29 September 2017

Trump should call the Democrats’ bluff on tax


On Wednesday, President Donald Trump outlined his tax overhaul proposal. The draft of the measure will undergo some changes and the final version will have to be voted on by both houses of Congress.

The main points of the overhaul are relatively straight forward and the reception on the Hill was encouraging. The measure will cut taxes and, consequently, almost certainly add to the national debt. On the other hand, cuts and simplification will most probably stimulate growth, thereby offsetting some of the revenue shortfall.

Even the conservative Freedom Caucus in the House Representatives, which is usually against debt increases, pledged to support it. The Democrats, predictably, panned the overhaul of America’s grotesquely complex and antiquated tax code. As such, it will have to survive in a narrowly divided Senate without significant Democratic support. Still, the odds are that it will become the law of the land before the year is out. So, what are the main points of Trump’s tax reform proposal?

First, there will be a 20 per cent corporate tax rate as opposed to the current statutory federal rate of 35 per cent.

Second, there will be a 25 per cent rate for pass-through businesses. Instead of getting taxed at an individual rate for business profits, people who own their own business will pay at the pass-through (ie lower) rate.

Third, it will eliminate some of business deductions, industry-specific incentives, etc.

Fourth, there will be a one-time repatriation tax. All overseas assets of US-owned companies will be taxed at a lower rate designed to bring corporate profits back to America.

Fifth, seven tax brackets will be reduced to three. The bottom individual tax rate will rise from 10 per cent to 12 per cent. The middle-class bracket will be 25 per cent and the top individual bracket will fall from 40 per cent to 35 per cent. There is an intriguing possibility of a fourth (higher) bracket for the super-rich (ie the top 1 per cent), which I will return to in a moment.

Sixth, in order to avoid rising taxes on those in the 12 per cent bracket, the standard tax deduction will rise from $6,350 to $12,000 for individuals and from $12,700 to $25,000 for couples. Itemised deductions will be eliminated.

Seventh, child credit will increase.

Eighth, state and local tax deductions and the estate (death) tax will be eliminated.

To be sure, on the whole, this is not a perfect proposal. That would consist of scrapping all income taxes in favour of the Hall–Rabushka flat tax on consumption. Alas, Trump is a disruptor, not a revolutionary.

Still, much of the American commentariat agrees that Trump’s proposal will deliver a meaningful tax reduction on the middle class and has the potential to stimulate America’s sluggish growth. Predictably, the Democrats were not amused. Having lost all sense of proportion, their anti-Trump rhetoric is permanently dialed to 11, with Bernie Sanders, the Vermont socialist, calling the tax measure “morally repugnant and bad economic policy”.

The Senate Minority Leader Chuck Schumer said that Trump’s plan only gives “crumbs” to the middle class and called it a “punch to the gut of working Americans”. Not to be outdone, the House Minority Leader Nancy Pelosi warned:

“Make no mistake: after the Republicans’ tax plan blows a multi-trillion dollar hole in the deficit, they will sharpen their knives for Social Security, Medicare, Medicaid and vital job-creating investments for middle class families across America… The American people want tax reform for hard-working middle class families, and not one penny more in deficit-exploding tax breaks for the wealthiest one per cent.”

It is a charming display from the Democrats, who allowed Barack Obama to double the national debt from $10 trillion when he took office to $20 trillion when he left – an act of fiscal incontinence unprecedented in American history. But it is equally remarkable to see so many Republicans, who opposed adding to the nation debt, perfectly willing to do so today.

That said, one idea tucked innocently in Trump’s proposal is worth looking at in greater depth. According to reports, Trump is open to a “surcharge” of, say, three or four per cent on the wealthiest Americans (presumably the top 1 per cent). This is good politics, for it would make the Democratic attempt to derail the reform by describing it as a give-away to the super-rich more difficult to pull off. But it would also be bad economics.

However, let us consider a few facts.

First, the top 1 per cent of Americans paid 46 per cent of all individual income taxes in 2015, while the bottom 80 per cent of Americans paid 15 per cent of all federal income taxes. The bottom 60 per cent paid less than 2 per cent of the revenue collected by the Feds, which is why the OECD called America’s tax system to be “most progressive” in the world.

Second, high marginal tax rates on income are harmful, because they destroy the incentive to earn more money. Following President Ronald Reagan’s reduction in the top marginal tax rate, the richest 10 per cent of Americans paid $60 billion dollars more in 1988 than they did in 1980, while the remaining 90 per cent paid $5 billion less.

Democrats understand the role of incentives in human behaviour when it suits them. They know that taxes on cigarettes reduce smoking. Why, then, should additional tax on higher incomes not reduce income creation?

Still, I am intrigued by the fourth bracket for the super-rich as an experiment in human behaviour. For years now, many left-leaning billionaires have called for higher taxes on the rich. Let’s indulge their desires and see how many would be willing to put their money where their mouths are.

Let’s have a 40 per cent tax bracket for the super-rich and automatically enroll the top one per cent in such a scheme with the possibility of an opt-out. The super-rich, who support the Republican tax-cutting agenda and pour millions into the GOP’s super-packs would, presumably, opt out and take advantage of the lower 35 per cent bracket.

The left-leaning super-rich, who pour millions into Democratic campaigns, would face an interesting ethical dilemma: stay in the 40 per cent bracket voluntarily to publically affirm their convictions or opt-out and be shown to be hypocritical.

I dare Trump to dare them.

Marian L. Tupy is Editor of HumanProgress.org and a senior policy analyst at the Center for Global Liberty and Prosperity