With a new president from a new party coming in now is the time to consider tax policy. We favor the Graetz proposal with some modifications but that is a highly unlikely outcome. More likely, there will be some mucking about to change incentives but nothing like Graetz. Refunds and refundable are still important.
A taxpayer gets a refund in 2017 when he pays more taxes in 2016 than his final 2016 tax bill. Most taxpayers pay taxes by having them withheld from their paycheck. A refund is the taxpayer getting part (or all) of his earlier tax payment back. If the government takes some action to reduce taxes by say, increasing the opportunity to deduct child care expenses, there is a chance that folks will end up with big refunds and that is unlikely to be the desired outcome. Now alert taxpayers could adjust their withholding but there will probably need to be to help taxpayers to be successful in increasing paychecks. Withholding rates can’t be changed unless we change everyone’s taxes.
For example, if we all the deduction of more childcare expenses then the folks that use childcare will need to change their withholding. If we increase the exemption for each child ($4,050 in 2016) then everyone’s taxes change and the federal government can adjust the withholding schedules and paychecks will increase for everyone with children. Well, to be precise, up to a certain amount of income. Exemptions are phased out at fairly high income levels. A less targeted program might turn out to be more effective in producing the desired outcome.
Refundable means that a taxpayer get a check from the government in excess of the amount he paid in. Settling up before year end is much more of a challenge here.
Sidebar: This is one reason why reducing payroll taxes for low income folks makes so much sense. It reaches, essentially, all working Americans. Such a tax reduction will increase paycheck immediately with no need for taxpayer payments later. They may get refunds but they are not at risk if withholding is done properly. End Sidebar.
Refundable tax credits might be really useful but the details are going to be extremely delicate. Be assured that there will be several folks (out of millions) that suffer negative side effects from even a well thought out program. Their problems will be well publicized.
Our advice is simplify the tax code and make simple changes. The two examples of changing the exemption amount to get a childcare and reducing payroll taxes for low income are just examples. What ever you want think simple. Don’t give the IRS a chance to mess up. The former will also make Ramesh happy as well.