Tax Reform in Name Only

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In a last-ditch effort to show some legislative progress in his first 100 days in office, President Trump presented a “tax reform plan” this week. I put that in quotes because I do not think it is tax reform in any meaningful sense of the term. I also agree with those who say it isn’t even a plan, just a one-page wish list of things the President would like to see in a plan. At this point, the proposal is too skimpy on details to evaluate in more than a very general way. One thing that seems clear is that it is mainly another tax cut for the wealthy that will add to the federal deficit.

The first section of the proposal lists “goals for tax reform”:

  • Grow the economy and create millions of jobs
  • Simplify our burdensome tax code
  • Provide tax relief to American families–especially middle-income families
  • Lower the business tax rate from one of the highest in the world to one of the lowest

One goal that is not on this list is making sure that all individuals and corporations pay their fair share by closing tax loopholes. That might be awkward for Donald Trump, since he is suspected of paying unreasonably low taxes on his own vast earnings. He feeds that suspicion by refusing to release his tax returns. (Later sections do refer to “eliminating tax breaks,” without mentioning any particular ones.)

Because the proposal emphasizes tax cuts more than anything else, it also does not promise to fulfil Trump’s pledge to reduce the deficit and reverse–or at least control–the growth in the national debt.

Some of the goals that are listed are questionable. For example, according to most analysts, the bulk of the tax relief would go to corporate shareholders, business owners, and other wealthy individuals, not to middle-income families as claimed.

Corporate taxes

The proposal would reduce the corporate tax from “one of the highest in the world”–35%–to “one of the lowest in the world”–15%. The 35% rate is misleading, since most corporations take advantage of various loopholes to pay much less than that, and many pay no taxes at all. Billionaire hedge fund managers pay only 15% now because of a loophole known as the “carried-interest deduction.”

The most obvious beneficiaries of corporate tax cuts would be shareholders, whose stockholdings would increase in value. Indeed, stock prices have already risen, at least partly in anticipation of the cuts. That benefit goes mainly to the wealthy, since the richest 10% of the population owns over 70% of the assets, and that certainly includes stock ownership. (See, for example, Piketty’s Capital in the Twenty-First Century.)

The proposal would also apply the 15% tax rate to unincorporated but owner-operated businesses such as limited partnerships. That would be a big break for business owners whose income currently “passes through” from the business to the individual and is taxed at ordinary income tax rates as high as 39.6%. That has the potential to create a new loophole for people who do not currently structure their work as a business but could find ways of doing so. Even employees might save taxes by starting a business and arranging to sell their services to their former employer.

The proposal calls for a “one-time tax on trillions of dollars held overseas,” in order to encourage companies to bring money back and invest it at home. On the other hand, it calls for a “territorial tax system” that eliminates taxes on future earnings in other countries. Whether on balance, these provisions encourage or discourage domestic job creation is not clear.

Individual taxes

The proposal would simplify taxes by reducing the number of tax brackets from seven (ranging from 10% to 39.6%) to three (10%, 25%, 35%) and eliminating most tax deductions.  Evaluating the financial impact with any precision is impossible, since the proposal does not even provide the income ranges covered by each bracket!  Based on ideas put forth during the campaign and some commonsense analysis, the overall effect would probably be to make the income tax flatter and less progressive.

Obviously taxpayers in the 39.6% bracket (incomes over $415,050 individual or $466,950 married) would have their marginal rate lowered to at least 35%. People who currently fall into the next three brackets (35%, 33% or 28%, with incomes over $91,150 individual or $151,900 married) would have the potential to be moved down to the 25% bracket. These are very nice tax reductions. Lower than that, the savings are more questionable, since the 10% and 25% brackets would remain, although not necessarily with the same income divisions. The 25% bracket contains so many people (incomes from $37,650 to $91,950 for individuals and $75,300 to $151,900 for couples) that moving very many of them all the way down to 10% would probably be too costly. The people in the very lowest brackets pay so little in taxes already that a further cut would not amount to very much. If the numbers turn out to be similar to a proposal Trump endorsed during his campaign, the savings would be much greater at the top of the distribution, and at least half of all the benefits would go to the top 1% of taxpayers.

The proposal doubles the standard deduction while eliminating most itemized deductions, the big exceptions being the mortgage interest deduction and the charitable deduction. Taxpayers who do not itemize deductions would benefit, but those who do would lose. The loss that affects the most people would be the inability to deduct state and local taxes. The Committee for a Responsible Federal Budget estimates that on the average, giving up itemized deductions would cost taxpayers a little more than getting a higher standard deduction.

The proposal would repeal the Alternative Minimum Tax, which was designed to keep wealthy people from avoiding too many taxes. Certain taxpayers have to calculate their tax two different ways and pay the higher of the two. Eliminating most itemized deductions would make some rich people pay more, but repealing the AMT would allow them to pay less, in some cases much less.

One proposal that is a flat-out gift to the wealthy is repeal of the estate tax, which affects only large estates. Currently individuals can shelter the first $5.5 million from estate taxes, and couples can shelter $11 million, so it makes no difference to most people. But for the 0.2% of estates that are larger than that, the tax savings could be substantial.

President Trump would benefit personally from many provisions of his own wish list. The New York Times analyzed his taxes based on the portion of his 2005 return that became public this year. If all of his proposals were to be enacted, he would save $31 million through repeal of the Alternative Minimum Tax, $27 million from reductions in business taxes, $1.5 million from repealing Obamacare taxes, and $0.5 million from reducing individual tax rates.  He would have to pay $3 million to $5 million more because of the elimination of most deductions, but he would still come out at least $55 million ahead. That’s just in one year. Presumably, he could have similar savings every year. Then when he died, he could transfer his property–worth an estimated $3 billion now–to his heirs without paying 40%–currently 1.2 billion–in estate taxes. That’s not reform; that’s just a raid on the Treasury.

The impact on federal debt and job creation

The Committee for a Responsible Federal Budget has produced a rough estimate of how much the proposed tax cuts would cost the federal government in lost revenue. They expect them to add about $5.5 trillion to the national debt over the next ten years ($6.2 trillion with interest). To put that in perspective, the debt is now about $20 trillion and rising. About two-thirds of the added debt would come from the corporate tax cuts and one-third from the individual tax cuts.

This creates a dilemma for Republicans, who generally love tax cuts but claim to hate deficits, at least when a Democrat occupies the White House. One way of dealing with that dilemma is to claim that tax cuts pay for themselves by growing the economy. Part of this claim is the standard “trickle-down economics” argument that tax cuts for corporations and the wealthy free up capital that can be used to create jobs. Take the argument a little further and it becomes “supply-side economics,” the idea that tax cuts can generate enough economic growth and new tax revenue to offset the cost of the tax cuts themselves.

However, few economists would go that far. The more mainstream consensus is that economic growth only offsets a portion of the revenue lost through unfunded tax cuts. Maya MacGuineas, president of the Committee for a Responsible Federal Budget, says that “it seems the administration is using economic growth like magic beans: the cheap solution to all our problems.”

Beyond that, there is the larger argument about how to create jobs. Is the sluggish pace of job creation really due to a lack of capital in the hands of corporations and rich people? With economic inequality in the U.S. already at such a high point, the rich would seem to have plenty of money to invest. And corporations have found ways to make big profits without creating many domestic jobs, especially by offshoring manufacturing and replacing workers with machines.

Maybe our problems of job creation have more to do with the inability of low-wage workers to create growing markets for many goods and services. Maybe the areas in which we could be creating jobs require more public spending, such as on rebuilding infrastructure or making health care and education more affordable. (One thing Obamacare has been doing is creating jobs in healthcare, but another thing the Trump proposal would do is repeal the taxes on higher incomes that mostly pay for it.) The trouble with another tax cut for the wealthy is that it may be worse than economically ineffective; it may deprive government of the fiscal resources it needs to create jobs in a much more direct fashion. Also, the additional borrowing required to offset lost tax revenue could force up interest rates, discouraging such things as borrowing to buy homes.

If the jobs benefits of the tax proposal turn out to be grossly overstated, then it turns out to be what the New York Times called it this morning, “a multitrillion-dollar shift from federal coffers to America’s richest families and their heirs….” This is about the last thing that anyone who claims to be a populist should be doing. If that doesn’t make people wake up and see Donald Trump for what he really is, I don’t know if anything will.

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