Excuse the multi year absence from my blog. But I’m back to talk about Tax Reform.
Full disclosure: my taxes will in fact go UP under this bill. But I think that’s ok, because overall this makes the right tradeoffs for the country.
Starting at a high level: the #1 problem we face as a country is that we can’t afford the projected growth in entitlements if our economy grows as slowly as it has grown over the last decade (about 1.5% – 2.0% in real terms through 2016 https://fred.stlouisfed.org/series/GDPC1).
So, regardless of your feelings about fairness or other elements of the tax code, that is the core problem that needs to be solved. We simply need to grow the economy faster, and that informs much of my belief about policies for taxes, immigration, and the like.
Positives of the tax plan include:
1) Reducing corporate income tax for C corporations. You’ve heard of corporate inversions, parking money overseas, ability to exchange money between subs, moving IP offshore, etc. The era when corporations were an effective entity to tax is long gone as countries compete for a business’s domicile and technology removes many of the physical boundaries that kept profits where they were made. Simply reducing corporate taxes goes a long way towards triggering renewed investment and avoiding the complex list of laws that would otherwise need to be in place to ensure taxes are paid.
The reduced rate should trigger investment, over time, and therefore increased growth. How? If a company now retains $800 of $1000 of pretax earnings instead of $690, that extra $110 can be used to invest in improvements in equipment, buildings, etc. The growth results of this move won’t show up immediately but should permanently step up GDP growth rates.
Corporations are faceless entities, so it is a natural instinct to want to tax them. However, this tax reduction should benefit the entire economy, and gets a big thumbs up from me.
2) Eliminating the estate tax. The argument against eliminating the estate tax is that “it is only paid by the wealthiest 0.2%” – in other words, this is a redistribution argument. However, the estate tax is an incredibly inefficient way to redistribute wealth. Even the most optimistic estimates of its tax efficiency show it is “average” efficiency. More likely, the hidden and direct costs of compliance are almost equal to the actual cost that the tax generates for the federal government every year. The lawyers, accountants, time, and economic contortions to avoid this tax are all wasted to our society. If you want redistribution, let’s get it another way.
3) Simplifying and consolidating deductions. The concept of reducing specific tax giveaways always has interest groups crying how “Un-American” it would be to eliminate their preferred deduction. Of course, it’s simple to be “for” an ownership society (aka the mortgage interest deduction), “for” kids (the child tax credit), “for” health care (aka deductible health care insurance) – each one sounds wholly justified. But the combined effect of all of these is that it perverts and contorts the tax code, leads to inefficient economic behaviors, forces us to spend greater time energy preparing taxes, bloats the IRS which has more deductions to argue against, and raises marginal tax rates. Doubling the standard deduction, as this bill proposes, goes a long way towards making tax forms easier to understand and fill out, and reducing the inefficient use of resources that is tax accountants, people’s time, and the IRS.
Additionally, itemized deductions like the mortgage interest and SALT deductions are regressive. Eliminating them or reducing their deductibility is a simple way to redistribute without harming tax efficiency (vs. the estate tax mentioned above).
4) Immediate expensing of investment. Again these investments should grow the economy which is the #1 goal. Also reduces the complexity of the tax code with its myriad timetables for depreciation.
Negatives of the proposed tax reform include:
1) Reducing the tax rate on “small businesses” (aka S corps and LLCs). Opening up an avenue for people to redefine what is passive income will lead to all kinds of new tax avoidance, making the carried interest loophole look like small potatoes. It is almost certain that we see a massive increase in income flowing through these corporations, and a corresponding increase in audits. If business owners want a lower tax burden and the ability to retain earnings, they should incorporate as C corps. Best thing to do here is to drive the corporate tax rate down even further but end the preferential tax treatment of S corps and LLCs.
2) Retaining the carried interest loophole. This is a second avenue used by wealthy people to avoid paying appropriate income tax. Carried interest is a form of income that pays a vastly reduced tax rate. A better way to deal with all of this is to have ONE rate – and it should apply to all income, however garnered (including capital gains!). You then avoid the shuffling of profits to the lowest tax regime or the timing of sales to make sure a gain or loss is short or long term.