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Why every taxpayer might get a raise next year

Rick Newman
Senior Columnist

Politicians like doing favors for voters every now and then. But the party in power also wants voters to remember those favors the next time they hit the ballot box.

That’s certainly part of the aim of Republicans who are planning big tax cuts, with a bill most likely early in 2018. Republicans claim tax cuts are necessary to improve sluggish growth, but they also want voters to feel the benefit by the time the midterm elections arrive next November. Can Republicans pass tax cuts that leave voters feeling tangibly better off by then?

Actually, yes. Congress can engineer tax cuts to literally make paychecks grow in the runup to next year’s elections. “You make them retroactive,” Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office, said at the Yahoo Finance All Markets Summit on October 25. “You immediately adjust withholding schedules, so paychecks are bigger.”

I asked Holtz-Eakin, a veteran Capitol Hill staffer, whether he thought that’s what the GOP tax bill is likely to do. “Yes,” he said. “Yes.”

Tax battle royale

There’s still a ways to go before that happens. Republicans in the House and Senate still haven’t released their much-anticipated bills, and once they do, a battle royale will explode over whose tax breaks get cut, whose survive, and who gets the sweetest treatment under the new tax regime. In order to lower rates significantly for middle-class taxpayers, Congress will have to close or dial back some tax breaks that are popular, such as the deduction for state and local taxes and certain breaks on retirement savings.

But President Trump has promised a large middle-class tax cut, and if Republicans can’t deliver, it would be a spectacular failure voters are likely to punish them for next fall. That’s why a 2018 tax cut is likely to be retroactive to January 1 of next year. If tax rates change, then the IRS has to adjust the withholding tables that instruct employers how much tax to take out of workers’ paychecks. If tax rates go down—which is what Republicans are promising—then employers would withhold less tax and paychecks would get bigger. Almost like magic—and without ever getting a raise.

There’s a catch, of course. Lower taxes would boost take-home pay, but also balloon annual deficits and the national debt. Congress can come up with new ways to bring in tax revenue, but that risks offsetting the gains from lowering income taxes. And it’s possible the economy might grow more in the future, which would fatten paychecks further, bring more people into the workforce and produce more federal revenue, not less. But such “supply-side” growth is more theoretical than proven, which means anybody who gets a tax-cut raise next year ought to spend the windfall carefully—or not at all.

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Rick Newman is the author of four books, including Rebounders: How Winners Pivot from Setback to Success. Follow him on Twitter: @rickjnewman