The most disappointing aspect of Trump's tax plan is what it's lacking
With Donald Trump having officially been sworn in as the 45th president of the United States, the next step in Trump's unlikely journey will be the implementation of certain policies touted during his campaign. While repealing and replacing the Affordable Care Act is likely near the top of Trump's list, it's his vision for individual and corporate tax reforms that could define his presidency.
Trump's tax plan, in a nutshell
Donald Trump's revised tax plan, which was released in August, aims to tackle both individual and corporate tax reforms.
For businesses, Trump has two particular fixes in mind that could make growth prospects for domestic businesses much rosier. First, he plans to lower the corporate tax rate from its current 35% to just 15%. According to the Tax Foundation, a nonpartisan research group, the U.S. has the third-highest marginal corporate tax rate in the world when state and local taxes are added in. High corporate tax rates can discourage reinvestment and hiring, and it can also lead to foreign investors choosing to keep their distance.
Second, Trump wants to offer a special tax repatriation tax rate of 10% for U.S. multinationals. An estimated $2.5 trillion in profits is being held in foreign countries because domestic businesses don't want to pay the high U.S. corporate income tax rate to bring that money home. Creating a repatriation tax holiday rate could encourage these multinationals to pump hundreds of billions of dollars back into the U.S. economy, which could lead to hiring, business reinvestment, and expansion.
For individual taxpayers, Trump's proposal boils down to simplification. Currently, the tax schedule contains seven brackets ranging from a low of 10% to a peak of 39.6%. Trump's individual income tax proposal contains just three tax brackets, as shown above.
If the above proposal looks in some way familiar, it's probably because the 12%/25%/33% three-tier individual income tax schedule was previously devised by House Republicans. Trump's willingness to change from his initially proposed tax plan in 2015 that included four brackets to three brackets could signify his willingness to compromise with a Republican-led Congress to get the current tax code amended.
Additionally, Trump's individual income tax proposal would pump up standard deductions for individual and married filers, while at the same time eliminating practically all itemized deductions. The charitable giving deduction and the mortgage interest deduction would be among the very few exceptions to survive. On the other hand, the estate tax, alternative minimum tax, net investment income tax, and Medicare surtax, along with the head-of-household filing status, would be eliminated.
Trump's tax proposal comes under fire
As with practically all Republican tax proposals, Trump's goal is to cut taxes so as to put more money in the pockets of consumers and businesses. Since roughly 70% of U.S. GDP is based on consumption, the idea is that allowing consumers to keep more of their income will more than offset the loss in federal tax revenue.
Of course, there are also a handful of critiques to Trump's tax plan.
Arguably the biggest concern is what it might do to income inequality in the United States. According to the nonpartisan Urban-Brookings Tax Policy Center, nearly half (47%) of Trump's proposed tax cuts would wind up heading into the pockets of the top 1% of income earners, with only a minimal impact for the lower- and middle-income taxpayer. Income inequality is usually associated with lower growth potential since it's difficult for lower-income folks to climb the socioeconomic ladder given their inability to pay for college and/or medical care.
However, I'd contend that it's not what's in Trump's proposal that could be its biggest disappointment. It's what's not listed.
The biggest disappointment of this tax plan is what it's missing
Perhaps the biggest issue with Trump's tax plan is that it does nothing to address the capital gains tax rate.
Under Trump's individual income tax reforms, most investors would owe less than they would under the current system if they sold assets that are held over the short term (365 days or less) since the short-term capital gains tax rate corresponds to a taxpayer's peak marginal tax rate. However, the long-term capital gains tax rates of 0%, 15%, and 20%, which are also based on a taxpayer's peak marginal tax bracket, would remain unchanged from the current tax code based on Trump's proposal. Presumably, the 0% long-term capital gains tax would apply to the 12% ordinary income bracket; the 15% long-term capital gains tax to the 25% ordinary income tax bracket; and the 20% long-term capital gains tax to the 33% ordinary tax bracket.
If Trump and the Republican-led Congress are serious about boosting the wealth of the American middle class, they would strongly consider adjusting the capital gains tax rate down to encourage long-term investment.
Take the stock market as a great example of long-term wealth creation. Sure, the stock market has had its ups and downs; the better-than-50% decline in the S&P 500 during the Great Recession likely comes to mind. Yet in spite of 35 corrections of 10% or more (when rounded to the nearest whole number, as seen above) since 1950, the S&P 500 always manages to put corrections and bear markets firmly in the rearview mirror.
Historically, the stock market has returned 7% annually, including dividend reinvestment. That's an inflation-trouncing return that's incredibly tough to top over the long run, and if capital gains taxes were lowered, it would probably compel middle-class individuals and families that make up the backbone of the American workforce to invest more.
Admittedly, lowering the capital gains tax rate wouldn't be without its own faults. It could wind up putting a lot of tax savings into the pockets of wealthier Americans, and there's also a chance it could further reduce federal tax revenue and widen the federal budget deficit. But lowering capital gains tax rates may also represent the best chance the middle class has to close the wealth gap with the top 1%.
Keep this in mind
One last point you should keep in mind is that Trump's revised tax proposal released in August still isn't a final piece of legislation. This means it's still possible we could see individual and corporate income tax changes to come, including an adjustment to the capital gains tax rate.
It's really anyone's guess at this point what campaign pledge Trump plans to tackle first, but his tax reforms could very well shape his legacy as the 45th president. Don't be surprised if his final tax proposal winds up looking noticeably different than the plan he released in August.
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.