April 10, 2024
Amid the Trump tax cuts’ many regressive policies, one move was a boon to working-class households. The standard deduction1 for federal income taxes was nearly doubled in the 2017 Tax Cuts and Jobs Act (TCJA). By making itemized deductions less viable and reducing taxable income by a sizable amount, the higher standard deduction was good news for low- and middle-income filers. With the increased standard deduction set to expire next year, we are at risk of returning to a status quo that only benefits the tax preparation industry. It is important to understand the disproportionate impact that a sudden drop in the standard deduction would have on working-class households.
Data Analysis
This analysis is interested in tax liability, which represents the amount a household owes in federal income taxes for a year. This is not the amount you owe after filing taxes; this is the amount the government says you should have paid over the course of the year.
This analysis aims at comparing tax liability under a higher and lower standard deduction, then relating that difference to the household’s annual income. Using IRS data from 2017 (the tax year preceding the TCJA) and 2021 (the most recent year for which the IRS offers detailed data),2 I compare households under two scenarios, with all else equal:3
- Actual standard deduction (SD) in 2021
- Reduced-SD scenario for 2021
- SD sits at pre-TCJA level, adjusted for inflation
- This is what it will return to at the end of 20254
Consider the following example: a married couple earning $60,000 annually with no incentive to itemize deductions.
- Under the actual 2021 tax regime
- Standard deduction: $25,100
- Taxable Income: $34,900
- Assuming the lower standard deduction
- Standard deduction: $14,3895
- Taxable income: $45,611
This household occupies the 12 percent tax bracket in either case. Tax savings under the current system are $1,285 — roughly 2.1 percent of their annual income. Compare this to a married couple earning $600,000 annually with $30,000 in property taxes and mortgage interest to deduct. For the latter household, the higher standard deduction is irrelevant because they will itemize regardless.
The above example is purely illustrative, but we can use actual IRS data to extend this analysis. A representative household from each income group was systematically determined from each group’s average AGI (Adjusted Gross Income) and the likelihood of itemizing deductions in 2017 and 2021.6 Therefore, this analysis captures the impact on the typical household in each income group, rather than an aggregate impact. Of course, some millionaire households benefit slightly from the increased standard deduction, but they are far from the norm.
Table 1 shows the results of this analysis for the two most popular filing statuses. Among single filers, notice that 11 million people had income between $50,000 and $75,000; the typical household in that group saves 1.9 percent of its annual income with the higher standard deduction.7
Table 1
Figure 1 visualizes the pattern shown in Table 1. The general trend is the same for both kinds of filers. Low-income filers benefit more, as a percentage of income, from the increased standard deduction than high-income married filers do. With the higher standard deduction, the married couple making $25,000–30,000 saves 3.7 percent of their income, while the married couple making over $500,000 sees no change in their tax liability. A similar story applies to single filers; those making below $75,000 clearly benefit more from a higher SD than those making six figures.
Figure 1
The increased standard deduction makes itemizing unviable for many tax filers, which represents another important benefit of the change. Table 2 shows that 44.5 percent of married filers in the $75,000–100,000 income range opted to itemize in 2017, while only five percent of those filers itemized in 2021.
Table 2
When itemization is more viable, taxpayers are more likely to solicit costly tax preparation help. Research shows that this industry has been growing in recent decades, and the costliness of such services means wealthier households are much more likely to claim all their potential deductions.8 Many of these paid preparation services are unregulated, and their errors result in major headaches for filers and the IRS alike.9 Discouragement of itemizing means millions of working-class households no longer need to turn to the tax preparation industry.
Conclusion
We know the federal income tax is not the most effective way to tax the rich. With so much of the spoils of corporate power stowed in wealth and retained earnings, we need a multifaceted approach to reduce inequality. However, the planned dilution of the standard deduction next year would have disproportionate consequences for working-class households. Though the TCJA was rife with provisions that were regressive or complex,10 the increased standard deduction is progressive and easier for the average taxpayer. Congress must consider the distributional impact of a lower standard deduction, and how the added incentive to itemize is a giveaway to the tax preparation industry. A tax system that discourages itemization is a simpler and more just tax system.
- The standard deduction is a fixed dollar value that reduces a taxpayer’s Adjusted Gross Income (AGI). Alternatively, households can take the time to itemize their deductions, but will typically only do this if the sum of their itemized deductions exceeds the standard deduction.
- IRS Statistics of Income (SOI) Publication 1304, Basic Tables, Table 1.2, Taxable Returns. https://www.irs.gov/statistics/soi-tax-stats-individual-income-tax-returns-complete-report-publication-1304-basic-tables-part-1
- A few other TCJA provisions are set to expire in 2025, including the new tax brackets, elimination of personal exemptions, and increased child tax credit. It is beyond the scope of this analysis to quantify the impact of those changes; therefore, the standard deduction is the only variable element in my scenarios. If anything, the change in tax brackets would magnify the impact of a reduced standard deduction.
- https://crsreports.congress.gov/product/pdf/R/R47846
- Based on the 2017 value of $12,700, scaled up by 13.3% based on CPI-U adjustment.
- This is straightforward for low- and high-income groups, whose representative household will make the same choice in either scenario. The typical middle-income household, however, is influenced in its decision by the level of the standard deduction. If itemization was the more popular option in 2017, but not in 2021, I assume the representative household’s itemized deductions lie at the midpoint of the two potential SD values.
- This group sees higher savings than some lower-income groups because their tax bracket is much higher (22 percent vs. 12 percent), meaning that an increase in taxable income has a greater impact on tax liability.
- Benzarti, Y. (2020). How Taxing Is Tax Filing? Using Revealed Preferences to Estimate Compliance Costs. American Economic Journal: Economic Policy, 12 (4), 38–57. https://doi.org/10.1257/pol.20180664
- https://big.assets.huffingtonpost.com/athena/files/2024/03/26/66035ffae4b0cca5da3e2737.pdf
- Section 199A and the massive corporate tax reduction are two of the most striking examples.
