Tax 2018: Requiem for Ability to Pay

Abstract

This is not just another tax reform piece. Although the tax system changed at midnight on New Year’s eve, 2017, in the flurry of activity to understand the new legislation and its effects, almost no attention has been paid to analyzing whether the income tax system has been transformed in any fundamental way. But transformed, it has been.

The new legislation, informally known as the Tax Cuts and Jobs Act, (or “TCJA”), transforms the income tax system in at least four fundamental ways, significantly undermining one of the bedrock principles of our tax system — horizontal equity — and ignoring ability to pay. First, the TCJA eliminates consideration of a taxpayer’s support obligations in determining the tax base, thereby creating a situation in which two taxpayers with wildly differing ability to pay will nevertheless face equal tax burdens. Second, it unmoors the zero bracket — the amount of income that will never be included in the tax base — from the poverty level so that taxpayers with income significantly below the poverty level may nevertheless face positive tax liabilities. Third, it creates a distinction between types of income from labor, reserving for employees the highest possible tax rate and making that rate dependent on the form in which personal services are rendered. Fourth, it rejects the principle of capital export neutrality, thereby creating a dramatic difference in the tax burden placed on income as a result of its source: henceforth, much foreign source income received by some U.S. persons, in the U.S., will not be subject to U.S. income tax, ever. And of all the changes, only the last was widely anticipated (at least in part), and long debated and analyzed by tax scholars and professionals prior to enactment.

Although some of the most important changes I discuss are set to expire or phase out after 2025, understanding their policy implications is important, not only because they are now the law but also because Congress may extend them, perhaps indefinitely. Before that happens, their policy implications should be thoroughly understood and debated.

Keywords: tax, tax reform, TCJA, Tax Cuts and Jobs Act, Ability to pay, horizontal equity, labor, alternative minimum tax, dependents, tax expenditures, territorial

JEL Classification: K34