Rumor has it that in an effort to bolster his “100 Days” image Trump threw together a tax proposal based on a “back of the napkin” outline from a Larry Kudlow/Stephen Moore luncheon. Or a bit more specifically, Trump read a recent op-ed by Kudlow, Moore, Steve Forbes and Arthur Laffer regarding the GOP’s lack of tax reform progress, and grew concerned.
This is a delicious rumor cooked up by the Mainstream Media in its ongoing battle against the Trump presidency. Goldman Sachs DEMOCRATS Gary Cohn and Steve Mnuchin crafted this plan over a span of months. Not days. And the political Left is scared because it knows that the plan puts them in a box.
[For anyone that finds the nature of this post offensive, and has thus chosen to not actually read it: To be clear, I am not rejecting the reporting that Trump is racing to release tax reform details in order to bolster his “100 Days” image.]
Unbeknownst to hyperventilating anti-Trumpers, the Trump Administration learns quickly. Following an embarrassing legislative defeat on the AHCA after out-sourcing the policy construction to Paul Ryan, the Administration quickly pivoted to an in-sourcing strategy led by Gary Cohn and Jared Kushner. Bye, bye “Better Way” idiots.
[Please see Bill Maher here for a live demonstration of said hyperventilation.]
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Individual Tax Reform
- Reduce the number of brackets from 7 to 3: 10%, 25% and 35%
- Double the standard deduction
- Eliminate all itemized deductions but Charitable Donations and Mortgage Interest
While Republican hardliners may balk at the “progressive” nature of the three brackets, the fact of the matter is that the US individual tax code is quite fair when payroll taxes are taken into account (please see my analysis of this issue here). The proposed three brackets with a top rate of 35% is brilliant, as it brings much needed simplification to the individual tax code while cutting the Democrats off at the knees from a “tax the rich” standpoint (Kushner, Cohn and Mnuchin’s DEMOCRATIC influence is clearly visible, as Candidate Trump’s tax reform template called for a top rate of 25%).
According to the above-referenced Candidate Trump’s tax reform template, a married couple earning $300,000 would have been subject to the top rate of 25%. Using that level and rate as a rough gauge, I would not be surprised to see the following tax scheme:
- Up to $50,000: 0%
- $50,001 to $250,000: 10%
- $250,001 to $500,000: 25%
- $500,001 and up: 35%
But the crown jewel of the proposed individual tax reform is the full repeal of the state & local tax deduction. Something like 90% of those making over $200,000 utilize this deduction (i.e. the middle class is not “devastated” by the repeal, as Chaz Schumer recently indicated), and almost 40% of the total deduction is comprised by NY, NJ and CA taxpayers. It will be entertaining – to say the least – to watch the Democrats, if they so choose, to fight a proposal that directly soaks the rich in order to pay for Middle Class tax reform. Again, thanks to NY and CA DEMOCRATS Trump, Kushner, Cohn and Mnuchin.
Business Tax Reform
- 15% corporate tax rate (including “pass through” entities)
- Territorial tax system
As my recent analysis outlines, almost 50% of tax returns with an AGI above $500,000 are S-corps and partnerships. There were approximately 615,000 of such tax returns in 2014. So while of course this cohort contains big, bad private equity and hedge fund partnerships, the likely fact of the matter is these partnerships are dwarfed by the small and medium businesses that drive middle class job growth (i.e. according to CNBC, there are just under 10,000 hedge fund partnerships in America). In short, reducing the tax rate on “pass through” entities to 15% is an enormous win for Middle Class America.
In my opinion, easily the biggest knock on the entire tax reform plan is the potential for “pass through” business owners to game the system by turning employment income into business income. This must be dealt with.
Dropping the corporate tax rate to 15% will not be as big of a boost to multinational corporations – as they already effectively pay something around, if not below, 15% due to global tax loopholes – but moving to a territorial tax system that allows tax-free repatriation in perpetuity, in conjunction with the 15% rate, immediately turns America into THE go-to global destination for corporate investment projects. And if anything, dropping the rate to 15% while slamming the door shut on major loopholes could in fact immediately raise revenue to Treasury.
Cost of Tax Reform
This week the NYT estimated that relative to the 10-year projected status quo the tax reform plan would add approximately $5.5 trillion to the national debt. But critical to the NYT’s analysis are two relatively dubious assumptions: 1) That $1.5 trillion is lost to “creative accounting” under the “pass through” tax rate reduction; and 2) $2.5 trillion of projected savings from closing all deductions except for Charitable Donations and Mortgage Interest is somehow lost in the shuffle (full savings is $4.5 trillion and the NYT assumes $2). If we assume $750 billion is lost to “creative accounting”, and that $1 trillion of savings from the elimination of deductions is lost in the shuffle, the ten year cost falls to $3.75 trillion.
But all of the above simply extrapolates the low economic growth funk the United States has been in since the Great Recession of 2008. This extrapolation not only fails to take into account the growth uplift from higher deficit spending (i.e. by accounting definition federal government deficits = private sector profits), but the likelihood that after 8+ years of private sector balance sheet restructuring following the Great Recession combined with the favorable Millennials-driven demographic outlook, the United States is staring down the most favorable economic growth runway it has seen since the early 1990s.
Sustained nominal and real GDP growth of 6% and 3% will more than make up for the cost of restructuring the individual and business tax codes today…as well as covering the remaining 25 million uninsured Americans that deserve access to Medicaid.
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If the political Right and Left sincerely care about Middle Class America, they will support this tax reform in the 60%+ bipartisan fashion that makes the reform permanent beyond 10 years. My hunch is that the Right is not stupid enough to screw this up as they did with the AHCA; so more than likely the onus is on the Democrats.
In my opinion, this is a pristine opportunity for the Democrats to get in line with the Trump Democrats – Trump, Kushner, Cohn and Mnuchin – and bury the Freedom Caucus once and for all. If a bipartisan governing coalition is formed via comprehensive tax reform, the Democrats will be in fantastic position to work with the Trump Democrats on an infrastructure bill, as well as an appropriate ACA reform that unleashes free market forces at the state level while providing coverage to the remaining 25 million uninsured. If not, best of luck in 2018 to the Democrat Party.