Tax Reform: Your Household & the Economy

The Tax Cut & Jobs Act was passed by Republicans at on December 22nd, affecting our filings for 2018 and beyond.  The new law sets seven individual income brackets at 10%, 12%, 22%, 24%, 32%, 35%, and 37%.  It also nearly doubles the standard deduction, to $12,000 for single filers and $24,000 for joint filers.

The Republicans’ objective in this bill was to simplify the tax code.  The sound bite you’ve probably heard is that they’d like everyone to be able to “file their taxes on an index card”.  The new law mostly accomplishes that objective.  The vast majority of Americans will end up claiming the new standard deduction instead of itemizing. 

In reviewing the impact of the new tax bill, there are two important angles to consider.  First, the changes will obviously affect your household finances.  Most families will see a reduction in their tax liabilities, and many investment and planning strategies will need to be reconsidered. 

For example, a common tax planning strategy is to spread out income evenly over multiple years in order to stay below certain marginal brackets.  This can be accomplished be spreading out income generating events (Roth IRA conversions, distributions from retirement accounts, etc.) and itemized deductions evenly.  With a higher standard deduction, it may make sense to hold back your itemized deductions and “lump” them together in one year.  Since we now have a higher hurdle to clear in order to itemize in the first place, grouping deductions together could help you itemize (and reduce your tax bill) once every few years, instead of not at all.

Secondly, tax reform will have an impact on the markets and economy in addition to your household finances.  It’s been widely reported that corporations will see significant tax savings from the bill, with their tax rates dropping from 35% to 21%.  This will be a shot in the arm for the US stock market in the short term (markets have already reacted favorably).  Simply put – stocks like lower taxes.

Longer term, it’s unclear what the effect will be.  From a fiscal budgeting perspective, the law has dangerous potential.  Cutting taxes without corresponding spending cuts will widen our federal budget deficit.  It’s been well reported that Republicans expect the tax cut to boost economic growth significantly, which they believe will offset the widening deficit.  Reports are mixed surrounding the accuracy of that claim though.  Unless there are additional budget cuts, our federal deficit will probably get worse before it gets better.  And that could be a problem for our economy over the next ten years or longer.