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September 30, 2017

Trump’s Tax Plan

I don’t mean to sound like Susan Collins, but count me as “disappointed” with Trump’s tax plan. There are certainly some very good things in it, but it misses two big-picture fronts.

I don’t mean to sound like Susan Collins, but count me as “disappointed” with Trump’s tax plan. There are certainly some very good things in it, but it misses two big-picture fronts.

First, I am baffled why the art of the deal-meister chose to present only the bare bones outline of a plan and leave the details to the same cast of characters who couldn’t get out of their own way on health care. While health care impacts every American, the folks don’t have permanent representatives on K Street; only a handful of industries directly affected by health care policy do. And while every American is also impacted by tax policy, so is every special interest lobbying group across every industry category. Tax policy is the single biggest lever in the classic revolving door game among legislators, lobbyists, and special interests – industry pays lobbyists millions to argue about tax changes to the same legislators who cash in on their office to get nine-figure compensation when they leave office and join the same lobbying groups.

So, when you leave essentially a blank slate on the tax plan fine print, you invite a world-class free-for-all. If health care couldn’t get done, the long odds of an exponentially more difficult deal on taxes do not inspire confidence that we will wind up with something meaningful on growth, simplification, lower taxes, and limited government.

The second, even more disappointing aspect is that there is no effort to position taxes in the grand scheme of the role of government. Trump is uniquely positioned to be the messenger on that. It is budgets that rule, not tax policy per se. In the real world, revenue (the government word for taxes) is only a part of the budget process. The cost to make the product also matters, as does the investment that might be made to improve the business longer term. Private sector budget processes take a fresh look at everything, every cycle, but government seems to assume that programs are only on auto pilot, and the role of taxes is simply to fund them as is. Whether the amount of money being taken from the folks by government is appropriate never seems to matter, nor does a fresh look at what government should actually do, and how.

The most obvious examples of this are entitlement programs, which comprise large and growing percentages of spending. No one seems to want to touch them, but why is the current structure cast in stone? Think about the distortion that emerges. We are told that the new tax plan is aimed at the “middle class,” that the “rich” won’t benefit, and it’s the largest tax cut in history. But almost half the country doesn’t pay any federal income tax, so it’s not feasible to have major tax cuts or to optimize economic stimulation without providing them to those who actually pay taxes. If the goal were to cut taxes for the lower/middle class, the best way to do that is to deal with the regressive payroll tax, which cannot be addressed without taking an overall look at Social Security.

We have been sold the fiction that Social Security is a retirement program that we pay into during our working lives through payroll taxes and are paid out in retirement, so any reduction in the payroll tax would compromise the government’s ability to pay benefits. But in fact, payroll taxes go into the general pot, not some dedicated personal pension account, and payouts are also made from the general accounts. The interagency IOUs that have been created by a mismatch of inflows/outflows from more workers than beneficiaries are smoke and mirrors that will begin reversing themselves shortly.

I think most would likely support the original purpose of Social Security as a role of government to alleviate poverty among the elderly and disabled, so why play the game of imposing a massive bureaucracy that winds up taxing away most of the Social Security benefits to the “rich” anyway? Why not go back to the roots and have Social Security be a welfare program for the truly poor? Have the debate about who would qualify and for how much and fund it out of general revenues. Then figure out how general taxes would be adjusted to fund it. Talk about stimulating the economy. Payroll taxes would disappear, putting huge dollars in the hands of consumers, particularly lower-income consumers who would spend the proceeds. Social Security costs would decline since only the truly elderly poor would qualify, and the overall burden of caring for the elderly poor would be distributed progressively. Explaining to folks that what they thought they were going to get from “paying into the pension plan” is being eliminated might take some doing, but maybe a one-time rerun of payments that recognizes some of the unfunded liability could substitute.

That’s just one example of how tax policy should be driven by budget considerations that are reviewed regularly and reflect careful and ongoing debate about the proper role of government. But again, that’s nowhere to be found in the current atmosphere. We hear the same old tired rhetoric from the Democrats that the plan is simply tax cuts for the rich. But the vast bulk of the cuts are business-related — either corporate reductions from 35% to 20%, capping pass-throughs at 25%, or repatriating offshore profits at single-digit rates. Memo to Democrats: Corporations are neither rich nor poor; they are corporations. Details of changes in deductions and loopholes are conspicuously absent.

The number of personal brackets is reduced from seven to three, but the income levels at which each bracket kicks in are not specified, and there is even talk that the top rate will not be reduced, or there will be a surcharge on those in the highest bracket to make the plan “revenue neutral.” Trump claims that the benefits will go to the middle class, but if you read his words carefully, he is not saying that big tax breaks will go there, but rather that the middle class will benefit from the new jobs that the lower business taxes will encourage businesses to provide. I agree with that approach, but the rhetoric should be more clear.

Ideally, the tax code would be simplified to a point where rates could be lower across the board and deductions eliminated. The plan tiptoes there by increasing the standard deduction so more folks don’t need to consider itemized deductions, but why not go all the way? Take the rates even lower and inject more fairness into the process. Sacred cow deductions like mortgage and charity will get huge lobbying efforts not to be touched, but if the rates were low enough, the impact on the housing and charity industries would be minimized and distortions eliminated. The folks I know generally don’t check with their tax accountants before making most charitable contributions. Indications are that deductions for interest, state/local taxes and property taxes will be eliminated, but that’s before the lobbyists make their moves. Trump eventually has to go back to the Upper West Side, so don’t hold your breath that the disproportionately impacted New York City residents, real estate developers, and hedge fund operators will lose these benefits.

The Democrats don’t want Trump get this win either, so expect zero cooperation from them to get anything close to the plan passed. And relying on the GOP to hang together in the face of dollars dangled by the lobbying army is a long shot. Two days before (no typo) the plan was released, a left-leaning poll organization found that 63% of Americans were against it. And as an example of the reasoned debate to follow, Chuck Schumer said that the increase in the lowest rate from 10% to 12% was a “gut punch to working Americans.” He somehow neglected to mention that the standard deduction was doubled to $24,000, which more than offsets the rate increase for the vast majority of lower- and middle-income taxpayers. And by the way, is it just me who hates the use of the term “working Americans,” as if only those earning $25,000 and below are “working”? Back when I was in the financial services business earning substantially more than $25,000, I was working 12-hour days, six days a week, with maybe a few days off a year. I’m not looking for sympathy, because it was by choice. I just don’t care to be lectured and insulted by someone who takes four months’ vacation a year and could fit his accomplishments in a thimble.  

And while we’re doing language, can we please dispense with the laundry list of clever tax phrases that are simply designed to hide the true use of the tax code? “Refundable tax credits” sounds sophisticated but it’s really the only way to make welfare payments seem less like welfare. And then there’s “tax expenditures,” which are simply special goodies given to certain groups through tax provisions like credit exemptions, deductions, etc. They’re just special interest gifts dressed up as legit tax matters, so why give them a fancy name? Just tell us the government is writing a special interest check to its preferred pals.

And finally, there’s my least favorite tax phrase – when it comes to tax cuts, how are we going to “pay for them”? The presumption is that the bucks belong to government and the only way to “give” it back to the folks is if revenue from other sources can even it out. But why do things need to be revenue neutral? I realize that the arcane Senate rules may be a factor, but common sense private sector economics/finance would say that whether the government runs a deficit or not is a function of numerous considerations, not some blind loyalty to refraining from tinkering with the tax code unless it comes out even.

The private sector invests all the time in projects that cause near-term loss for longer-term gain and actually takes into account human behavior when analyzing the projections. Somehow we have accepted the ridiculous fiction that tax cuts don’t influence economic activity, so the CBO rejection of dynamic scoring has become gospel. Ditto the absurd blanket statement that we can’t run deficits because “we are $20 trillion in debt.” The actual debt level in a vacuum is meaningless, and what constitutes an appropriate amount of government debt is a very complex issue, influenced heavily by the overall size of the economy and the perceived political will to do what is necessary to make good on debt payments. Maybe the correct level should be zero, or twice the current amount, but maintaining that we can’t do tax cuts that could increase the near-term debt, without taking all factors into account, is ridiculous.

It seems illogical that tax cuts must be “paid for” while spending increases (e.g., the Obama stimulus) don’t. That is in part thanks to the two most dangerous and destructive individuals in DC, No, not Barack Obama and Joe Biden — Ben Bernanke and Janet Yellen. By using a series of QEs to monetize the debt from deficit spending, the Fed kicked the can down the road on the vital debate about the role of government and the choices that must be made about allocation of resources and appropriate debt levels. If the private sector were the provider of deficit spending debt, the story might have been different. The private sector has a great mechanism for dealing with this. It’s called the market, which will say no más if the debt conditions get out of line. But the Fed has been able to play a Ponzi-like game to sweep the need for tough debates about the role of government, and tax/spending policy, under the rug. Even with that and Obama’s spending blitz, he couldn’t produce 2% growth. Now that the Fed is starting to unwind the program, we’ll see what happens.

I got off topic a bit, but back to Trump’s tax plan. There are some very good business-oriented provisions in it, and that’s been Trump’s focus, so no surprise. But it is a far cry from a comprehensive reform of the tax code, or a major improvement in the individual tax landscape, and it’s certainly not a conservative document that forces a debate on the role of government and taxes. It’s also unclear, even if accepted as is, whether it will be enough to truly jump-start the economy. And there is no doubt that the gang at the other end of Pennsylvania Avenue on both sides of the aisle will look at it as a first bid.

Trump is correct that this is a once-in-a-generation opportunity to change the course of the country partly via the tax code. I realize, as I’ve said many times, that we do not have a doctrinaire conservative in the White House, and anyone who thinks we do is going to be disappointed. But I wish Team Trump had taken the opportunity to make a bigger difference. Outlines are fine if you know you’ve got the detail guys on your team. Trump does not. There will be huge political pressure on Congress from the folks to do tax reform that could offset the lobbying assault, particularly after the health care failure, but starting from a more comprehensive level of detail and daring Congress to turn it down would have had a better shot at success. And, ironically, it would involve less political risk for Trump.

If the plan gets through and has the expected positive impact on business and the economy, all will be fine. I would have preferred more detail on both the business and individual fronts, but I’ll take 4% growth and deal with the role of government discussion later. It will be a fascinating negotiation.

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