Taxes on wages make up the bulk of federal revenue every year. Where does that money go, and who decides how much you should pay?
The process is extremely complicated - and deeply political - which is why it's important for everyday taxpayers to understand how the people they elected choose to spend the money voters give out of their paychecks every year.
We talk with tax policy expert Beverly Moran, a Paulus fellow at Boston College Law School and professor emerita at Vanderbilt, about how budget reconciliation works. We also talk about how those decisions affect the vast majority of taxpayers, who earn most of their wealth from salary or wages... and how it looks different for the wealthiest Americans. Find Beverly's research on the impact of the 2017 TCJA here.
Listen to the episode:
Related reading and listening:
Listen to our episodes on the history of the income tax in the United States, and how the tax return process works.
We used a number of sources in this episode. Here are some, in order of appearance:
How much revenue has the US government collected this year? from the US Treasury Department.
Reconciliation explainer from the Congressional Budget Office.
Budget Reconciliation: Tracking the 2025 Trump Tax Cuts from the Tax Foundation.
What are itemized deductions and who claims them? from the Tax Policy Center.
How did the TCJA change taxes of families with children? from the Tax Policy Center.
The 2017 Tax Law Was Skewed to the Rich, Expensive, and Failed to Deliver on Its Promises from the Center on Budget and Policy Priorities.
Lifting the SALT Cap: Estimated Budgetary Effects, 2024 and Beyond from Penn Wharton Budget Model at the University of Pennsylvania Wharton School of Business.
Differences between the traditional CPI and Chained CPI from the Congressional Budget Office.
Republicans say Medicaid cuts won't happen. But does their budget work without them? from NPR.
Republicans want to lower taxes. The hard part is choosing what to cut. from the New York Times.
Transcript:
Note: This transcript is AI-generated and may contain errors
Christina Phillips: I feel like I've had the income tax song stuck in my head for a solid week.
Hannah McCarthy: What's that song? What is that?
Christina Phillips: Oh, you don't know the income tax song?
Hannah McCarthy: No. Am I gonna hear it?
Christina Phillips: I paid my income tax today. No no no no no no.
Archive: I paid my income tax today. I'm only one of millions more whose income never was taxed before. Art tax. I'm very.
Christina Phillips: Tax. I'm very glad to pay. Is it.
Hannah McCarthy: Just propaganda?
Christina Phillips: Yes, it is a 1942 propaganda song. Are you telling me you don't have this in your, like, Spotify playlist? Because. Because I do.
Archive: The sky Rockefeller helped to build them, so did I. I paid my income tax today.
Archive: I paid my income tax today.
Christina Phillips: This is the first time I think it's just the two of us.
Hannah McCarthy: I know. Hello.
Christina Phillips: Hello.
Hannah McCarthy: It's a whole new environment in here.
Christina Phillips: Yeah, it's a huge studio in just two people.
Hannah McCarthy: Just two people.
Christina Phillips: And we're talking about taxes.
Hannah McCarthy: What could be more thrilling than that?
Christina Phillips: Uh, do you want to introduce yourself and set us up?
Hannah McCarthy: Yes. Hello. I am Hannah McCarthy. I'm the co-host of Civics 101. I am here with Kristina Phillips, senior producer of Civics 101. And I am told that today. Kristina, you're going to explain income taxes to me.
Christina Phillips: Yes, well, sort of.
Hannah McCarthy: Okay.
Christina Phillips: So we're going to talk about income taxes, but we're not talking about how you pay them.
Hannah McCarthy: Right.
Christina Phillips: Or the history of the income tax because we've already done that.
Hannah McCarthy: We sure have.
Christina Phillips: We did that a couple of years ago. I'm going to put the links to those two episodes in the show notes. So we are going to talk about the politics of taxes.
Hannah McCarthy: Oh, this is actually great because every single election and then every single presidential term or congressional term or what have you, it's always like taxes, taxes, taxes, taxes, taxes. But, you know, it's like a chief thing at the top of everyone's mind. Yes. Because people don't want to pay him, or sometimes they want to pay more. But like it's.
Christina Phillips: Or sometimes they want to pay less, I feel like is the normal.
Hannah McCarthy: Yes. Yeah. I mean, I just don't want to say, like, every person in America wants to pay fewer taxes. Maybe some want to pay more, you know. Mhm. Um, but I don't think I really have ever closely followed any political debate about it or you know, I'll know when there's a vote or something and I'll know what someone's policies are, but that's it.
Christina Phillips: Yeah. We're going to talk about how politicians come up with and then pass legislation on collecting taxes. And these are taxes that fund the federal government. And how they do that while keeping major donors and voters happy, but still meeting that bottom line.
Hannah McCarthy: That's the thing.
Christina Phillips: Yeah, yeah. And I say major donors, because the biggest lobbying groups in the country are the National Association of Realtors and the US Chamber of Commerce, which represent people who own assets like houses and then businesses and business owners. So we are talking about keeping the people that have a lot of money happy. And then also, you know, the voters like you and me. So why are we talking about this now, other than the fact that it's tax season? Well, one, Congress is currently haggling over a major budget overhaul because huge chunks of Trump's last big tax bill, the 1 in 2017, are going to expire at the end of 2025. So our Republican Congress is trying to figure out how to keep Trump's tax cut legacy alive, and then also meet the demands that he has for shrinking the federal government and dealing with the national debt. And I want to be clear, we cannot and will not possibly talk about everything. I tried to pick examples that bubble up when people talk about wealth and inequity and taxes. And then I've got one super fascinating example that I knew nothing about, but really got me thinking that I learned about when I was doing my interviews.
Hannah McCarthy: Okay.
Beverly Moran: I mean, it's purposefully complicated so that no one will understand it. I'm thinking about people who go to law school for three years and they're not really up on it. Right? It's deliberately made so that you have to have an Encyclopedia Britannica and just be going through it constantly, you know?
Christina Phillips: That's Beverly Moran. She is a tax policy expert and professor emeritus at Vanderbilt and a policy fellow at Boston College Law School. And she's going to help walk us through this. Okay. I want to do super 101 here for just a second.
Hannah McCarthy: Yeah, please.
Christina Phillips: The kind of taxes we're talking about today, for the most part, are the ones that come out of your paycheck. So when you look at your pay stub, you can see several categories of taxes that are withheld. Can you think of one.
Hannah McCarthy: Categories like Medicare?
Christina Phillips: Yes, Medicare.
Hannah McCarthy: Categories like Social Security.
Christina Phillips: Yeah. So Medicare and Social Security are both those are flat taxes. So that just comes right out of your paycheck.
Hannah McCarthy: And then I know that there are in some states, not in New Hampshire. State taxes that are withheld from your paycheck.
Christina Phillips: That's one. And then we've got one other big one.
Hannah McCarthy: Just income tax. Right. Okay.
Christina Phillips: Yep. Federal income tax. More than half of federal revenue. That's money that the federal government makes every year is from income and payroll taxes. Now here's another question. Do you know where most of that money goes.
Hannah McCarthy: To the defense budget?
Christina Phillips: No, actually this is fascinating. So the defense budget, I believe is only like 13%. More than half of all of the revenue, including revenue that's earned from business taxes, borrowing and interest goes directly into social programs.
Hannah McCarthy: Oh, okay.
Christina Phillips: All right. So we're talking Social Security, Medicare, Medicaid, unemployment insurance, veterans benefits and economic benefits like Snap, the Supplemental Nutrition Assistance Program. So this is kind of the essence of paying taxes in this country, right? You take care of your government and your government takes care of you. Your taxes pay for the programs that are supposed to help you raise your kids. If you lose your job, if you get sick, if you are or become disabled, if you served in the military, and if you're supporting someone else, or when you reach retirement age.
Hannah McCarthy: So this is not just like the federal income tax. It's all of the categories we talked about. It's also okay. Got it.
Christina Phillips: Yeah. So most of revenue comes from income and payroll taxes. And most of that money goes right back out the door for services that support people directly.
Hannah McCarthy: Oh. Which is why in countries that are famed for having just a great deal of social services at a very high level, you hear about incredibly high tax rates.
Christina Phillips: Exactly. Okay. Yeah. Yeah. And in the US, it's, you know, this is still the bulk of revenue and the bulk of the budget, but it is certainly not as simple and straightforward as it is in other countries where there's just a big tax that's taken out and lots of services from those tax. So the agency that collects all these taxes is the IRS, the Internal Revenue Service. Right now, Congress is attempting to pass a budget through a process known as budget reconciliation that's going to address many expiring tax provisions from the 2017 Tax Cuts and Jobs Act. And they also want to accomplish Trump's mission to cut spending, shrink the federal government, lower people's tax bills, etc., etc.. Now, one thing I do want to clarify we're not talking about the stopgap spending bill that Congress just passed to avert a government shutdown. So that's a spending bill that's just funding the government for the next seven months.
Hannah McCarthy: So budget reconciliation. Right. Like reconciling. Right. Making amends, making it all good. What is that process, Christina.
Christina Phillips: Yeah. So I sort of think of the reconciliation as two things. You have to reconcile what the House wants to do and what the Senate wants to do. And you also have to reconcile cuts you want to make to revenue with how you're going to earn revenue that both the House and Senate approve of. So it's going to be we're going to make tax cuts, or we're going to make cuts that are going to decrease revenue, but we're also going to either make cuts in spending or we're going to introduce new ways to raise revenue. To make it all balance out. It has to make sense. The math has to math basically to a certain degree in a way that's responsible, okay. As in 2017, what's happening now is that the House and Senate have drawn up proposals. They have their own proposals for spending and for tax cuts. And each chamber passes their version by a simple majority. But neither one is law yet. And the only way it becomes law is once the House and Senate work off of these proposals and create an identical budget. This is the reconciliation process. So that's where we're at now.
Hannah McCarthy: It sounds like a like so much work, I struggled to envision how even within the chambers themselves, these individuals are going to work it out, let alone between the two of them.
Christina Phillips: Yeah, I think that this is super interesting because I feel like what we hear politicians sell is we're going to stop taxing tips, for example, and we're also going to reduce wasteful spending. But when you ask how, it's sort of like when a kid asks you how money works and you're like, well, so money is money and you know, it's got value. So I actually I want to jump back to when I talked to Eric Toder, who's a tax policy expert who worked in the Clinton administration, I talked to him a couple years ago for our earlier tax episodes. He actually was right in the middle of some of these budget discussions with a different president.
Hannah McCarthy: So can I just ask, Christina, were these interviews the kind of thing where you were you would ask a question and these experts would be like, Well, you know, I've had that before with like, explain the two party system. Seriously?
Christina Phillips: Yeah.
Hannah McCarthy: That's what you want. Do you have three hours? You know?
Christina Phillips: Yeah. I think with Eric, what I remember is he explained that the reconciliation process. And I was like, so can you give me an example of that? And he was like, yeah, okay. And so then this is what he said.
Eric Toder: I remember when I was in the Clinton administration and we decided for political reasons, we had to have a middle class tax cut. So if we lowered rates a little bit, it just cost too much money. You couldn't lower rates across the board. So that said, we had to give some kind of credits or some benefit. So people had talked about a child credit and the number that Republicans had raised was $500. So we said, well, we have to have $500. It can't be less than $500. Well, how do we save money if it's $500? Well, we have to phase it out if people's income is above a certain amount and maybe we want to limit it instead of with personal exemptions, which was 18, maybe we ought to limit it to people under 17. And you get the picture. You go through one contortion after another to hit these various targets for how you're changing the system. And those things just stay in there.
Hannah McCarthy: Okay. So he he said cutting the rate like the tax rate would be too expensive, right? They would lose too much money. Is that. Am I understanding.
Christina Phillips: That? I do want to stop you. I don't I don't think it's even worth it to try to make this make sense. I really, purely I think that this is just a good example of what these things look like. Yeah, it is so kind of like absolutely chaotic, right?
Hannah McCarthy: It's like the biggest butterfly flapping its wings. She's like, whoa, that changed a lot.
Christina Phillips: Right? So this is how we end up with tax policies that are like our tax code is thousands and thousands of pages long, and it's because politicians float an idea and then they have to figure out how to make that work. And it becomes this like as he said, contortion of, well, we try this and then we try that. But what if we do this? And what if we change that? And what if we like, set this limit? And then you and I, as taxpayers, we go to pay our taxes and we're like, I'm sorry, which form is this and also which credit? And do I need to fill out this and which papers do I need. And like, which deduction do I take? What happens is that the people who have the time and the money and the resources to go through all of this, or even to hire somebody who understands a very specific part, maybe like a couple hundred pages of this, thousands of pages of tax code and how they can help somebody benefit from that and lower their tax burden. That's how this ends up working right is that you have to have this level of knowledge to navigate it, and it just keeps getting more complicated.
Hannah McCarthy: I use it in accountant very briefly thinking that would be a good idea. And then they fired me. They were like, no, you don't have enough money, we can't deal with you anymore. We're like too busy and you are not worth it.
Christina Phillips: I love that you're fired by your accountant.
Hannah McCarthy: Yeah, yeah, your taxes are out.
Christina Phillips: You're not complicated enough here. Oh my goodness. We'll be right back with more Civics 101 after a quick break. So now that we've established what this looks like, whether or not it makes any sense, I want to talk about what this looked like in the 2017 tax bill. And I'm going to pick out the major things that were cut, the tax cuts that happened in the 2017 tax bill. And then we're going to look at a couple of ways that Congress tried to make those tax cuts make sense.
Hannah McCarthy: Okay.
Christina Phillips: So are you ready?
Hannah McCarthy: Yeah.
Christina Phillips: We can do this. Okay. So the federal income tax rate went down.
Hannah McCarthy: This is 2017.
Christina Phillips: This is 2017.
Hannah McCarthy: So I'm with you.
Christina Phillips: The tax cuts it's called the Trump tax cuts by a lot of people. It's the 2017 Tax Cuts and Jobs Act. The federal income tax rate went down. The old brackets used to start at like the highest earners owed 39% and now ends at 37%. So that's set to expire if they don't pass a new tax bill. The standard deduction, which is a deduction that is supposed to be a simpler substitution for the itemized deductions you can get for investing in retirement and paying off loans and donating to charity. That went up, which meant that more people would say, okay, so I could itemize my deductions, but the standard deduction is pretty high and I might just take that instead. So it's simplified taxes for a lot of people. A lot more people took the standard deduction. And that standard deduction is dependent on your status. So if you're single head of household married etc. also if you're 65 or older, if you're blind or supporting a dependent. So it's a standard deduction. That sort of depends on you as a taxpayer. And I should just say that for the most part, people who use itemized deductions, it's disproportionately the top 10% of earners who go through and use the itemized deductions.
Hannah McCarthy: Yeah, that makes sense, because every now and then I've tried to do it and I'll go through the itemized and then I'm like, this is so not worth it. There's I'm not complicated enough. Right. Like I don't have like all of the, the questions that I would have to not not even questions is like, do you qualify for this, this this, this. I'm like, I don't qualify for any of this. Yeah, I'm a very simple entity, you know?
Christina Phillips: Yeah. I think going through the itemized deductions make you realize all the ways that people can make money that like, yeah, you I'm like, I, I can't imagine owning enough stock.
Hannah McCarthy: It never would have occurred to me to pursue that lifestyle.
Christina Phillips: I'm sorry. Estate taxes. What's going on? Like. Yeah, it makes it obvious how many different ways you can get incentives. If you have the money and you have the know how to invest your wealth in different ways, which is relevant, and we'll talk about it in a little bit. Okay. So then the other like big thing that was felt for most taxpayers I think was the child tax credit. So it used to be a $1,000 per child. It went up to $2,000 per child. Also, the bill raised the maximum income you could earn and still get that credit, meaning that people with higher incomes might still qualify for that $2,000 tax credit per child. Okay. So there is another deduction that I think is it mostly only applies to wealthier earners. But I think we should talk about it which is the pass through income. Do you know anything about that.
Hannah McCarthy: No.
Christina Phillips: Okay.
Hannah McCarthy: Does that surprise you? I probably don't qualify for it.
Christina Phillips: Okay. So this is a way that self-employed people and small business owners could deduct up to 20% of their business income from their individual tax burden. I'm not going to try to explain it with any depth, because I spent an inordinate amount of time trying to simplify it into a paragraph or less, but I do just want to talk about who this is for.
Hannah McCarthy: Yeah. Is it for like, I'm thinking of my dearest, dearest friend who runs a single person photography business? It's just it's their business. Right. So, like, would they qualify for that?
Christina Phillips: Yeah. So so this is really specifically for people who are self-employed or they have a business that is a partnership, a sole proprietorship, and I don't think he's even worth it to go like how this works. What I will say is this deduction in 2024 results in about $60 billion in savings in people's individual taxes. Okay, so put another way, $60 billion that used to go to the government stayed in people's pockets. But almost all of that went to people who made over $100,000. And the most savings went to people who made over $1 million.
Hannah McCarthy: Okay.
Christina Phillips: So this pass through deduction is mostly being used by people at the upper end of the tax bracket.
Hannah McCarthy: Okay.
Christina Phillips: This is one really good example of when you hear that the 2017 tax bill resulted in tax cuts that benefited the wealthiest Americans directly. This is one of the ones they're talking about. So those are some of the things that are supposed to expire. Republicans really want to keep them in. There is one other big thing that's not going to expire that happened in 2017 and that was the business tax cut.
Hannah McCarthy: We're talking like business versus individual. Yeah. Okay.
Christina Phillips: So businesses have to pay taxes right. The old business tax rate was 35%. Trump lowered it to 21%. That rate is not going anywhere.
Hannah McCarthy: That's a huge cut. Yes. I did not realize it was that significant. That's it's a massive difference.
Christina Phillips: Yeah, yeah. And do you remember like when you hear business tax cuts. How is that sold. Do you remember how that was sold to people.
Hannah McCarthy: That it will it will support businesses essentially. Right. And that's a very American idea. It might be a political American idea, but it's it's in the water. It's talked about all the time. And often you hear about the small business owner or the entrepreneur who will benefit from this. And if those businesses are strong, then the American economy will be strong.
Christina Phillips: Yeah. And a big part of that is that if those businesses have more income, they will put that income back into their businesses, they'll grow their businesses, they'll grow their wages that the worker will benefit from this growth. So did this happen?
Hannah McCarthy: You tell me.
Christina Phillips: No, the answer is no. The answer, Hannah, is it did not. So at one point, Trump had promised that these kinds of tax cuts would conservatively increase household wealth for most Americans, at least by $4,000 over the first few years.
Hannah McCarthy: I remember that.
Christina Phillips: Yeah, that was his conservative estimate.
Archive: Along with a lower business tax rate, would likely give the typical American household around a $4,000 pay raise. And that's money that will be spent in our economy.
Christina Phillips: There are multiple studies that looked at how salary and wages changed across workers, in companies that found that this did not happen.
Beverly Moran: And the thing is that people who have high wages, like really high wages, have enough power within their organizations to restructure how they're paid in order to take advantage of whatever is left remaining.
Hannah McCarthy: The people in charge of how much people get paid, paid themselves. Right?
Christina Phillips: Yeah, yeah.
Beverly Moran: Those corporate tax changes had a big effect on people who are in the top 10% of the income in the United States. Those are the people who own stocks. I mean, it's all this idea that, oh, if you have a pension, you own stocks, if you have a 401 K, you own stocks, but pension accounts and 401 S and 403 B's and all those pension, you know, retirement accounts are actually taxed differently Then the way that just an individual stop is taxed. So first of all, whatever happens within the account, the retirement account is not taxed at all. So all you're buying and selling is not taxed. But then when you pull the money out of the account, you are paying taxes as though you earned that money from wages. So you're paying at the highest rates for that money. But if you just an individual who has stocks, which is very few people, now, you're in a whole different situation because if you pull money out of that stock, in other words, if you sell it, your tax rate is remarkably low.
Hannah McCarthy: So, Christina, you were telling me about the reconciliation process, the fact that, you know, the numbers kind of have to work out when Congress passes one of these budget bills. How did Congress in 2017 justify all of these cuts?
Christina Phillips: Yeah. So I have to say, even in 2017, many economists said that this bill overpromised on revenue and it under promised on how much it would help the average taxpayer. The thing is, though, you do have to factor in the fact that, like they are pricing this out for a decade and there's no way to account for things like the pandemic or other policies, but there were still things that they said we're going to do in order to make these tax cuts work. The first has to do with that mandate to have health insurance. Do you know what I'm talking about there?
Hannah McCarthy: I do know that when I pay my taxes now, I have to essentially certify that I have viable health insurance, right? Like, I have to prove that I have health insurance. And, you know, if you don't get health insurance through your company, you have to get it through through the marketplace, which can be complicated and expensive. But it's part of the tax process to prove that you have health insurance.
Christina Phillips: Yeah. So the Affordable Care Act, passed in 2014, created a way for people to purchase their own health insurance on the marketplace, like you said. And you could get a penalty if you didn't have some kind of health insurance for longer than a few months. And so that's where that process was introduced, where you have to prove you have health insurance. Well, in 2017, the Tax Cuts and Jobs Act eliminated the penalty. So the mandate is still there, but there is no penalty now. And so how does this save money? Well, this is what Beverly said.
Beverly Moran: So it used to be that if you didn't have employer provided insurance, you had to get your own insurance. And so you went into the marketplace. And in order to make sure that you were able to afford the insurance. There were all sorts of federal subsidies, so the Tax Cuts and Jobs Act got rid of the individual mandate and then counted that people would not go to the marketplace and therefore there would be less demand for federal subsidies.
Christina Phillips: So basically what happened was with the mandate, the federal government was like, if we're making you buy health insurance, we have to make sure that you can pay for it. And some people are not going to be able to afford it unless they get a subsidy from the government. So the government will subsidize you buying your health insurance because it's good overall for people to have health insurance. Now, if we zero out the mandate and there's no longer a penalty, then the expectation was that less people would apply for health insurance, which means that the government would be spending less money on subsidies.
Hannah McCarthy: Got it. Okay. Yeah. So because nothing happens to you if you do not abide by this mandate, which is so interesting. And as a rule follower, there's a point at which I just glitch and I can't like, well, I'm going to do it anyway. I have to. They told me to. Um, okay. Got it. So really, I mean, it's, it's they're banking on the fact that tons of people are just going to say like, well, nothing's going to happen to me, so. No.
Christina Phillips: Yeah. And and specifically it's a certain demographic of people. So even with the subsidies, when that mandate still had a penalty, the vast majority of people who paid the penalty were making under $75,000 a year.
Beverly Moran: The theory was, and it turned out to be true, that if you take away the penalty, the poorer you are, the more every penny counts, right? So even though it might have been nice to have insurance, if you're saying, okay for the year, I'm going to have to put in $500 for insurance or $500 for groceries. I'm not going to get the insurance. So the number of people who are covered by health insurance dropped when the individual mandate was taken away, and those people who dropped out no longer were eligible for federal subsidies to buy insurance because they weren't buying insurance. So the federal government saved money because people were no longer buying insurance. Right. And the Republican Congress used that as a way to meet the the deficit targets for the Tax Cuts and Jobs Act.
Hannah McCarthy: So they took a gamble and it paid out.
Christina Phillips: No. So it didn't really work. So initially it did. In the first couple of years, the number of people who enrolled in the marketplace dropped, which did save the government some money in subsidies. But then the pandemic hit and the Biden administration started offering even more subsidies. And on top of that, you know, people really want insurance because there's a pandemic and more people lost their jobs, so they're going for insurance on the marketplace. So in short, the marketplace enrollment went way up. But these subsidies are set to expire at the end of this year. I think this is a really good example of how you can the budget in some ways is a little futile, because you have to demonstrate how you're going to affect the budget over the next ten years, but there's no possible way to account for things like a pandemic. But also it's hard to account for what the next president might do or policymakers might do. I want to talk about another way that they tried to sell this, that another part of the reconciliation. And this is the salt cap. Do you know anything about the salt cap?
Hannah McCarthy: No.
Christina Phillips: Okay. So this stands for state and local taxes cap, which it basically limits how much of your local tax burden you can deduct from your federal tax burden to $10,000. So before this, there wasn't really a limit on how much state taxes you could deduct from federal taxes, which meant that there was a lot of lost tax revenue on the federal level from people who lived in states with high state and local taxes. Essentially, if if you paid like $25,000 in state taxes, you could then say, well, I'm taking that off my tax burden on the federal level because I'm paying these state taxes and I'm not going to, again, on top of that, pay the federal taxes. So they set the cap at $10,000 in an attempt to sort of recapture that money that people might normally deduct. And 91% of the people affected by this cap made over $100,000. And it disproportionately impacted people in high tax states. So the top ones are California, New York, new Jersey, Illinois, Texas, and Pennsylvania. Now, what I think is interesting about this is looking ahead to this current budget proposal. There's a lot of different ideas about what to do with this salt cap, because a lot of high income earners in these high tax states do not like it, because it does limit how much they can take off their federal taxes. Right. And so there have been proposals like, okay, so maybe we lift the cap, we eliminate the cap, or maybe we lift the cap. So maybe now it's a $50,000 cap. The main takeaway was this is one way to recapture lost revenue that was most affecting people who were making over $100,000 in these high tax states. This blew my mind a little bit. Hannah, this is my favorite one. It has to do with tax brackets.
Hannah McCarthy: I always think I know something about tax brackets, and then I'll say it really confidently to someone who actually understands them and they're like, no dummy.
Christina Phillips: Okay, so tax brackets is basically like basically the IRS sets a bracket. And if your income is between this and this, you pay that rate of tax. Right. And one of the ways that they adjust those tax brackets over time is by adjusting for inflation. Right. So costs are going up. But then also wages are going up. So you have to raise the brackets in order to continue to adjust for how people's wages are going up. So in 2002, a single person who had $6,000 or less in income got a 10% tax rate. In 2024, if you had $11,600 or less in income, you had that 10% tax rate. So that's adjusting for inflation that that tax bracket got higher and higher. Well, the inflation adjustment, which also is sometimes called a cost of living adjustment, that also applies to some of the credits people get, in particular the earned income tax credit, which is a tax credit that is specifically targeted at people who have some income but not very much income. Okay. Especially like working families. So that's a credit that will go up a lot if you have kids, if you are a single earner, if you're a couple and you've got children, but you're earning some income, but you're not earning very much income. So that incentive rate is also adjusted based on inflation. What if, in order to collect more taxes to compensate for the tax cuts, you change the inflation formula. So inflation seems to go up more slowly, meaning the IRS cost of living adjustment goes up more slowly, meaning more people's incomes are getting taxed at a higher rate proportionally over time, and more people are being priced out of credits like the Earned Income Tax credit.
Hannah McCarthy: It's so interesting, right? Like here I am just breezing along, thinking that the calculation that determines the rate of inflation is like a mathematical formula. That's absolute or something, right? Like this is what inflation is. This is how you determine inflation. But they're just saying like we're going to change what formula is the inflation rate. Right.
Christina Phillips: Yeah. When it comes specifically to the IRS.
Beverly Moran: The Tax Cuts and Jobs Act changed how inflation adjustments were made. And they changed it so that they could show that they were bringing in revenues. Right. So now how are they bringing in revenues? Because they went from one calculation that would peg inflation, you know, at this level. And they changed it to a different calculation that would peg inflation at this level, so that the inflation adjustments would go up more slowly, right. But that means that people who are right on the edge. Right. For things like the earned income tax credit, they could get inflation out of those credits.
Christina Phillips: There are different ways to calculate inflation. They were using one system and they changed to a different system.
Hannah McCarthy: In order to tax people at a higher rate.
Christina Phillips: So the effect is that the tax brackets are being adjusted more slowly over time. This does not change prices. Right. It doesn't change how much things cost. And it doesn't necessarily change how much you get paid to pay for those things. The old way that the IRS measured inflation was based on what's called the CPI You the consumer price index for all urban workers. So for what it's worth, most public and private organizations use this to calculate inflation and do inflation adjustments. That's across the government on many, many businesses use the CPI You the one.
Beverly Moran: The original one was based on a basket of goods. So like they would always check on orange juice they would always check on eggs.
Hannah McCarthy: Can't do that anymore. I tell you that much. Yeah.
Christina Phillips: So this basket of goods is more like thousands of goods. But the whole point is that you're tracking how much the price changes on a set of things that an average consumer is buying over time. So in 2018, as a result of the 2017 tax bill, the IRS began using a different rule to measure inflation. And this was called the chained CPI. So the chained consumer price Index, which to me sounds like blockchain. It sounds like crypto.
Hannah McCarthy: Yeah.
Beverly Moran: It's based on the idea that if prices go up, you'll switch. So eggs are expensive. You'll buy tuna fish instead. Or orange juice is expensive. You'll buy apple juice instead.
Hannah McCarthy: I don't think that works. Like, I think you need a human behavioral analyst to come in and say, like, based on all this data, and maybe they are basing it on data that in actual fact, when people can't buy eggs, they buy tuna fish. But the idea that you can say like this is the swap. Good, right? This is the good you're going to buy instead. And if you can't get that, you'll get this instead. How on earth are you able to say like, this is the good you're going to swap out another good for? Like, sometimes if I'm at the store and I see that something's really expensive, I go and buy a frozen pizza instead. You know, like instead of buying a bunch of ingredients for salad, you know? So it's like, it's gonna be different for a woman in her 30s with no children. Then it's gonna be for any number of other people, right?
Christina Phillips: Yeah. So so what you're pointing to is one of the major critiques of this chained CPI, which is that it does assume a certain level of flexibility. Now, many people who like this formula, there are a lot of economists who say that this is actually a better way to adjust inflation, and that the CPI is like over exaggerating inflation, and that this is actually more of a moderated approach, because they argue that the old formula doesn't account for the fact that people will change up their basket of goods if the prices of certain things go up. But to your point, what Beverly says is that it's more complicated and inequitable to think of it that way.
Hannah McCarthy: You know, it's like that line from sex and the city where Carrie is like, some nights instead of dinner, I would buy myself a Cosmo. I felt it fed me more. There are people who will, like, pivot to a luxury item when they're frustrated that they can't get the simple item right.
Christina Phillips: Girl. Dinner versus Cosmo? Yeah. Okay, so here's what Beverly said.
Beverly Moran: Well, the poorer you are, the less likely it's going to be that you could make those sort of choices, because core people live in supermarket desert where they can't just say, oh, I'm not going to have eggs today. I'm going to get this other thing.
Hannah McCarthy: It's a far more equitable way of putting it than my reference to sex in the city and my frozen pizza.
Christina Phillips: So I am not an economist, and I am not able to say, like I have my feelings about chained CPI just like you, that that was one of my first questions as well, is like, I don't understand how you would calculate those things, but it does seem like it's less likely that people can make substitutions like this in certain places and with certain situations. So maybe that means that inflation feels different for different people. And this is going to raise the inflation rate as far as these tax brackets more slowly, when people might be feeling the pain of inflation more deeply in certain situations. I do think like if we're going to think about, okay, so what have politicians said about chained CPI before in the Obama administration? There was this idea that maybe chained CPI would be a good way to calculate Social Security payments. So this was something that was floated. Was that like we're using the CPI for Social Security payments and like thresholds for those payments. Maybe we switch to chained CPI instead because it will make those adjustments slower. They'll be putting less money out in Social Security over time. So people who wanted to switch to chained CPI for Social Security estimated that it would save the government over $300 billion back then. But if you think about what that savings looks like, it's savings because Social Security checks get proportionately smaller over time. And so even though this calculation doesn't apply to things like Social Security. When you apply it to tax brackets, the price of things keeps going up. The inflation calculators don't change the price of things, but the change is that the rate at which the government adjusts for those rising prices and rising wages.
Beverly Moran: So just the people who are really going to be hit by the highest inflation because they can't dip and dodge, right, are the people who are then going to get hurt on their eligibility for the earned income tax credit, which might help them buy the food that's in the basket, that's going higher and higher in price. And it was changed deliberately to make the Trump tax cuts hit the goals that they had to hit in order to make it legal to make that change. Right. Because of that, the reconciliation process and all of this, that you have to show that within ten years you have to show what the effect will be on the budget and you can't have that effect be too high.
Christina Phillips: So those were some ways that the 2017 Tax Cuts and Jobs Act was reconciled.
Hannah McCarthy: Okay.
Christina Phillips: And with that, we are going to take a quick break. Listeners, if you support this work, which is always free to get but not free to make, consider becoming a sustaining member by donating at Civics101podcast.org. And while you're there, you'll find our entire back catalog. We've got over 300 episodes with transcripts and teaching materials. You can find all of that on our website.
Hannah McCarthy: I believe it's tax deductible. That donation.
Christina Phillips: I think you're right. I think it is a tax deductible donation.
Hannah McCarthy: It's got to be we're a nonprofit, right?
Christina Phillips: Yeah. Yeah. No, it totally is. Yeah. You can deduct it from your taxes, folks. We're back. This is Civics 101, and today we're talking about the wheeling and dealing of tax policy. So now I want to talk about the new bill. So essentially, Republicans in Congress are pushing, for the most part, to extend all of those expiring tax cuts that we talked about that were enacted in 2017, which would lead to an even greater deficit. And Trump also wants to introduce a couple of new tax cuts. Do you know what some of those are?
Hannah McCarthy: I did like a month ago. That's fair. I don't remember now.
Christina Phillips: Yeah. So he doesn't want to tax Social Security. And he also wants to eliminate taxes on tips and overtime. So all of these things will cost money, right? Congress has said that it will allow $4.5 trillion in lost revenue over the next almost ten years to 2034. So they're saying we're allowing ourselves to make $4.5 trillion worth of tax cuts that will cut into revenue in order to pay for that. One of the solutions in the reconciliation is to reduce mandatory spending by $2 trillion.
Hannah McCarthy: What's mandatory spending versus another kind of spending.
Christina Phillips: Yeah. So mandatory spending is spending that's automatically allocated every year by law. So no matter what this amount of money needs to go to these things. And then there's discretionary spending, which is where most of the like usual every year, political haggling over where money is going happens because Congress designates that money through appropriations. So mandatory spending is more secure and stable. Source of funding. In 2023, it was at least $3.8 trillion. So a $2 trillion dollar cut to mandatory spending is like more than half right now. Do you know where most of that mandatory spending goes?
Hannah McCarthy: That's what I was just going to ask you.
Christina Phillips: Medicare, Medicaid, Social Security, economic assistance, veteran benefits and defense. Okay. So here's what's interesting. Republicans in Congress and the president have all promised that cuts to mandatory spending won't touch things like Medicare or Social Security. That's what they've said. And some have even said it won't cut into Medicaid and it won't touch veterans benefits, because these are all extremely popular across the political spectrum. But many policy experts say that it is virtually impossible to cut that much funding without touching these programs. And also these are programs that many people have been paying taxes on for years with the expectation that we will get to use them, right. So we have been paying into Social Security. If we've had jobs, if we've been working and paying our income taxes and payroll taxes, we've been paying into Social Security, unemployment, Medicaid, Medicare for years sometimes. And the idea is that, okay, I've been paying for this so that I can use it when I need to. So that's why it is so unpopular to try to cut that. But the call to cut that much mandatory spending is going to be really difficult without making some of these cuts.
Christina Phillips: So in the House proposal, there was a line in there that says if they don't meet the $2 trillion tax cuts, they'll lower the revenue loss proportionally. So like if we don't hit 2 trillion, we've got to like make it up in the 4.5 trillion worth of tax cuts. But that does kind of open the door up for which things they'll give up in order to make that proportional cut. Right. So that's what we should be paying attention to over the next couple of months. House speaker Mike Johnson has said that he really wants to get this budget through and on the president's desk by summer. This is what people are talking about. Now, how do we reconcile these things? And the Senate has said that they would like to pass two separate bills, right. So they want to do spending first and then do tax cuts later. And the House is like, we want to lump it all into one, and they need to somehow meet in the middle. And Johnson really wants to get that done as soon as possible. So that's what's being haggled over right now.
Hannah McCarthy: When it comes to Medicaid, Medicare and Social Security. Somebody who is budgeting very closely around their Social Security check if the numbers on that check change. I mean, for someone who is truly dependent on those checks to make ends meet every month, that's going to instantly change the calculations they have to make and how viable their living choices are.
Christina Phillips: Right. And that's, you know, another reason why, when we go back to that inflation calculator, when there was the idea of maybe changing how inflation adjustments affect how much you get in Social Security in order to save the government a lot of money. It was extremely unpopular because so many people who rely on that Social Security money are really living on that margin, like that Social Security money. If that changes, it's going to cause a lot of recalculations. And it might be the difference between whether or not they can afford housing or food or a lot of other really essential things. It's not about how much they have in savings. It becomes really like the everyday costs that you have to think about are going to change pretty quickly. So I did at one point ask Beverly, I'm like, you study tax policy and you've studied tax policies in different countries. Like what do you think is the like simplest solution to fund these programs that people rely on in a way that feels fair? So, you know, I am paying into my government because I know my government will take care of me. Like, how could that be done in a way that doesn't feel like these programs are at risk, and it feels like you're kind of like putting in and then getting back. And this is what she said.
Beverly Moran: The real fact of the matter is, if they got rid of itemized deductions and kept the high standard deduction, almost all of the pain would go to high income people. People under 50% would see like no difference. And almost all the pain would be in the people in the top 10%. You know, who could afford it. So why aren't they doing that? Because that's not really what they're trying to do, but they're just trying to do is sort of bargain back and forth to see how much they can give to the wealthy and take from the poor to cover.
Christina Phillips: I then was like, okay, so how long have we had the standard deduction? Which is like it seems like a very obvious question that I just never thought about. So I went back and looked so itemized. Deductions have been around since 1913 when the federal income tax was established, but only the top 10% of people even paid income taxes back then. It was like a very limited wealth tax, but we already were building incentives to lower your tax burden in from the very beginning. Right? So if we're going to charge you taxes, we're going to give you ways that like if you invest it in this way, then you can lower your tax burden. The standard deduction was introduced in 1944 when the income tax became a mass tax, meaning that it expanded to basically all working Americans because the idea of introducing this tax for all people, and then all of those people then trying to itemize like it just is absolute chaos.
Hannah McCarthy: They don't have business offices, right?
Christina Phillips: Yeah. And over time, what's happened is the tax code has added more itemized deduction possibilities like this is a thing that happens. It's like you find another thing that you want to itemize, another thing you want to incentivize people to do. And so there are more and more itemized deductions being added over time. But that standard deduction is what most people take.
Hannah McCarthy: I will also like just to reiterate, when I have personally been like, let me mess around with the itemized, it mostly doesn't benefit me because most of the options on there just do not apply to me at all. It's like it's a $0 change if I do the itemized deduction, so it's pointless. For me.
Christina Phillips: The very pessimistic idea of the American dream is that you have enough wealth that your itemized deduction is higher than your standard deduction. Like yeah, that's basically it. Right.
Hannah McCarthy: So clinical.
Christina Phillips: Yeah. It's not that you can just pick yourself up by your bootstraps. It's that you make enough money in creative enough ways that your itemized deductions are bigger than your standard deduction. I think where we are today is that a lot of the itemized deductions are more beneficial to people with more money to play around with.
Hannah McCarthy: Because they're doing more things with that money.
Christina Phillips: Exactly.
Hannah McCarthy: Yeah.
Beverly Moran: The Trump tax cuts blew up the deficit, right. Just like the George Bush tax cuts blew up the deficit, just like the Reagan tax cuts blew up the deficit. Right. So if they want to keep from making it worse, they have to get revenue from somewhere, getting revenue from single mothers. There's there's not like really a constituent group. Single mothers. Right. But there's a constituent group, high income individuals. Absolutely.
Christina Phillips: So this gets to another thing that might come up in this reconciliation process, and that is phasing out certain tax benefits. One of the ones that I have seen talked about was removing the head of household filing status, which is a higher standard deduction because it's meant for someone bringing in the majority of the income for a household in which there are other people living there, and you're supporting them under certain specifications.
Beverly Moran: That's very anti-female, because virtually everybody who files as head of household is a female.
Christina Phillips: The latest estimate I could find from the 2007 census was that over 75% of people who filed as head of household are women, and 75%. Yeah.
Hannah McCarthy: Yeah. All right.
Christina Phillips: And there was even more recent Tax Policy Center data that said that most people who get a higher deduction this way make under $100,000. There were other ideas that I've seen floated by politicians, including getting rid of deductions for interest paid on student loans, eliminating the tax exempt status for healthcare organizations like nonprofit hospitals, charging taxes on scholarships and green vehicles, and removing credits for using renewable energy like battery powered vehicles. So these are ways that some of these deductions that some of us may actually use could go away. Right. Like you think about somebody who's going to get it not going to have to pay taxes on paying back student loans. It's probably somebody who wasn't able to pay back their student loans in a lump sum, like you and me. And we're just over here paying and chipping away little by little every single year. Right. And like.
Hannah McCarthy: Moving one grain of sand from the pile to the other pile.
Christina Phillips: I think that's like when I was doing my deduction, I tried to do the itemized again this year and it was like, so how much did you pay in student loan interest? And I was like, no, you're going to make me look.
Hannah McCarthy: I know.
Christina Phillips: I don't want to see this.
Hannah McCarthy: And it's in a compartment under a bed in my brain.
Christina Phillips: Yeah. And it's like I put the number in and then it's like, nah, that's not enough.
Hannah McCarthy: That doesn't exactly. That's the that's what I kept running up against. I was like, why don't bother hon. Yeah. Just go back to the standard.
Christina Phillips: Yeah. Yeah. That's actually going to do you a lot more than what you think you're doing. Yeah. Yeah, yeah. So here's what I want to leave us. If you're trying to prepare your taxes and you feel underwater, we've had several people on TikTok, which, by the way, we are on TikTok now and I love talking to people and comments. People and comments are amazing. There. There were people who said, hey, there are free resources at the state level that can help you file your taxes and help answer your questions for free, especially if you're somebody who's lower income. Or maybe you're over the age of 65, you have limited access to technology. Maybe you're a new American. Maybe you need some assistance in a different language. These are volunteer and nonprofit organizations that help people file their taxes. And my advice is to open up a search browser, if you can, and look up the term volunteer income tax assistance and then type the name of your state. I did that for New Hampshire, and a couple of the top results sent me directly to nonprofits that have information about who you can call and where you can go to get help, specifically on your state income taxes sometimes, but also just generally federal and state income taxes. If you don't have a computer or access to the internet, I recommend walking into your local library and saying, I'm trying to find this because librarians are great at research, and they also probably know a lot of this stuff already because they're always thinking about the community. So walk into your library and be like, I would like help finding free tax resources, maybe nearby. And they will, I'm sure be delighted to help you. So that's where we are.
Hannah McCarthy: I love that it also reminds me, Christina, I believe this was in your last tax episode, right? Where you were like, you don't have to pay to file your taxes. There is a free way to file your taxes and don't let anyone tell you otherwise. There's a free way. And this is just an extension of that. It's like, and even if the software people pay for it makes it seem easier. There's another way to do that for free. Yes, I love that. That's great.
Christina Phillips: Yeah, the free file stuff, by the way. Go to irs.gov and click on the Explore Free File options. It's right there. And this is software that they've contracted with the government, and they've promised to make it accessible to people who should file for free, which is anyone who made under $84,000 a year and has a relatively simple tax return. So there you go.
Hannah McCarthy: There you go.
Christina Phillips: Civics 101 facts.
Hannah McCarthy: This was fascinating.
Christina Phillips: Oh, good. I'm so glad.
Hannah McCarthy: This was vaccinating.
Christina Phillips: Well thank you Hannah. This episode was written by me, Christina Phillips, with help from Hannah McCarthy and edited by Rebecca Lavoie. Our team includes host Nick Capodice and producer Marina Henke. Music. In this episode by Epidemic Sound and Chris Zabriskie, Civics 101 is a production of NPR, New Hampshire Public Radio.