Tax bills can be complicated documents. That’s why we’re diving deeper into understandings its far-reaching impact as we inch closer to achieving financial fluency.
So what happened?
After more than 6 weeks of negotiations, the Republicans passed the first major tax overhaul in nearly 30 years on December 20th. Marking the first legislative victory of the Trump presidency, the GOP made good on their promise of presumably providing tax cuts to the majority of Americans before the end of 2017.
While much has been discussed over the past 2 months regarding the bill’s revisions, the final bill contains several massive changes to our current tax system. Most importantly, the corporate tax rate has been cut from 35% to 21%. This change, as written in the bill, will be in effect forever or until another overhaul.
In addition, tax cuts will be given to most Americans, but it will be decided by several tiers. Analysts presume that around 60% of Americans will receive some sort of tax cut in the next year, however, many of those same analysts estimate that these cuts will only last for several years rather than forever.
In the long-term, most believe that the wealthiest Americans will be the true beneficiaries of the tax bill.
Lastly, many minor changes that do not receive as much attention as the previous changes will also carry significant impacts. State and local income tax deductions will be capped at $10,000, while personal exemptions have been eliminated. Also, although seemingly irrelevant to the tax cut, a major addition to the bill comes in the form of the repeal of the Affordable Care Act’s individual mandate, which requires that individuals purchase insurance or pay a fee.
But how will this affect our broader markets? Let’s use our financial fluency tools to take a deeper look.
Why does it matter?
Businesses will benefit the most from the tax reform due to the major corporate tax cut. While individual tax cuts end in 2025, the corporate tax cut is permanent. Therefore, many businesses will have more free cash to spend on stock repurchases, investment in core businesses, and special dividends. We have already seen stores such as Wal-Mart and Chrysler pay their employees higher wages or special bonuses following the passage of the tax reform bill.
Most analysts agree that the tax reform will in fact boost the economy in the short-term, while many also believe that its long-term effect and overall magnitude is still up for debate. Goldman Sachs estimates that GDP will grow by an additional 0.3% over the next two years due to the tax reform.
They also believe, however, that additional gain will slow down, if not reverse, after 2020. Republicans argue that future congressional discussions will help turn the temporary tax cuts for individuals into long-term tax cuts before the reform starts to drag on our economy as a whole. Regardless of conflicting perspectives, most analysts agree that it will boost markets as a whole in the next two years.
While the impact on individual business and our economy as a whole are obviously major concerns, we are ultimately most worried about one thing: ourselves. Analysts agree that most Americans will receive some sort of tax cut over the next two years. However, size of the tax cut will differ greatly across socioeconomic classes.
About 80% of middle class families (those with incomes between $50,000 and $75,000) will receive a tax cut of $100 or more in 2019. But by 2027, a meager 16% of Americans will receive a tax break of at least $100.
In addition, analysts also agree that in the long-term, the bill will disproportionately favor the wealthiest socioeconomic classes due to longer-term tax cuts for the 1%. Republicans argue that future congressional discussions will temper these worries, as current temporary cuts for the average American will hopefully become permanent. However, extending or expanding these cuts would likely involve nudging up the corporate tax rate, an aspect of the bill which the president has expressed an unwillingness to compromise on. By surrounding yourself with a greater understanding of the markets, you can continue to step closer to financial fluency.