What Is a Tax Overhaul and How Does It Affect You?
Understand the core principles of tax reform, including the policy goals that motivate them and how they alter the tax code for individuals and businesses.
A tax overhaul is a fundamental restructuring of the tax code, going far beyond minor annual adjustments. These large-scale legislative efforts can alter nearly every aspect of how federal revenue is collected, impacting individuals and businesses by redefining components like income brackets, rates, deductions, and credits. The process involves re-evaluating existing tax laws to achieve broad economic or social goals, such as simplifying rules or changing incentives to influence economic behavior. Because these changes have widespread effects, they are subject to extensive debate.
Core Objectives of Tax Reform
A primary objective of a tax overhaul is stimulating economic growth. By altering incentives for both individuals and businesses, such as reducing tax rates on wages or investments, lawmakers aim to encourage working, saving, and investing. The goal is for businesses to expand operations and hire more employees, fostering a more robust economy.
Another objective is simplifying the tax code. Over time, tax laws can become complex and difficult for individuals and small businesses to navigate, creating significant compliance costs in time and money. A tax overhaul often seeks to streamline these rules, making the system more transparent and reducing the administrative burden on taxpayers and the government.
Fairness, or equity, is a central goal of tax reform. This concept includes horizontal equity, the principle that taxpayers in similar financial situations should pay similar taxes. It also includes vertical equity, which suggests that those with a greater ability to pay should contribute a higher percentage of their income. An overhaul may attempt to rebalance this distribution to make the system more or less progressive.
Enhancing the nation’s economic competitiveness is a frequent objective. This goal focuses on structuring the corporate tax system to be more attractive compared to other countries. The aim is to discourage domestic companies from moving operations abroad and to attract foreign investment, which can lead to job creation and economic expansion.
Common Changes to Individual Taxation
A direct way a tax overhaul affects individuals is through changes to tax brackets and rates. The U.S. has a progressive tax system where portions of income are taxed at incrementally higher rates. An overhaul can change these rates, adjust the income thresholds for each bracket, or alter the number of brackets, impacting a taxpayer’s marginal tax rate and overall tax liability.
The standard deduction is another area frequently targeted for change. This is a fixed dollar amount that taxpayers can subtract from their adjusted gross income (AGI) to reduce their taxable income. Lawmakers may increase the standard deduction to simplify tax filing, as a higher deduction means fewer people need to itemize. This change is sometimes paired with the elimination of personal exemptions.
For those who continue to itemize, changes to specific deductions are common. The state and local tax (SALT) deduction has been capped in the past. The mortgage interest deduction may also be modified by lowering the limit on qualifying mortgage debt. Deductions for charitable contributions are also reviewed but often preserved to encourage giving.
Tax credits, which reduce tax liability dollar-for-dollar, are also a focus of reform. Unlike deductions that lower taxable income, credits provide a more direct benefit. Overhauls often expand or restructure credits aimed at families and students, such as the Child Tax Credit or the American Opportunity Tax Credit.
The Alternative Minimum Tax (AMT) is another provision often addressed in an overhaul. The AMT is a parallel tax system designed to ensure high-income individuals pay a minimum amount of tax. Because its parameters were not always indexed for inflation, it began to affect more middle-class taxpayers. Reform efforts often involve adjusting the AMT’s exemption amounts or repealing it to reduce complexity.
Common Changes to Business and Corporate Taxation
A common feature of tax overhauls is the adjustment of the corporate income tax rate. This rate applies to the profits of C corporations and is a factor in business investment decisions and international competitiveness. A reduction in the corporate rate is intended to leave businesses with more capital to invest in expansion, research, and job creation.
Taxation of pass-through entities, like sole proprietorships, partnerships, and S corporations, is also an area of reform. Their profits “pass through” to the owners, who report the income on their individual returns. Since these owners do not benefit from a corporate rate cut, overhauls may introduce special provisions for them, such as the Qualified Business Income (QBI) deduction.
Rules for capital investment are often modified to encourage businesses to spend on assets like equipment and machinery. Reforms may change depreciation rules by introducing or enhancing “bonus depreciation,” which allows businesses to immediately deduct a large percentage of the cost of eligible property in the year it is placed in service. Similarly, Section 179 expensing limits may be increased to provide further incentive for business investment.
A tax overhaul often addresses international tax rules for multinational corporations. Historically, the U.S. used a “worldwide” system, taxing profits earned domestically and abroad. Many reforms have moved toward a “territorial” system, which primarily taxes income earned within a country’s borders and exempts most foreign profits. This shift is usually accompanied by new anti-abuse provisions to prevent companies from shifting profits to low-tax jurisdictions.
Analyzing a Major Tax Overhaul Example
The Tax Cuts and Jobs Act of 2017 (TCJA) is a concrete example of a comprehensive tax overhaul. The TCJA permanently lowered the corporate income tax rate from 35% to 21%. This change was aimed at aligning the U.S. corporate tax rate more closely with other developed nations and encouraging domestic investment.
On the individual side, the TCJA nearly doubled the standard deduction, meaning fewer households needed to itemize. To offset this, the law eliminated personal exemptions and placed a new $10,000 cap on the state and local tax (SALT) deduction. The law also lowered individual income tax rates and increased the Child Tax Credit to $2,000.
These individual provisions are temporary and scheduled to expire at the end of 2025. Without new legislation, tax rates will revert to pre-TCJA levels, the standard deduction will be halved, the SALT cap will be removed, and the Child Tax Credit will return to $1,000.
For businesses, beyond the corporate rate cut, the TCJA introduced provisions to spur investment. It established the Section 199A Qualified Business Income deduction, allowing owners of many pass-through businesses to deduct up to 20% of their income; this deduction is also scheduled to expire at the end of 2025. To encourage capital expenditures, the law initially allowed for 100% bonus depreciation for qualified property, but this provision has been phasing down, with the rate for 2025 at 40%.
The TCJA also reshaped international taxation by moving the U.S. from a worldwide to a territorial system. This change meant most profits earned by U.S. corporations from foreign subsidiaries would no longer be subject to U.S. tax when brought back to the country. To prevent companies from shifting profits to tax havens, the act included new provisions creating a minimum tax on certain foreign earnings.