It's finally here, and I'm not talking about pumpkin spice lattes. Tax reform discussions are beginning to kick into high gear on Capitol Hill, with President Trump pushing hard for Congress to not disappoint him this next go-around after failing on multiple attempts to pass healthcare reform.
Of course, passing tax reforms won't be any easier for the GOP-controlled Congress. President Trump and Republicans were counting on what would have been somewhere in the neighborhood of $100 billion to $300 billion in long-term savings (defined as a 10-year period) from the repeal and replacement of the Affordable Care Act, which is affably known as Obamacare. With Obamacare remaining as the health law of the land for now, there are no guaranteed savings coming from healthcare as of yet. This makes tax reform at the individual and corporate level especially tricky for Trump and the GOP.
Continue Reading Below
Corporate tax reforms take center stage
While most consumers are eager to hear what Washington has in store for them with regard to individual tax reforms, it's corporate tax reform that's the apple of Trump's and the GOP's eyes. A recent Trump speech again called for an "ideal" corporate income-tax rate of 15%. Trump has long believed that this low tax rate would allow U.S. companies to be competitive with foreign countries, utilizing their extra cash to hire, reinvest, and boost wages. Corporate tax cuts are the cog that Trump believes can help the U.S. reach a sustainable 3% annual GDP growth rate.
However, as the Tax Foundation has suggested in an earlier-year analysis, a 15% corporate income-tax rate is going to remove about $2 trillion in revenue from the federal government over the next decade. Even with the possibility of improved growth prospects and cost-cutting in select federal agencies, there's a very strong likelihood that either new revenue, or steeper federal cuts, will be needed to cover the loss of revenue from lower corporate taxes.
How will Trump and Republicans neutralize a $2 trillion revenue loss? According to recent reports, they could be coming for your 401(k) or may make drastic changes to the exceptionally popular mortgage interest deduction for homeowners.
Are Republicans coming for your 401(k)?
According to a report from Politico, one idea being floated around on Capitol Hill involves altering the way employer-sponsored 401(k) contributions are taxed.
A 401(k) is a tax-deferred retirement plan, meaning before-tax money is shuffled from a worker's paycheck directly into an investment account, with the worker paying tax only when he or she begins making withdrawals during retirement. Doing so usually allows a worker to reduce his or her current-year tax liability, and it's designed to encourage workers to save. As of March 2017, there were 55 million workers with more than $5 trillion invested in 401(k)s nationwide.
The GOP idea being floated around would tax 401(k) contributions up front. That means less money to invest now in 401(k)s, and also less incentive to save. As a reminder, workers were socking away only 3.5% of their earned income as of July 2017, which isn't even a third of what they were saving 50 years ago, so you can only imagine how damaging a shift in tax regulations on 401(k)s would be.
Interestingly enough, though, this wouldn't necessarily be a terrible idea for everyone. For example, if you expect to be in a higher tax bracket when you retire than where you are now, your 401(k) is only going to worsen your tax situation. A 401(k) is a great tool for those who expect their tax rate to fall during retirement. Depending on where you stand financially, an up-front tax on 401(k)s might not be all that bad, although I imagine it would hurt more people than it'd ultimately help.
Will you be kissing that hefty mortgage interest deduction goodbye?
However, this isn't the only wild idea Republicans are throwing on the table.
According to the Los Angeles Times, the GOP has considered lowering the amount of interest homeowners can deduct from their mortgage. Currently, homeowners can deduct interest on up to $1 million in mortgage debt, but intimations from Washington suggest that this figure might be lowered down to $500,000. There's a ton of support for the mortgage interest deduction among the GOP and the real estate industry, so getting rid of it entirely is probably not on the table -- but reducing the benefits perceived to go to well-to-do homeowners is very much on the table at the moment.
Estimates from the Tax Policy Center, basing its analysis on a $500,000 mortgage interest deduction cap, suggest that 2.4% of taxpayers in California would be adversely affected by such a move, with 2.3% of Washington, D.C., taxpayers, and 2.1% of Hawaiian taxpayers also feeling the sting. Nationwide, an estimated 1.4 million tax filers, or about 0.8% of the tax filers in the U.S., would see an average increase in their tax bill of $3,100 if the GOP moved forward with this plan.
It's also worth noting that if the Trump administration held to its word and wound up doubling the standard deduction, fewer taxpayers would be expected to itemize their deductions. Therefore, the impact of a mortgage interest deduction change could be lower than the Tax Policy Center's estimates.
Patience is a virtue
Without mincing words, the prospect of tinkering with long-tenured deductions may not sit well with a lot of folks. However, we have to keep in mind that major legislative reforms like what Trump has proposed often bring out wild ideas that never wind up getting anywhere near the final bill. It's certainly nothing that taxpayers, homeowners, and investors need to be getting worked up over until we have a lot more clarity as to what direction a bill might be trending.
For now, taxpayers shouldn't be doing a thing different now with regard to their 401(k) or mortgage payment than they were doing a month ago. It takes time for legislation to work its way through Congress, and it's likely we could see a tax-reform bill passed back and forth between both houses of Congress a few times before any consensus is reached. Definitely keep your eyes peeled for an actual bill from lawmakers in Washington, but don't sweat the rumors in the interim.
The $16,122 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,122 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.