By Stephanie Hoffer, @profhoffer
The President’s one-page tax plan, released on Wednesday, claims that it will “[p]rovide relief to American families – especially middle income families.” Whether tax reform eventually lives up to the President’s claim, though, will depend on how he and the Congress choose to address not only tax rates and the standard deduction, but also the personal exemption and credits related to children and dependents.
Like the Republican blueprint for tax reform, the President’s plan would double the standard deduction while trimming itemized deductions. It also would expand the credit for child and dependent care, although the plan doesn’t specify how.
Notably, the Republican proposal would eliminate personal exemptions provided by § 151, which allow a deduction of $4,050 per dependent in 2017. Dependents include a taxpayer’s spouse, children, and other members of the household who rely family support. Although the repeal of § 151 was not specifically mentioned in the President’s proposal, the President and Congress must reach consensus on how to reduce the cost of tax reform. Eliminating personal exemptions in favor of an expanded standard deduction may be an approach on which both could agree, but it may not be good policy.
An outsized standard deduction initially looks like a gift to families, but simultaneous repeal of the personal exemption would wipe out its benefit for most. Consider a family of four. Both the Republican plan and the President’s plan would increase the standard deduction for a couple filing jointly from roughly $12,000 to roughly $24,000. The additional $12,000 deduction is offset, though, if taxpayers are not permitted to claim personal exemptions for themselves and their dependents. In 2017, a qualifying family of four may claim personal exemptions totaling $16,200. If the personal exemption is repealed, instead of being taxed on $12,000 less income, the family actually will be taxed on an additional $4,000. At an applicable marginal rate is 25%, holding everything else constant, the reform would result in a tax increase of $1,000 to the family.
The problem grows larger with increased family size. Families with more than two children and multi-generational families would bear the brunt of the repeal of the personal exemption. Demographic studies suggest that the burden would not be evenly distributed. In 2015, the Pew Research Center estimated that 50% of Hispanic mothers give birth to three or more children, as do 40% of Black mothers. In addition, Hispanic families are far more likely to live in inter-generational households, so they may be more likely to have adult dependents who are not eligible for the Republicans’ proposed child credit expansion. Repealing the personal exemption would harm these families by making taxes less sensitive to family size. A move away from the personal exemption, simply put, would be a move away from economic reality. At low and middle levels of income, family size directly impacts a household’s financial outlook. If Congress cares at all about ability to pay, or taxing net rather than gross income, or a number of other important policy considerations, making the Internal Revenue Code less cognizant of family size and structure moves the law in the wrong direction.
Stated differently, in order to call for repeal of the personal exemption and still assert that tax reform benefits middle-income families, legislators must make assumptions about the composition of a typical middle-income family, and those assumptions seem not to take into account the wide variety of families who find themselves in the middle of the income spectrum.
Of course, Congress and the President may gain some ground on the credit side of the calculation, depending upon the direction that reform takes. The President’s plan would expand, in an unspecified way, the child and dependent care credit. The credit is available only to families who have parents in the workforce, and it currently tops out at $3,000 for one child and $6,000 for two or more children. Providing support for childcare is crucial— according to a recent NPR report, the average cost of infant care in the United States is $10,000 a year while median household income is $55,000 a year. Helping taxpayers shoulder the burden is important, but not all families seek outside care. An expanded child care credit will do nothing to help families who have a stay-at-home parent in a care-giving role. Likewise, Congress’s plan to expand the child credit (which does not depend on the employment status of the parents) will do nothing to help families whose households include inter-generational dependents, like grandparents, aunts, or uncles. In short, neither credit, if expanded in isolation, would fully counteract the loss of the personal exemption for families that don’t fit into a particular mold.
What, then, remains of tax relief for middle-income families if the personal exemption is repealed? To benefit those families in all of their variety, both the President’s plan and the Republican plan would be forced to rely primarily on rate cuts. The Republican plan would provide, in many cases, a rate cut of 3% to middle-income families (a savings of $1,500 for a family with $50,000 of income). The President’s plan is less defined; currently, it doesn’t specify the width of its three brackets. Without more detail, it is impossible to know whether reformed rates would be sufficient to offset a potential loss of the personal exemption. An educated guess would suggest that neither reform package is the boon that it at first appears to be. Rather, if the personal exemption is repealed, what initially seems to be a decent-sized tax cut for families may end up being a wash, or even a tax increase, to families that don’t conform to common conceptions about how an American middle-income family should look.