A Principled Analysis of the Trump Tax Reform Plan
Okay. Chief Economic Adviser Gary Cohn and Treasury Secretary Steven Mnuchin have just released President Trump’s much awaited tax reform plan. It is a single sheet of paper with 19 lines on the goals of tax reform and the proposals. This is what the administration has been working on so arduously for three months. It looks like something that you or I could come up with in a half an hour.
The devil is in the details and we have few details here. Of course, such a proposal can only be a bare outline because it has to go through the legislative process and many changes are likely during that process. We also do not have the scoring of the Congressional Budget Office on the likely impact of this package (as well as other economists who might disagree with the CBO figures).
But even in this rough cut form I think it is important to look at how this proposal fulfills the principles outlined in my recent essay The Summation of the Principles of Taxation. I will try to explain how these principles are addressed in such a manner that it makes sense even to those that have not read the Summation (and it might make you want to go back and take a look at it).
The Goals for Tax Reform
The plan’s goals are:
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
This is a very Keynesian tax proposal. It assumes that that lower taxes generates higher growth because it puts more money in the hands of the people who go out and spend or invest it. This is the same concept used by the Democrats to justify increased government spending. Such policies might be warranted if we were in a recession (as was Keynes original concept) but we have had slow but steady growth for eight years, which has resulted in tight labor markets that cannot be closed because of a skills gap and other structural issues (of which the level of taxation is only one). It is hard to see how putting more money into an economy awash in money from deficit spending and quantitative easing is going to suddenly create faster growth. Further, a paper on dynamic scoring by Matthew Weinzierl and Greg Mankiw estimated that a broad-based income tax cut (applying to both capital and labor income) would recoup only about a quarter of the lost revenue through supply-side growth effects. The result would be huge increase in the already huge public debt as also occurred after the Reagan tax cuts.
Tax relief for American families, especially middle-income families:
Reducing the 7 tax brackets to 3 tax brackets of 10%, 25% and 35%
Doubling the standard deduction
Providing tax relief for families with child and dependent care expenses
Eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers
Protect the home ownership and charitable gift tax deductions
Repeal the Alternative Minimum Tax
Repeal the death tax
Repeal the 3.8% Obamacare tax that hits small businesses and investment income
I don’t see how a reduction in the number of brackets would substantially simplify the tax system. This was not really a problem even before computers and TurboTax. We have no idea at what income level these tax brackets apply so it is not possible to determine the impact of tax revenue or how much relief is provided to taxpayers. Doubling the standard deduction would provide a significant (and costly) benefit to lower and middle-income taxpayers. The standard deduction was the only deduction recommended in my original proposal because lower income taxpayers would have to forego necessities to pay for these taxes in the absence of the standard deduction compared to upper income taxpayers who would have to forego luxuries. This proposal would be deemed fair by a large segment of the population but because it affects so many taxpayers it will be very costly. I would prefer that child and dependent care expenses be handled directly through subsidy payments rather than through the tax system.
The elimination of tax breaks for the wealthy is a laudable goal but here we need to know exactly what tax breaks are being discussed. In my proposal I advocated eliminated all tax breaks. This would greatly simplify the tax system. If it was felt beneficial to offer benefits for certain actions by taxpayers (such as installing solar panels or buying an electric plug-in vehicle) these incentives could be provided by direct payments authorized by Congress rather than through the tax system. The same could be said for tax credit for lower income taxpayers as well. There are ways to provide these benefits without using the tax system. The manipulation of the behavior of the people through the use of tax incentives is a perversion of the limited role of government envisioned by the Founders.
The so-called home ownership deduction is actually a mortgage interest deduction. In my full essay I show that the mortgage interest deduction does not promote a higher percentage of home ownership but rather the purchase of larger homes subsidized by taxpayers. Lower and middle-income families do not pay enough mortgage interest to justify the use of the itemized deduction option so this benefit is primarily for the wealthy.
I know the gift tax deduction is popular and it may be one of the reasons why Americans give so generously compared to other countries. But there may be better ways to achieve this worthy goal. I remember during the 2012 election campaign I read that republican candidate Mitt Romney donated a substantial portion of his income to charity. He gave 29.4% of his $13.7 million income ($4.0 million) to charity. Wow! That’s a lot. About 80% of Mr. Romney’s gifts, however, are to the Mormon Church. If we substituted direct payments instead tax deduction as I have proposed for other deductions, the US government would have to write a multimillion-dollar check to the Mormon Church. I don’t mean to pick on Mr. Romney (I just remember that fact from pervious research). Many people do this (mostly wealthy because of the itemized deduction thing). I just don’t think a lot of people would support the government writing billions of dollars of checks to religious organizations but the tax deduction for charitable gifts has the exact same budgetary impact (although tax expenditures such as the charitable giving tax deduction are not included in the official budget).
Not mentioned on this brief sheet of paper but discussed in the press conferences was the elimination of the deduction for state and local taxes. This is a good idea. This deduction currently requires that the federal government subsidize tax-hungry progressive states like California at the expense of low-tax business friendly states like Texas. Whether you are progressive or conservative the federal government has no business subsidizing one state at the expense of another.
The Alternative Minimum Tax should have been repealed long ago. Period.
I have always felt that the Death Tax (actually the Estate Tax) is an unjust tax. It is a punitive tax on wealth, punishing people for being successful. It is onerous, placing a heavy burden on a grieving family that might have to sell the family estate or business in order to generate the funds to pay the tax. Furthermore, in many cases taxes have already been paid on the income that created the estate so that, in these instances, the estate tax is double taxation. A case could be made that the tax basis (book value) of the estate is far below the current market and that the inheritance of the estate is a financial transaction that requires the establishment of a new tax basis. But in these cases, the basis should be adjusted for inflation and be paid in installments (just like my long term capital loss carryover on a bad investment can only be $3,000 per year). On the other hand, a wealth tax on the value of an estate is not an unreasonable tax. Middle-income families pay property tax on their major wealth asset (their home) but wealthy families do not pay anything on their financial assets that represent a much larger portion of their wealth.
Repealing the 3.8% Obamacare tax before repealing Obamacare will leave the government with an unfunded expenses mandated by law. Without these funds, the size of the fiscal deficit will increase.
15% business tax rate
Territorial tax system to level the playing field for American companies.
One time tax on trillions of dollars held overseas
Eliminate tax breaks for special interests.
One gets the feeling that the 15% corporate tax rate is an opening bid in a lengthy negotiation. That may be so. But the United States must be careful not to instigate a bidding war on who has the lowest rate. That will just beggar all the other developed economies. And, although most of corporate taxes are passed on to consumers in the form of higher prices, many people will feel that a 15% rate is a giveaway to rich fat cats who don’t need a break. A better idea would be to go to the G-20 meeting of developed economies and establish a range of corporate rates so that one country’s rates does not disrupt those of its neighbors and trading partners (of course in the private sector this would be an illegal collusion).
The global tax system of the United States has disrupted and distorted how our private sector does business and led to companies not only keeping foreign earnings offshore but also investing those offshore funds in operations that compete with the US. A switch to a territorial tax system would allow US companies to compete with the international competitors on a more even basis.
Likewise a one-time tax on repatriating offshore funds is a reasonable idea. Many people would consider a tax-free repatriation an unfair giveaway. So a one-time tax in combination with a switch to a territorial tax system is a good idea.
Businesses are taxed on the difference between revenues and expenses so deductions are a key part of business taxation. But the complexity of the tax code derives from special tax treatments for certain companies or industries (particular interests). Elimination of all these special treatments is a key element in developing a tax system that will be deemed not too unfair by the citizenry (a fair system being an unachievable goal).
Issues not addressed in the tax proposal.
Capital gains tax: the gain should be taxed the same as other income but the amount of the gain should be adjusted for inflation.
Dividend double taxation: dividends should be deductible by companies and taxed only on the recipient of the dividend.
The double tax exemption of healthcare benefits: this double exemption has resulted in the distorted healthcare mess we currently have in the US. Again, the recipient of this benefit should pay the tax.
Border tax: Although the Trump administration is leery of this new tax, House Republicans are counting on $1 trillion in taxes on imports over 10 years from this tax to cover the lower corporate tax rates. This is the equivalent of asking foreigners to pay for our tax cut. Don’t expect our trading partners to sit idly by while we gouge them for all this money. Besides, Veronique de Rugy and Daniel J. Mitchell showed in a recent op-ed piece in the Wall Street Journal (The Border-Adjustment Sleight of Hand) that the playing field is already level.
Some elements of the Trump Administration tax proposal are good and some are not so good. If the administration and congress can come up with a plan that achieves the proposal’s stated goals they will have achieved a major piece of legislation. President Trump will be accused of feathering his own nest because some of the tax proposals would greatly benefit his business interests. People are demanding to see his tax returns in order to determine how he will benefit from these proposals. This is a legitimate request of a publicly elected official because it is the appearance of a conflict of interest that must be avoided.
It will be a while before we begin to see the details of this tax plan and also see how Congress begins to try and distort it. The Trump plan goes partway in clearing up the mess of confusing deductions and corporate welfare but it would be better if the plan made a clean break. Particular interests (which means not the public interest) are what drive the electoral cycle in Washington. Lobbyists try and get legislators to draft legislation (especially tax legislation) in the interest of their clients. Legislators need the support of the lobbyists in order to get reelected. While a partial solution to the tax code mess is better than nothing, it leaves space for K Street to try and insert some tax benefits for their clients. A clean break, as I proposed, would clear the field and expose such maneuvering to the light of day.
Don’t sit back and wait to see what Congress comes up with. Let your congressional representative know how you feel.