Tag: Tax Reform

Trump and Taxes: A Bush-Like Plan from “The Donald”

It’s been a challenge to assess Donald Trump’s fiscal policies since they’ve been an eclectic and evolving mix of good and bad soundbites.

Though I did like what he said about wanting to pay as little tax as possible because the government wastes so much of our money.

On the other hand, some of his comments about raising tax burdens on investors obviously rubbed me the wrong way.

But now “The Donald” has unveiled a real plan and we have plenty of details to assess. Here are some of the key provisions, as reported by the Wall Street Journal. We’ll start with the features that represent better tax policy and/or lead to lower tax burdens, such as somewhat lower statutory tax rates on households and a big reduction in the very high tax rate imposed on companies, as well as a slight reduction in the double tax on capital gains.

…no federal income tax would be levied against individuals earning less than $25,000 and married couples earning less than $50,000. The Trump campaign estimates that would reduce taxes to zero for 31 million households that currently pay at least some income tax. The highest individual income-tax rate would be 25%, compared with the current 39.6% rate. …Mr. Trump also would cut the top capital gains rate to 20%, from the current 23.8%. And he would eliminate the alternative minimum tax. …For businesses, Mr. Trump’s 15% rate is among the lowest that have been proposed so far.

But there are also features that would move tax policy in the wrong direction and/or raise revenue.

Most notably, Trump would scale back certain deductions as taxpayers earn more money. He also would increase the capital gains tax burden for partnerships that receive “carried interest.” And he would impose worldwide taxation on businesses.

To pay for the proposed tax benefits, the Trump plan would eliminate or reduce deductions and loopholes to high-income taxpayers, and would curb some deductions and other breaks for middle-class taxpayers by capping the level of individual deductions, a politically dicey proposition. Mr. Trump also would end the “carried interest” tax break, which allows many investment-fund managers to pay lower taxes on much of their compensation. …The Trump plan would raise revenues in at least a couple of significant ways. It would limit the value of individual deductions, with middle-class households keeping all or most of their deductions, higher-income taxpayers keeping around half of theirs, and the very wealthy losing a significant chunk of theirs. It also would wipe out many corporate deductions. …The plan also proposes capping the amount of interest payments that businesses can deduct now, a change phased in over a long period, and would impose a corporate tax on future foreign earnings of American multinationals.

Last but not least, there are parts of Trump’s plan that leave current policy unchanged.

Which could be characterized as “sins of omission” since many of these provisions in the tax code - such as double taxation, the tax bias against business investment, and tax preferences - should be altered.

…the candidate doesn’t propose to end taxation of individuals’ investment income… Mr. Trump would not…allow businesses to expense all their new equipment purchases, as some other Republicans do. …All taxpayers would keep their current deductions for mortgage-interest on their homes and charitable giving.

So what’s the net effect?

The answer depends on whether one hopes for perfect policy. The flat tax is the gold standard for genuine tax reform and Mr. Trump’s plan obviously falls short by that test.

But the perfect isn’t the enemy of the good. If we compare what he’s proposing to what we have now, the answer is easy. Trump’s plan is far better than the status quo.

Now that I’ve looked at the good and bad policies in Trump’s plan, I can’t resist closing with a political observation.  Notwithstanding his rivalry with Jeb Bush, it’s remarkable that Trump’s proposal is very similar to the plan already put forth by the former Florida Governor.

I’m not sure either candidate will like my interpretation, but I think it’s flattery. Both deserve plaudits for proposing to make the internal revenue code less onerous for the American economy.

P.S. Here’s what I wrote about the plans put forth by Marco Rubio and Rand Paul.

Assessing Jeb Bush’s Pro-Growth Tax Plan

In my 2012 primer on fundamental tax reform, I highlighted the three biggest warts in the current system.

1. High tax rates that penalize productive behavior such as work and entrepreneurship.

2. Pervasive double taxation that undermines saving and investment.

3. Corrupt loopholes and cronyism that lure people into using resources inefficiently.

These problems all need to be addressed, along with additional problems with the internal revenue code, such as worldwide taxation and erosion of constitutional freedoms and civil liberties.

Based on these criteria, I’ve already reviewed the tax reform plan put forth by Marco Rubio. And I’ve analyzed the proposal introduced by Rand Paul.

Now let’s apply the same treatment to the “Reform and Growth Act of 2017” that former Florida Governor Jeb Bush has unveiled in today’s Wall Street Journal.

Senator Rand Paul’s Very Good Tax Plan Needs One Important Tweak

Our nation very much needs fundamental tax reform, so it’s welcome news that major public figures - including presidential candidates - are proposing to gut the internal revenue code and replace it with plans that collect revenue in less-destructive ways.

A few months ago, I wrote about a sweeping proposal by Senator Marco Rubio of Florida.

Today, let’s look at the plan that Senator Rand Paul has put forward in a Wall Street Journal column.

He has some great info on why the current tax system is a corrupt mess.

From 2001 until 2010, there were at least 4,430 changes to tax laws—an average of one “fix” a day—always promising more fairness, more simplicity or more growth stimulants. And every year the Internal Revenue Code grows absurdly more incomprehensible, as if it were designed as a jobs program for accountants, IRS agents and tax attorneys.

And he explains that punitive tax policy helps explain why our economy has been under-performing.

…redistribution policies have led to rising income inequality and negative income gains for families. …We are already at least $2 trillion behind where we should be with a normal recovery; the growth gap widens every month.

So what’s his proposal?

…repeal the entire IRS tax code—more than 70,000 pages—and replace it with a low, broad-based tax of 14.5% on individuals and businesses. I would eliminate nearly every special-interest loophole. The plan also eliminates the payroll tax on workers and several federal taxes outright, including gift and estate taxes, telephone taxes, and all duties and tariffs. I call this “The Fair and Flat Tax.” …establish a 14.5% flat-rate tax applied equally to all personal income, including wages, salaries, dividends, capital gains, rents and interest. All deductions except for a mortgage and charities would be eliminated. The first $50,000 of income for a family of four would not be taxed. For low-income working families, the plan would retain the earned-income tax credit.

Kudos to Senator Paul. This type of tax system would be far less destructive than the current system.

Fiscal Fights with Friends, Part I: Responding to Reihan Salam’s Argument against the Flat Tax

In my ultimate fantasy world, Washington wouldn’t need any sort of broad-based tax because we succeeded in shrinking the federal government back to the very limited size and scope envisioned by our Founding Fathers.

In my more realistic fantasy world, we might not be able to restore constitutional limits on Washington, but at least we could reform the tax code so that revenues were generated in a less destructive fashion.

That’s why I’m a big advocate of a simple and fair flat tax, which has several desirable features.

  • The rate is as low as possible, to minimize penalties on productive behavior.
  • There’s no double taxation, so no more bias against saving and investment.
  • And there are no distorting loopholes that bribe people into inefficient choices.

But not everyone is on board, The class-warfare crowd will never like a flat tax. And Washington insiders hate tax reform because it undermines their power.

But there are also sensible people who are hesitant to back fundamental reform.

Consider what Reihan Salam just wrote for National Review. He starts with a reasonably fair description of the proposal.

The original flat tax, championed by the economists Robert Hall and Alvin Rabushka, which formed the basis of Steve Forbes’s flat-tax proposal in 1996, is a single-rate tax on consumption, with a substantial exemption to make the tax progressive at the low end of the household-income distribution.

Though if I want to nit-pick, I could point out that the flat tax has effective progressivity across all incomes because the family-based exemption is available to everyone. As such, a poor household pays nothing. A middle-income household might have an effective tax rate of 12 percent. And the tax rate for Bill Gates would be asymptotically approaching 17 percent (or whatever the statutory rate is).

My far greater concerns arise when Reihan delves into economic analysis.

Grading the Rubio-Lee Tax Reform Plan

In my 2012 primer on fundamental tax reform, I explained that the three biggest warts in the current system:

  1. High tax rates that penalize productive behavior.
  2. Pervasive double taxation that discourages saving and investment.
  3. Corrupt loopholes and cronyism that bribe people to make less productive choices.

These problems all need to be addressed, but I also acknowledged additional concerns with the internal revenue code, such as worldwide taxation and erosion of constitutional freedoms an civil liberties.

In a perfect world, we would shrink government to such a small size that there was no need for any sort of broad-based tax (remember, the United States prospered greatly for most of our history when there was no income tax).

In a good world, we could at least replace the corrupt internal revenue code with a simple and fair flat tax.

In today’s Washington, the best we can hope for is incremental reform.

But some incremental reforms can be very positive, and that’s the best way of describing the “Economic Growth and Family Fairness Tax Reform Plan” unveiled today by Senator Marco Rubio of Florida and Senator Mike Lee of Utah.

Tax Reform Error #2: Phasing-in Lower Tax Rates

Since 1981, Republican legislators have shown a strong penchant for phasing-in tax rate reductions over several years.  That tradition is maintained in Ways and Means Committee Chair Dave Camp’s proposed 979-page “simplification” of the U.S. tax system.  The Camp draft retains a very high top tax rate of 38.8 percent on businesses that file under the individual income tax as partnerships, proprietorships, LLCs or Subchapter S corporations. For those choosing to file as C-corporations, by contrast, the Camp proposal would gradually reduce the corporate tax rate by two percentage points a year over five years, eventually reducing it from 35 to 25 percent. 

The trouble with phasing-in lower tax rates is that it creates an incentive to postpone efforts and investments until later, when tax rates will be lower.  Reducing the corporate tax rate by two percentage points a year would create an incentive to repeatedly delay reported profits, year after year, holding back the economy and tax receipts.  Sensible tax planners would write-off expenses soon as possible, including interest expenses, but defer investment until future years when the tax rate would be reduced on any resulting added earnings.  

Meanwhile, the widening gap between corporate and noncorporate tax rates (a difference of 13.8 percentage points after five years) would encourage many small businesses, farms and professionals to set up C-corporations to shelter retained earnings.  Owners of closely-held private corporations can defer double taxation indefinitely by not paying dividends and taking most compensation in the form of tax-free corporate perks. Many enterprises contemplating the new incentive to shift income from individual to corporate tax forms after five years would postpone expansion plans until after they made that switch, further depressing the economy and tax receipts.

The Republican Party’s proclivity for phased-in tax cuts may have originated with former Federal Reserve Chairman Alan Greenspan.  In his January 25, 2001 testimony before the Senate Budget committee, Chairman Greenspan said, “In recognition of the uncertainties in the economic and budget outlook, it is important that any long-term tax plan … be phased in.”  That was the same advice he gave in January 1981 when Greenspan and I served on President Reagan’s transition team.  Unfortunately, his advice to phase-in lower tax rates was followed both times, with disastrous results.

During the deep recession from July 1981 to November 1982, Congress opted to postpone most tax relief until the 1983-84 tax years.  Individual tax rates were ostensibly reduced by 5 percent in October 1981, but with only three months left in the year that meant just 1.25 percent.   Rates were again reduced by 10 percent in July of 1982, but that applied to only half of that year’s income.  Meanwhile, bracket creep from high inflation kept pushing people into higher tax brackets (until indexing took effect in 1985), negating much of the intended effect.  The final 10 percent reduction in July 1983 was not fully effective until calendar year 1984. 

Oddly enough, the painful blunder of phasing-in the Reagan tax cuts after a recession was repeated by the Bush administration in March 2001, three months after the economy slipped into recession.  Aside from the fiscal frivolity of adding a 10 percent tax bracket on the first $12,000 of income (cutting taxes $300-600 at all incomes), reductions in the four highest tax rates were originally scheduled to be very gradually phased-in by 2006.  Congress later came to its senses in May 2003 and reduced marginal tax rates. Yet substantial damage was already done.   University of Michigan economists Christopher House and Matthew Shapiro found, “The phased-in nature [of lower tax rates] contributed to the slow recovery from the 2001 recession, while the elimination of the phase-in helped explain the increase in economic activity in 2003.” The harmful impact of the phase-in was confirmed by Cornell University economist Karel Mertens and Morton Ravin of University College London. 

Mertens and Ravin also found that lower corporate tax rates do not reduce U.S. tax revenues, partly because lower tax rates increase domestic investment while reducing tax incentives to take on excess debt.  The Camp plan to phase-in a 25 percent corporate tax rate over many years would be as unnecessary as it would be counterproductive.  Most other countries reduced their corporate tax rates to 25 percent or less long ago – creating marginal effective rates on new investment that are commonly less than half the U.S. level – with clearly beneficial effects on their economies and tax receipts.  

The important, unlearned lesson of 1981 and 2001 is that phased-in reductions in marginal tax rates can make things worse before they make things better.

An uncompetitive U.S. corporate tax rate fosters excessive tax-deductible debt and gives a big cost advantage to foreign enterprises.  There is nothing to be gained, and much to be lost, by improving the U.S. tax climate slowly rather than quickly.

Tax Reform Error #1: Confusing Tax Expenditures with Revenues

House Ways and Means Chairman Dave Camp has released a complex 182-page “discussion draft” called The Tax Reform Act of 2014. Rather get bogged down in details, I will take this opportunity to review several fundamental errors that repeatedly plagued most past and present efforts to reform the federal income tax, including the Camp proposal.

One of the most pernicious errors among would-be tax reformers is to assume that, as the Tax Policy Center asserts, “tax expenditures are revenue losses” attributable to various “loopholes.” On the contrary, the Joint Committee on Taxation (JCT) clearly states that the estimated dollar value of any “tax expenditure … is not the same as a revenue estimate for the repeal of the tax expenditure provision.” As the JCT explains, “unlike revenue estimates, tax expenditure calculations do not incorporate the effects of the behavioral changes that are anticipated to occur in response to the repeal of a tax expenditure provision…. Taxpayer behavior is assumed to remain unchanged for tax expenditure estimate purposes … to simplify the calculation.”

One glaring difference between revenue estimates and tax expenditure estimates involves taxation of capital gains if those gains are realized by selling assets from a taxable account (unlike IRAs or most home sales). Estimated tax expenditures from not taxing realized capital gains at the top income tax rate of 43.4 percent is listed as a big revenue-losing tax expenditure, even though Treasury, the JCT and the Congressional Budget Office (CBO) revenue estimates would rightly predict that the behavioral response to such a high tax would crush asset sales and thus lose revenue. 

Mainly because the artificially estimated “tax expenditure” from a lower capital gains tax is wrongly equated with estimated revenues, the Simpson-Bowles plan hopes to raise an extra $585 billion over ten years. In reality, investors realize fewer gains when the tax rate goes up, so the higher tax on fewer transactions means revenues fall rather than rise.