Some points you may have missed on Trump’s ill-advised tax plan

August 9th, 2016 at 8:35 am

As you’ve probably seen, Donald Trump talked mostly tax policy yesterday in a big speech in Detroit. He’s amending his original tax plan, which I guess he no longer thinks is as awesome and amazing as when he first introduced it. Here are a few points which, amidst all the hoopla, you might not have picked up on.

Interestingly, the plan is pure, old-fashioned, supply-side, trickle-down orthodoxy. How that squares with Trump’s play for disaffected working class voters hurt by globalization is left as an exercise for the reader (because I don’t get it). Believe me, those voters benefit not one cent from eliminating the estate tax. I assume his motives are a) a sop to the top 1% who fund such campaigns, b) a way to shrink gov’t by starving it of revenues, and c) a signal to the Ryan wing of the party that “despite all the cray-cray, I’m really with you re the parts you care most about (eg, a and b).”

–He claims to close one loophole but opens up a much bigger one. This, to me, is a big deal that’s easy to miss. I’m talking about the Trump plan for a 15% tax rate on “pass-through” income.

His updated plan sets the top income tax rate at 33% but creates “a much lower rate than 33 percent for a substantial number of very-high-income households by allowing people to pay a new low rate of 15 percent on “pass-through” income (business income claimed on individual tax returns).  More than two-thirds of all pass-through business income flows to the top 1 percent of tax filers (see figure).”

passth

This invokes Jared’s first rule of tax avoidance: when you can pay a lower a rate on a particular type of income, lo and behold, it turns out that’s the very type of income you now have gobs of!

Being of sound fiscal personality, I probably wouldn’t go there, but if you’re in the top income bracket, any putz with a tax lawyer will march into their boss’s office and declare that “I’m no longer Joe Paycheck, I’m Joe Paycheck, LLC. Pay me the same salary but call it a consultant’s fee for services provided by my limited partnership.” Joe then passes that income through from the business to the personal side of the tax code and pays 15% on it.

There are rules against such avoidance, but they’re rarely enforced; distinguishing salary from profits in such cases is more art than science. Marr and Huang provide the details here.

One has little trouble imagining hedge fund and private equity managers making this move. Right now, the carried interest loophole lets them pay 24% on their earnings as opposed to the 40% they should be paying. Under Trump, by tapping the pass-through loophole, they’ll pay 15% instead of 33%. So, basically, he lowers, not raises, their tax burden, and by a lot (-9 ppts: 15-24).

–Repeal the estate tax: This one also risks getting lost in the mix. But it’s just a pure sop to a tiny group of really rich families, a classic example of rich donors buying tax breaks for themselves (that would include the Trump family themselves, though hard to know without seeing the Donald’s taxes).

Because the exemption is already so high–$11 million for a couple—only 0.2% of estates (that’s 2 in a 1,000) pay it. The average benefit to these estates, were the tax repealed, is $3 million. And please spare me the BS around “small family businesses” and “family farms.” The families—and again, there are hardly any of them (in a classic NYT piece, the paper exhaustively looked for one family farm that qualified and couldn’t find one)—with estates above the threshold may not be GE, but neither are they the mom-and-pop hardware store on the corner.

–The new child-care deduction: Trump added a new idea: a tax deduction for child-care costs. The problem here stems from the difference between a deduction and a credit. Deductions are “upside-down” tax breaks. That is, since you deduct expenses according to your tax rate, those with higher incomes and thus higher tax rates get a bigger break. Moreover, if you face no federal tax liability at all, as is the case for 44% of households (the vast majority of whom pay some other form of taxes), this can’t help you because you’ve got no liability against which to deduct the cost of care.

Refundable tax credits work like a negative tax in this context, and I’ve read some references that this is where the Trump team wants to go with this, but they’re clearly lurching about here and don’t seem to have any expertise in this space.

Which leads me to this final point. Some argue that the above critique is ill-considered, not because it’s incorrect but because it credits an incoherent candidate with coherent plans. I freely admit that what Trump says on Monday, he often contradicts on Tuesday, and perhaps I’m mistaken to take this stuff seriously. But my point is that if you do so—if he really means it—it’s terrible policy.

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10 comments in reply to "Some points you may have missed on Trump’s ill-advised tax plan"

  1. Matthew says:

    This is my first time on your blog, Jared. I appreciate the measured, easily digestible takedown of the “repeal the estate tax” position. I’ve added your blog to my regular reading list. Thanks.


  2. Mike says:

    I’m trying to wrap my head around Trump’s new child care deduction. Here’s the quote from his speech:

    “My plan will also help reduce the cost of child care by allowing parents to fully deduct the average cost of childcare spending from their taxes,” Trump said Monday in a sweeping economic policy speech at the Detroit Economic Club.

    I’m not sure what he means by the “average cost.” Is it the average over a few years? The average of childcare costs in the region? Nationwide average? And why isn’t just a straight deduction of what you spend, or some portion thereof?


    • PJR says:

      I have the same question because it’s related to another: isn’t this a tax break for even fewer people than the “44 percent who pay no income tax” at all? The tax deduction would benefit people who itemize deductions, right? Only about 32 percent of tax filers currently itemize deductions and many of them have no childcare expenses to deduct (many are past their child-raising years, others have no children, others have stay-at-home spouses, etc.). Regarding the other 68 percent, for those who do have childcare expenses, I suspect the new deduction is too small to exceed the standard deduction and the net deduction–after subtracting a foregone standard deduction–would be tiny.


    • mike says:

      Isn’t the child care deduction going to get AMT-ed and then Peased away for higher income people? I’m not arguing that it comes close at all to being a good idea, I’m just trying to fully understand the system/


  3. Jill SH says:

    Well, first, Jared, kudos for valiantly stabbing back at the dragon on Diane Rehm this morning.

    Next, we need to start identifying just who is “hurt” by the death tax. Daddy doesn’t pay the tax as long as he is living; he worked hard for his money (we can suppose) and is enjoying the fruits of his labor during his lifetime. But the moment he leaves this worldly realm, the tax comes out of the estate (since he couldn’t take any of it with him), lessening the amount that goes to all Daddy’s offspring-heirs. Now, THEY did not do the work for/build all that wealth — it’s just being handed to them. (Or, even if they did work for Daddy, they were/should have been paid.) So maybe we should call it the “inheritance windfall” tax.

    I have to believe there are plenty of ways to build family business corporations, with offspring/heirs as corporate members, that a lot of any business can be transferred other than by direct inheritance. That solves the “family farm” problem, yes?


  4. Bob Palmer says:

    It just dawned on me where I last heard the trope about reducing pass-through income as a political issue. Governor Brownback of Kansas eliminated all tax on Kansas LLC’s a few years ago. The Kochs, for whom Kansas is a virtual wholly-owned subsidiary, promptly converted their Kansas operations to a LLC. Viola! no Kansas state income taxes on Koch Kansas income.

    LLCs (Limited Liability Corporations) were created to give owners of businesses the ability to avoid “double taxation” on taxable income they receive from their businesses. The theory is, business income from a C corporation is taxed twice: once at the corporate level and again at the personal level when dividends are paid to owners. Businessmen could always avoid double taxation by simply operating their businesses as proprietorships or general partnerships. But then they would lose the limited liability protection from creditors that C corporations and limited partnerships provide. So Congress created the LLC hybrid to enable businessmen to have their limited liability cake and eat it too.

    Sounds fair, doesn’t it? I can already see the heads nodding up and down. But think some more about it. My wife and I together paid into Social Security for well over a combined one hundred years. We could not deduct our SS contributions which means we paid income taxes on the income we used to make our contributions. Now that we are finally receiving Social Security, we pay federal and Minnesota income taxes again, on most of the payments we receive. When we use some of our Social Security income to buy gas at the local CoOp we are taxed again in federal and state motor fuel taxes. And then there are sales and excise taxes. And on and on.

    Double, triple and quadruple taxation are pervasive throughout our economy, and nearly all of us pay them. So don’t shed too many tears for the Kochs and other poor “small business job creators” who need a break from double taxation. Or maybe ask your Congressperson for a similar break for you.


  5. Smith says:

    No one cares about these minutiae of tax policy, especially the average swing state swing voter. Here’s what they hear, Trump is going to cut taxes. It’s a losing argument to say you are against tax cuts, or that the government doesn’t waste tax dollars. Here instead is the way forward.
    Trump is cutting tax mostly for the rich, he is hoodwinking you, the art of the deal, you get pennies in tax cuts while the rich take in extra millions to buy penthouse apartments that guess who builds. Meanwhile, our roads and bridges crumble that you need because he’s given away the money needed to his rich buddies. All the while the deficit explodes. What president raised taxes, restored the economy and left a surplus? Clinton.
    Obama closed his 2012 campaign, a more challenging enterprise (and closer margin) than the 2008 breakthrough greatly aided by the financial crisis, by reminding voters he was trustworthy. Somehow Ms Million Dollar Speaking Fee Clinton has to convince voters she won’t sell voters down the river if they vote for her, instead of Mr Art of Deal, Trump U, Bankrupt Casino, 2nd Amendment folks I don’t know, NATO sellout, Putin Appeaser Don. It’s an unfunded tax cut, so the middle class will have to pay off the debt with interest for giving rich people money now to spend on luxuries they don’t need. Borrow for school and roads, not gold watches.


  6. Raymond L says:

    It should be noted that forming an LLC and getting pass through would require payment of the additional employer Social Security and Medicare percentages (13.85%) which erases any tax advantages gained by the 15% rate for workers who earn less than the maximum SS salary ($118,500). That $118,500 income level is in the top 18%. So no one in the bottom 82% would benefit at all.


    • Smith says:

      I don’t think that’s correct. If you are a corporation, and the business pays the employer Social Security and Medicare, and it’s largely your corporation, you are paying that 13.85% either way. Pass through is only for closely held corporations, whether an S or an LLC, you get limited liability but skip the corporate tax which doesn’t include a fair salary paid the principal owner nonetheless. But either way the Social Security and Medicare are paid, and it matters not whether officially your company pays it (which in discussing S or LLC you’re basically the owner anyway) or you pay it directly. What matters is all of sudden the rest of the income is subject to a 15% tax instead of a maximum 39%.
      What Trump does get right is that it’s an uneven playing field where large corporations don’t pay enough tax and have too big an advantage over small businesses. The answer is to close loopholes and raise corporate rates. What is galling is hearing Obama concede repeatedly a willingness to close loopholes and lower rates, along with a tax holiday and repatriation of foreign profits. Expect Clinton to give a huge give away to corporations with tax holiday, which encourages exporting jobs, and will begin a new round of keeping profits abroad, held hostage to blackmail the treasury with same gambit.


  7. Mitchell Harwitz says:

    I can recall descriptions of firms in which workers are converted from wage recipients to “independent contractors” as soon as they start to qualify for either benefits or overtime pay. The new rules on overtime were designed to restrict this practice weren’t they? In principle, would not the “Trump Pass Through” apply to such workers as well? In all likelihood the provision will do these lower-income workers no good, but would it not actually apply?


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