at the House Plan without Family Credits. It also makes sense to look at the effect of the tax plans on families with additional non-child dependents since these families exist. The following tables show the effect of the tax plans on single taxpayers with 1 to 3 non-child dependents and on married couples with 1 to 6 non-child dependents.

Example G - Single Person Making $25,000 Per Year with N Non-Child Dependent             Example H - Married Couple Making $50,000 Per Year with N Non-Child Dependents

House                                     Senate                                         House                                    Senate

   Non-Child   Tax Cut(-)   w/o Family       Non-Child   Tax Cut(-)                         Non-Child   Tax Cut(-)  w/o Family       Non-Child   Tax Cut(-)
  Dependents  or Increase      Credits      Dependents  or Increase                        Dependents  or Increase     Credits      Dependents  or Increase
           1    -11.17438     45.76512               1    -17.48517                                 1    -20.43956    12.52747               1    -17.98535
           2      5.123967   153.8843                2    -38.92562                                 2    -11.17438    45.76512               2    -17.48517
           3     76.84211    708.4211                3   -168.6842                                  3     -3.261538   89.04615               3    -23.75385
                                                                                                    4      5.123967  153.8843                4    -38.92562
                                                                                                    5     22.26415   286.4151                5    -69.93711
                                                                                                    6     76.84211   708.4211                6   -168.6842
As can be seen in the first and third tables, elimination of the Family Credit causes tax cuts to become tax increases in the House bill. These increases get larger with additional non-child dependents. With the Family Credits, the House bill provides a tax cut for a single payer with one non-child dependent and for a married couple with up to 3 non-child dependents. However, additional non-child dependents beyond this cause the tax cuts to become tax increases.

Under the Senate bill, both single and married taxpayers appear to get a tax cut with any number of non-child dependents. In fact, the percentage of the tax cut grows as the number of non-child dependents grow. This would suggest that the $500 Family Credit in the Senate bill is large enough to make up for the loss of the exemption but the $300 Family Credit in the House bill is not. This actually makes sense since the exemption amount for 2018 is $4,150. Multiplying this by the 12 percent rate paid by the above examples gives $498. Hence, the House bill $300 Family Credit in the House bill is far too small to compensate for the loss of the exemption but the $500 Family Credit in the Senate bill is large enough. The brackets in the Senate bill also help in that the first $9,525 for single taxpayers and $19,050 for married taxpayers is taxed at 10 percent.

Example I was created from Example G by increasing the number of non-child dependents from 1 to 2. Similarly, Example J was created from Example H by increasing the number of non-child dependents from 2 to 4. The following tables and plots were generated by selecting these two new examples in the same interactive application.

Example I - Single Person Making $25,000 Per Year with 2 Non-Child Dependent             Example J - Married Couple Making $50,000 Per Year with 4 Non-Child Dependents

House                              Senate                                                House                              Senate
         Names      Taxes                   Names      Taxes                                      Names       Taxes                  Names      Taxes
1 Current 2018 605.000000          1 Current 2018  605.00000                             1 Current 2018 1210.000000         1 Current 2018 1210.00000
2   House 2018 636.000000          2  Senate 2018  369.50000                             2   House 2018 1272.000000         2  Senate 2018  739.00000
3       Change  31.000000          3       Change -235.50000                             3       Change   62.000000         3       Change -471.00000
4     % Change   5.123967          4     % Change  -38.92562                             4     % Change    5.123967         4     % Change  -38.92562

As mentioned in my prior post, the biggest concern raised by the House bill is likely the higher taxes that they represent to some lower income taxpayers in the first year and to many more lower income taxpayers in future years. The Senate bill has similar problems.

In any event, the above tables and plots do show several cases in which certain groups of taxpayers will immediately pay higher taxes. The plots for Examples A and B show that taxpayers who currently have deductions as large as the new standard deductions (about $12,000 for single and $24,000 for married) will likely pay more if their incomes are below about $37,500 for single and $75,000 for married. For the Senate, these incomes look to be closer to $40,000 and $80,000. The plots for Examples C and D show that taxpayers with the above-mentioned incomes that have additional deductions that are expiring on the order of $3,000 for single and $6,000 for married will see tax increases under both plans. The plots for Example E and F show that taxpayers with state and local income taxes that are 10 percent of their income will see tax increases above about $250,000 for single taxpayers. For married taxpayers, the tax increases will occur above incomes of about $350,000 for the House plan and $500,000 for the Senate plan. Example I and J and the preceding tables show that single taxpayers with two or more non-child dependents and married taxpayers with 4 or more non-child dependents will see tax increases. Examples I and J and the preceding tables show that some single taxpayers with two or more non-child dependents and married taxpayers with 4 or more non-child dependents will see tax increases under the House plan. Those taxpayers will have lower incomes, between about $25.000 and $30,000 for single and between about $50,000 and $60,000 for married. Under the Senate plan, however, these taxpayers will all see tax cuts.

It should be noted that these examples don't include a number of major components that should greatly favor taxpayers with higher income. As can be seen in this article, those components include repeal of the alternative minimum tax, a large tax cut for some “pass-through” income of individual business owners, and the large corporate tax cut. There's also the repeal of the estate tax which will chiefly benefit taxpayers of great wealth, if not great income. Hence, it would seem very possible that both plans are heavily tilted to those with high incomes and/or wealth. In any event, the examples show that there are a number of lower-income taxpayers who will see their taxes increase. There are also a number of higher-income taxpayers who will see their taxes increase due to the elimination of the deduction for state and local income taxes.

The Problems with "Taxpayer Examples"

The Problems with "Taxpayer Examples" (Part 2)

The Problems with "Taxpayer Examples" (Part 3)

Monday, November 6, 2017

The Problems with "Taxpayer Examples"

On November 2, a press release from the office of Speaker Paul Ryan announced the introduction of the Tax Cuts and Jobs Act. It begins as follows:

Today, House Speaker Paul Ryan (R-WI), Ways and Means Committee Chairman Kevin Brady (R-TX), and other members of House leadership and the Ways and Means Committee introduced the Tax Cuts and Jobs Act—bold legislation to overhaul America’s tax code for the first time in 31 years. With this bill, a typical middle-income family of four, earning $59,000 (the median household income), will receive a $1,182 tax cut.

At the end of the release is a link to descriptions of this and several other examples of how the proposed tax cuts would save money for various types of taxpayers. I've created an R Shiny application which can interactively show the tax savings for the first four examples and other variations. That application can be accessed at this link.

Selecting "Example 1" in the "Tax Examples" select list causes the following table and plot to be output:

         Names       Taxes Released
1 Current 2017  1582.50000     1582
2   House Bill   400.00000      400
3       Change -1182.50000    -1182
4     % Change   -74.72354         

The second column shows the calculated taxes and the third column shows the taxes reported in the press release. As can be seen in the table, they are almost identical. The plot, on the other hand, shows the percent taxcut for the example but does so for all incomes from $0 to $200,000 with the example's income denoted by a red vertical line. As can be seen, this income has one of the higher tax cuts among those displayed.

Selecting "Example 2" in the "Tax Examples" select list causes the following table and plot to be output:

         Names       Taxes Released
1 Current 2017  -670.54660         
2   House Bill -1276.79660  < -1000
3       Change  -606.25000   < -700
4     % Change    90.41132         

Note: Taxes for both plans include an EITC of $1536.7966 (using the 2017 formula)

As can be seen in the third column of the table, the press release was somewhat vague about the tax numbers for this example, stating that "Cindy will receive a tax refund of over $1,000" which is "over $700 larger than the refund she receives today. However, the second column shows her paying taxes in both cases, not getting a refund. The $1277 tax refund for the House Bill can be verified by the following calculation:

($30,000 - $12,000) * 0.12 - $1600 - $300 - $1537 = -$1277
In this calculation, $12,000 is the standard deduction for single taxpayers, 0.12 is the 12% tax rate, $1,600 is the child credit for the child, and $300 is the family credit for the mother. Finally, the $1537 is the Earned Income Tax Credit (EITC) as calculated using the 2017 formula.

Hence, the figure for the House Bill refund is "over $1,000" but it is just $606 more than the current refund, not "over $700 larger than the refund she receives today". To my knowledge, the House Bill has not changed how EITC is calculated and is using the 2017 formula. In any case, $606 rather than "over $700" is a relatively small disagreement.

Selecting "Example 3" in the "Tax Examples" select list causes the following table and plot to be output:

         Names       Taxes Released
1 Current 2017  5173.75000     5173
2   House Bill  4020.00000     3872
3       Change -1153.75000    -1301
4     % Change   -22.30007         

As can be seen from the table, the numbers for the Current 2017 taxes do match but the calculation for the House Bill taxes is $148 greater than the releases figure. The $4,020 figure can be verified by the following calculation:

($48,000 - $12,000) * 0.12 - $300 = $4,020.
Hence, the $3,872 figure appears to be in error. Unlike the prior two examples, however, the plot shows that the income of $48,000 provides among the lower tax cuts for incomes under about $60,000.

Finally, selecting "Example 4" in the "Tax Examples" select list causes the following table and plot to be output:

         Names       Taxes Released
1 Current 2017 12180.00238    12180
2   House Bill 10450.00000    11050
3       Change -1730.00238    -1130
4     % Change   -14.20363         

The press release specifies that the taxpayers in this example "will pay $8,400 in mortgage interest and $6,900 in state and local property taxes". However, it does not specify how much they paid in state and local taxes despite stating that they were in a "high tax state". For this reason, I calculated that paying 7.64347 percent of their income in state and local taxes would have provided them with the deduction to achieve the $12,180 figure for Current 2017 taxes given in the press release. With no deduction for state and local taxes, their taxes would have been $14,377.50.

As can be seen from the table, the calculated taxes for the House Bill is $10,450, exactly $600 less than the $11,050 figure given in the press release. This suggests that the figure in the press release may have been calculated without including the family credit of $300 per person. This can be checked by selecting "House Bill w/o Family Credits" in the "Tax Plan 2" select list. In that case, the following table and plot are output:

                          Names        Taxes Released
1                  Current 2017 12180.002375    12180
2 House Bill w/o Family Credits 11050.000000    11050
3                        Change -1130.002375    -1130
4                      % Change    -9.277522         

Now, the calculated taxes match those in the press release. Also, the plot shows that the income of $115,000 has about the highest tax cut among those displayed.

The selection of "House Bill w/o Family Credits" is appropriate for another reason. A Washington Post article points out that the "new Family Flexibility Credit of $300 for each tax filer and another $300 for a spouse" expires after five years. It links to an analysis by David Kamin, a tax law professor at New York University which goes into more details. It shows that, because of this and other provisions in the House Bill tax bill, the tax cut shown in the first example would turn into a tax hike over current law in 2024 and beyond.

The above two plots show something else that's interesting. In the fourth example, the House Bill represent a tax hike for some lower income taxpayers in the first year. For example, selecting "Example 4" and changing "Wages, salaries, tips, etc." to 45000 causes the following table to be output:

         Names       Taxes Released
1 Current 2017 1816.043850    12180
2   House Bill 1920.000000    11050
3       Change  103.956150    -1130
4     % Change    5.724319         
Hence, the House Bill represent a 5.7 percent tax increase in this case. Of course, the 7.64347 percent of income for state and local taxes may be a bit high for this income level. Still, you can move this number to "Medical and dental expenses (% over 10% of income)" and set state and local taxes to 0 and get the same result. Or, alternately, you can set both medical and state & local taxes to zero, set "Charitable contributions" to $3,440 and get about the same result.

The biggest concern raised by the House Bill bill is likely the higher taxes that they represent to some lower income taxpayers in the first year and to many more lower income taxpayers in future years. Also, the above plots show that it is helpful to look at taxpayer examples over broad ranges of income. Still, it is very concerning that the examples released by the office of Speaker Paul Ryan (which came from the Committee of Ways and Means) appear to contain a number of errors. This suggests that, even for something as seemingly simple as the calculation of taxes under various plans, publications should show their work.

The Problems with "Taxpayer Examples" (Part 2)

Who Will See Their Taxes Go Up under the House and Senate Plans?

Tuesday, April 25, 2017

Will the Fed selling Treasuries affect interest rates?

On April 5, it was reported that the Federal Reserve wants to start unwinding the $4.5 trillion in bonds on its balance sheet this year. This revelation came from a summary of the Federal Open Market Committee meeting held in March. The composition of the Fed's balance sheet can be seen in the following chart:

Note: In the following charts, click on the chart to see its data and sources.

Federal Reserve balance sheet: 2003-2017

As can be seen from the purple area in the chart, about 2.5 of the 4.5 trillion in assets are Treasuries. Also visible is that these levels have remained stable since the end of 2014, when QE3 ended. In any event, there has been much discussion on what will happen when the Fed starts selling its Treasuries. More specifically, who will step in and buy the Treasuries that the Fed is selling plus any additional debt being created? To judge this, it helps to look at how the holders of Treasuries have changed over time. The following chart shows the holders of Treasury securities since 1970:

Major Holders of Treasury Securities: 1970-2016

As stated below the table on this page, this includes marketable and nonmarketable Treasury securities held by the public (net of premiums and discounts) and Treasury securities held by federal government employee retirement funds. Hence, it does not include the $2.8 trillion of special-issue treasuries held by the Social Security trust fund. In any event, it's worth noting how the total value of Treasuries has increased sharply since the financial crisis. Hence, there is likely to be a great deal of new Treasuries that need to be bought in addition to those being sold by the Fed.

The chart does show that the value of Treasuries held by individuals and mutual funds increased sharply after the 2008 financial crisis. It would seem likely that this was in response to the fact that Treasuries were one of the few asset classes that did not go down sharply during the crisis. The value of Treasuries held by banking institutions also increased somewhat, possibly due to the improvement in their balance sheets. Treasuries held by government (state and local) and insurance companies seemed to remain fairly stable. Pension funds (including government retirement funds) did increase somewhat but were already major holders of Treasuries. Of course, as shown in the first chart in this post, the value of Treasuries held by the Fed increased sharply starting in 2011.

The one other major holder of Treasuries were foreign holders and they likewise can be seen to have increased after the crisis. The composition of this group can be seen in the following chart:

Major Foreign Holders of Treasury Securities: 2000-2016

As can be seen, Japan and Mainland China are the two countries with the largest holdings of Treasuries at just over $1 trillion each. The chart shows that the holdings of both countries have decreased over the past three years. The next two largest holdings are in Ireland and the Cayman Islands. This may initially seem surprising but the reason is that both are regional financial centers. The holdings in both of those countries have increased sharply since the financial crisis. Finally, the olive-colored line shows that the holding of all other countries have remained about the same over the past two years. As a result, the blue line at the top shows that the holdings of all countries has decreased slightly over the past two years.

Judging from the above chart, it would not seem that foreign holders of Treasuries can be counted on to buy many of the new Treasuries being created or sold by the Fed. One exception would be if those Treasuries pay higher interest rates. Another exception might be if there is another global financial crisis and U.S. Treasuries are seen as a safe harbor. The same may be true for Treasuries bought by individuals and mutual funds. Higher interest rates and/or a major market correction could motivate more investors to buy Treasuries.

There is no agreement on the effect of all this on future interest rates. For example, one blog suggests that "[i]n addition to actual rate hikes, this would put further upward pressure on interest rates, and downward pressure on bond prices." However, another blog reminds readers that "[a]s the Fed ceased QE1 and all economists knew rates must rise...rates shocked 100% of economists and fell by a third." It concludes "I don't think the Federal Government nor the Federal Reserve are about to let a "so called free-market" determine the yields paid on America's debt." Of course, the Federal Government and Federal Reserve may not be able to do anything to avoid higher interest rates. However, it is true that higher interest rates will cause the interest payments to increase, putting additional pressure on the U.S. budget. This will certainly be a motivation to keep interest rates low if that is possible.

Friday, April 21, 2017

Why does President Trump like a low-interest rate policy?

In an interview with the Wall Street Journal published on Wednesday, April 12th, President Trump said "I do like a low-interest rate policy, I must be honest with you". This view has reportedly changed over time with Trump saying that "Janet Yellen should have raised the rates" on November 3, 2015. In any event, it seems worth looking into why Trump may be supportive of a low-interest rate policy now.

This blog post lists winners and losers from low interest rates in the United Kingdom. The third item listed under winners is government debt payments and the first chart shows that bond yields are declining but then states the following:

This fall in bond yields is occurring, despite a rise in government debt to GDP, and a persistent budget deficit. It is important for limiting the percentage of tax revenue spent on debt interest payments.

This same statement could be made about the United States. The following chart shows various treasury interest rates since the early 50s:

Note: In the following charts, click on the chart to see its data and sources.

Treasury Interest Rates: 1953-2017

As can be seen, they have been dropping since they reached highs in the early eighties. The following chart then shows the federal debt as a percentage of GDP:

Public and Gross Federal Debt: 1940-2021

The red line is the gross federal debt and includes the debt owed to Social Security and other government trust funds and the blue line is the federal debt owed to the public. The net interest that is paid on this debt to the public is the purple line in the following chart:

Top U.S. Federal Outlays: 1970-2012

As can be seen, the net interest has come down to historically low levels even as the federal debt has risen sharply. This is due to the historically low interest rates being paid on that debt. However, note that the net interest is projected to double from about 1.25 percent of GDP in 2015 to about 2.5 percent of GDP by 2021. This is chiefly because the interest rates being paid on that debt is projected to increase. The following table shows the projected rates that will be paid on 91-day Treasury bills and 10-year Treasury notes through 2026:

Table S–12. Economic Assumptions
(Calendar years)
                            Actual  Projections
                            ------  -----------------------------------------------------------
                              2014  2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Interest rates, percent:      ----  ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
  91-day Treasury bills  .....   *     *  0.7  1.8  2.6  3.1  3.3  3.4  3.4  3.3  3.3  3.2  3.2
  10-year Treasury notes ..... 2.5   2.1  2.9  3.5  3.9  4.1  4.2  4.2  4.2  4.2  4.2  4.2  4.2

* 0.05 percent or less.
Source: U.S. Budget, FY 2017, Summary Table S-12
The CBO (Congressional Budget Office) just put out The 2017 Long-Term Budget Outlook in March. On page 19, it states:

The government’s net interest costs are projected to nearly double as a share of the economy over the next decade—from 1.4 percent of GDP in 2017 to 2.7 percent by 2027—as currently low interest rates rise and as greater federal borrowing leads directly to greater debtservice costs. In the extended baseline, those costs reach 6.2 percent of GDP by 2047 (see Figure 5 on page 12).

It would seem very possible that President Trump has been made aware that lower interest rates would have a beneficial effect on the budget, making any planned tax cuts or infrastructure spending more affordable. That could have much to do with why he now likes a low-interest rate policy.

About Me

I became interested in U.S. budget and economic matters back in 1992, the first time that I remember the debt becoming a major issue in a presidential election. Along with this blog, I have a website on the subject at http://www.econdataus.com/budget.html. I have blogged further about my motivations for creating this blog and website at this link. Recently, I've been working on replicating studies such as the analysis at this link.

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