The head-scratching miasma presented by a new tax reform proposal in the House of Representatives leaves no doubt as to whom the benefits will flow.
Starting with an end to estate and gift taxes — which now apply only to estates worth over roughly $5.5 million, or $11 million for a couple — that revenue is still a source of 0.6 percent, or $30 billion, of our nation’s annual income that will need to come from everyone else. With the extremely wealthy benefiting the most from proposed tax reform (the top 1 percent receiving three-quarters of the tax savings), we can expect the $30 billion shortfall and much more to be made up by the rest of us, since middle-income earners will receive an average reduction of just $260.
It’s impossible to see how the country will pay its bills without increasing taxes on people like you and me, or alternatively, by borrowing an estimated $3 trillion over the next 10 years to fill the gap. I’m not the only one with a headache. Various think tanks and “big four” accounting firms offer line-by-line internet-available analyses reflecting their confusion as well.
For an example of future tax “simplification,” there is the proposal to reduce so-called “pass-through” business income to 25 percent. This is down from the proposed maximum marginal tax of 33 percent, which would otherwise be the tax rate when a successful business elects to be taxed at the owner’s personal tax rate rather than at the corporate tax rate. Small business owners routinely elect this option to avoid double taxation at both the company and personal level.
Under the proposed law, what the business owner reinvests would receive a 50 percent deduction on what was earned on the reinvested profits. Think about this for a moment, if we take that statement at face value. First, this does not apply to what is invested in the business itself. Anything spent on employee salaries, rent, capital equipment and costs of operating a business has always been 100 percent deductible.
This 50 percent deduction presumably applies to the earnings on profits that business owners keep for themselves and invest someplace other than in their own businesses. So, in perpetuity, there would be two sets of books to include earnings on assets attributable to profits taken out of the business — as compared to those on just regular money that someone might have saved up until now or money they may have inherited.
Furthermore, a typical business owner has a wide degree of latitude in determining what their salary will be versus what they deem to be pass-through taxable profit. The new law as proposed would inspire most to pay themselves a small salary and take the rest as profits — so they benefit from favorable taxation on the earnings from those profits. The bill tries to cover this potential abuse by stipulating that salaries must be “reasonable” (meaning not artificially small). Good luck trying to police that vague condition.
Of course, the theory is that reducing taxes stimulates the economy because businesses and individuals have more to invest. If the economy grows as a result, the government collects more revenue even with lower taxes because the economy itself is larger. That theory has been debunked over and over, and corporations today have more cash and access to cheap capital than at any time in history — capital they are choosing to sit on. Given those circumstances, our growth from this point will not exceed 2 percent, and any promise of more is just a hoax.
Finally, retirement industry lobbyists report that they are now hearing about the possibility of an excise tax over and above the regular income tax on income retirees draw from their retirement accounts, such as IRAs and 401(k) plans. The fact that there is more than $25 trillion in these plans is just too tempting for lawmakers to resist.
They are struggling to find income sources to manage an end-run around campaign promises to lower the tax burdens of the working middle class and still collect what will support tax breaks for the very wealthy. A boomer generation sitting on much of that $25 trillion may strike lawmakers as a soft underbelly where an excise tax, while unpopular, would still present the path of minimum regret.