I said not to waste much time on the new tax plan outline from President Trump because we don’t know whether it will pass or what shape it will be in if it actually passes. A few readers emailed me saying they were very concerned about losing the state income tax and property tax deductions because they have a high income in states with high taxes and therefore they pay high state income tax and high property tax.
The Tax Foundation published a map showing the average amount of state and local tax deductions claimed in different areas of the country (see Which Places Benefit Most From State and Local Tax Deductions?). The area I live in is affected the most. It’s one of the top 10 counties, shaded in the bluest of the blue. Because the cost of living here is one of the highest in the country, people with white collar jobs here also have high incomes.
It sounds like I’m in the same camp as the concerned readers. I modeled the changes to see whether the concerns are real or not.
Remove Tax Deductions
When you have downloaded tax software, it’s very easy to see how taxes would change without messing up your tax return. I made a copy of my tax return file. I opened this copy in my tax software. I changed the state income tax withholding on my W-2 to zero. I deleted the property tax entry.
Without those deductions, my taxes would increase, no doubt. But the change is quite small. It comes to +0.7% of my AGI.
An increase of 0.7% of AGI is just from removing the deductions, with no changes to the brackets, AMT, or increasing the standard deduction. It’s not a big deal as you would think from reading articles that stir an horror.
The Trump tax plan outline simplifies the brackets into just three — 10%, 25%, and 35% — with no specifics on where the lines would be drawn. I don’t suppose those who are currently in the 15% bracket will suddenly go to 25%, or those who are currently in the 28% bracket will suddenly go to 35%. So I imagine the current 10% and 15% will become 10%, the current 25% and 28% will become 25%, and the current 33%, 35%, and 39.6% will become 35%.
I manually calculated my taxes under that assumption. With an increase in the standard deduction, I would no longer itemize. It’s really easy to calculate when you have only three brackets and the standard deduction. I did not include any personal exemptions. I even counted qualified dividends and long-term capital gains as regular income.
The increase in the standard deduction and the lower rates would more than compensate for losing all of these:
- the personal exemptions
- the state income tax deduction
- the property tax deduction
- the mortgage interest deduction
- the special treatment for qualified dividends and long-term capital gains
The amount of the change from just having a larger standard deduction and lower rates is also quite small. It comes to -0.7% of my AGI.
+0.7% or -0.7% of AGI, and we are talking about a high income in the bluest of the blue.
1. When multiple things change, we have to look at them overall. Remember the story of blind men and an elephant. The media and interest groups will always push us to look at only certain parts. There are always things to rally for or object to. You would think losing any one of the large tax breaks would be a big deal. Actually even losing all of them altogether is really not a big deal when it’s compensated elsewhere.
2. We must quantify the changes, not just look at the direction: higher taxes or lower taxes. We won’t be swayed by forces that try to influence us only until we actually run the numbers.
3. When we look at the overall picture, it becomes much ado about nothing. At the end of the day, the country still needs taxes to run. By necessity, taxes will still come more from people with higher incomes than from people with lower incomes, simply due to their ability to pay. All politicians and interest groups argue about is making it ever slightly more progressive or ever slightly less progressive. They try to score points on the tiniest immaterial changes.
4. Our financial success does not depend on paying 1% less of our income or 1% more of our income in taxes. Something is really wrong with your financial plan if paying 1% less or 1% more will make or break your plan.
[Image credit: From Martha Adelaide Holton & Charles Madison Curry, Holton-Curry readers, Rand McNally & Co. (Chicago), p. 108, via Wikipedia.]–
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