President-elect Donald Trump's pick for treasury secretary, Steven Mnuchin, says the incoming administration is about to embark on the "largest tax change since Reagan."
He made those comments on CNBC last week. The change he's referring to could have a big impact on mortgage interest deductions — a driver of the housing market — and weaken an incentive for charitable giving.
Key features of Trump's plan could also lead to changes with state and local government tax collection. It all comes down to standardized deductions — or the amount of write-offs you can claim without having to provide lots of documentation (or even spending money on any of the things you can write off).
To be clear, only two things are certain at this point about the tax code under Trump's plan: it will look very different, and we don't fully know the details.
Trump's plan differs in some significant ways from one put forward by republican speaker of the house, Paul Ryan. And Trump's plan is vague in places and has changed during the campaign.
That said, here are some of Trump's major objectives:
- The number of tax brackets will be reduced from seven to three. The highest tax rate will be 33%, but Mnuchin said that tax cut will be offset by reducing deductions and loopholes for the wealthy.
- The standard deduction will go way up. Single filers will see the amount of income exempted from taxes rise from $6300 to $15,000. Married couples who file together will see their exemption go to $30,000. That means far fewer people will need to itemize deductions — which could change what many Americans spend on housing and charitable giving.
- Itemized deductions could be capped. For the wealthy, this could have a big effect on how much they give to charity, and whether they can deduct state and local taxes, depending on how the law is ultimately written.
Both Trump and Ryan say they want to simplify tax filing for most Americans. Independent analysts at the Tax Policy Center and the Tax Foundation agree that's likely. Of the roughly 143 million tax filers in the US, currently about 48 million of them itemize their deductions, which means they need detailed records of how much they gave to charity, paid in mortgage interest to a bank, and anything else that might offer a write-offs. That number would fall by more than half, to 22 million itemizers, if Trump's plan goes through.
Here are some of the effects that could have:
Mortgage interest deduction
The deductions for mortgage interest and charitable giving are "apple pie and baseball for the tax code," Richard Auxier, a research associate at the Tax Policy Center, told Business Insider.
That's why neither plan eliminates these deductions; that would be a political disaster.
However, "Trump's tax plan does effectively limit two itemized deductions without explicitly doing so," Kyle Pomerleau, director of federal projects at the Tax Foundation, told Business Insider. "By increasing the standard deduction, it reduces the number of itemizers."
Here's what Pomerleau means:
Let's say a single filer pays about $10,000 in mortgage interest in the first year she owns a home. That far exceeds the current $6,300 standard deduction, so she itemizes her deduction to claim a greater tax break. It's one reason she decided to buy rather than rent.
But under Trump's plan she's better off taking the standard deduction. Her taxes are simpler, but they're no longer significantly different than if she had rented. That's why industry groups are watching closely.
"Doing anything that would limit incentives for homeownership is a fundamental step in the wrong direction that could harm home values and keep more buyers on the sidelines," William E. Brown, the president of the National Association of Realtors said in a statement to Business Insider.
Michael Fratantoni, the chief economist at the Mortgage Bankers Association, told Business Insider that few would defend the current tax code's complexity, but "the other side of the argument is that mortgage interest deduction helps homeowners by lowering the cost of their interest on an after-tax basis," which is particularly effective for first-time buyers, he said.
Many economists, though, say the mortgage interest deduction does not actually incentivize more Americans to buy homes. But it does encourage those who do to spend more on housing, or buy a bigger home, which brings us to the next possible effect of these plans: it could push down home prices, especially in expensive cities like New York and San Francisco where the mortgage deduction takes some of the sting out of taking out jumbo loans to pay for small spaces.
"They might still own the house, but they won't pay as much" for it, Roberton Williams of the Tax Policy Center told Business Insider.
That said, many lower income Americans will have lower taxes, which will encourage them to spend money on all sorts of things, including housing, according to Todd Sinai of the University of Pennsylvania's Wharton School.
State and local governments
Our current tax system makes it easier for state and local governments to raise your taxes. That's because those property, sales, and income taxes are deductible from your federal earnings.
"Some consider it an implicit subsidy to state and local governments," Pomerleau said. "When they increase their taxes, they're passing their burden to the federal government. At the margin, it allows states and local governments to increase taxes."
For wealthy Americans living in higher-tax states like California and New York, it can be a big tax break at the 39.6 percent bracket. So those wealthy residents are less likely to complain to their state house. The states with higher taxes tend to be more liberal. And the various tax plans differ on whether they completely or partially eliminate the subsidy for local taxes.
Pomerleau said this is likely to spark a big debate in Congress.
"From a policy standpoint, limiting the state and local deduction requires states to have their citizens realize the full burden of their taxation," he said. State and local leaders would have to say, "We're providing you these services, we think they're valuable, so we're going to sell them on their merits, rather than passing some of it onto the federal government."
It's unclear if eliminating this deduction would actually lead to higher or lower taxes at the local level. Auxier of the Tax Policy Center said past experiences suggest the effect could be minimal. States didn't lower taxes during a brief period in the 1980s when the deduction was eliminated. And when the top tax rate went from 35 to roughly 39 percent in 2012, states didn't take advantage by raising taxes.
"A lot of states don't want to see it go because of the advantage it gives them. But what states do is an open question," he said.
Some in the middle class could be worse off
Some middle class Americans may be worse off under the Trump plan.
There are other big changes and effects from Trump's tax proposal. Despite caps on total deductions, the wealthy may still benefit greatly from much lower taxes on business income.
Two changes in the plan could also increase taxes for many middle class families. First, it eliminates personal exemptions, which are about $4000 for individuals and each of their children or dependents. Second, it eliminates the "head of household" tax filing status that's typically used by single parents. So, "millions" of families with many kids, and single parents could end up with higher taxes under Trump's proposal, according to an analysis by Lily Batchelder of NYU School of Law.
"All heads of household would be made worse off," Roberton Williams of the Tax Policy Center said.
Mnuchin, Trump's treasury pick, told CNBC that the incoming administration doesn't "believe in that analysis." And he left open the possibility that this could be fixed in a final plan, adding, "When we work with Congress and go through this, it will be very clear. This is a middle income tax cut." It'll be up to congress to decide the ultimate winners and losers in the tax changes that are likely in the next year.
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