Now that the GOP “tax reform” plan has been out for a day, there’s been a bit of time to digest it. We’ve covered the broad highlights here. The jury is still out to see if many Americans will benefit–in terms of keeping more of their money–from the tax recalibration. It wasn’t really “tax reform” to begin with, and many, including my friend Erick Erickson, have withheld their judgment on it, seeing as how Republicans tend to negotiate like the Red Sox make trades.
But as they say, the devil is in the details, and this plan has some particularly devilish ones. We’ll take a look at four.
“Pass through” businesses
If you’ve sold stuff on Etsy or eBay, or done any kind of personal service work that makes enough money to interest the IRS, you might have completed a Schedule C, or you may have even formed an LLC or S-Corp to handle your business. Or if you are an employee-owner of an LLC that functions as a 1065 partnership (yes, this is getting wonky), you have run into the nasty business of paying personal taxes on “pass through” business income.
This has always been taxed at your personal income rate, plus (in many cases) 50 percent of the Medicare and Social Security tax–the part employers are supposed to pay. The GOP plan caps the top rate for business “pass through” at 25 percent, versus the personal top rate of 39.6% (or over 46%, but we’ll get to that).
You’d think this is a good deal for small businesses, but it may not be at all. There are all kinds of rules to determine who is eligible for the “pass through” rate. These rules may let favored classes, like doctors, K-street consultants and high-priced lawyers have their cake and eat it. They may also not do a thing for a small landscaper or house cleaner, who don’t make enough money to hit the top rate.
Essentially, what was supposed to be a help to small business may end up padding the pockets of fat-cats. SMH.
The “bubble” tax
A nearly undocumented (or at least not briefed) provision in the tax plan is a 6 percent “clawback” for high earners over $1 million in income. This is to recoup the low 12% tax rate everyone pays on their first $45,000 of taxable income. The “bubble tax” over the first $1 million will tack on 6% for every dollar until the full $12,420 is back in the government’s pocket.
Of course, this only applies to personal income. So rich fat-cats will simply find a way to reclassify their personal income into a “pass through” business, which is capped at 25%. For billionaires, it’s not really an option, but what’s $12,420 to Bill Gates or Elon Musk? The supposed targets of this tax are high earners, but in reality it’s only going to hit a very narrow band of individuals who earn paid salaries over $1 million that can’t be reclassified as other types of income.
More money for the lawyers and tax accountants to find the loopholes. My father would have called this “a racket.” And I agree.
The news here is that there is no change. After President Trump railed against hedge fund managers getting away with millions by taking their management fees (around 20 percent) as capital gains versus personal income. This practice will not change, and people like Bob Mercer, if he had stayed at RenTech, would certainly thank Congress for their gift.
Corporate expense incentive
This could be a very good thing: the corporate tax rate will drop to 20%, making us more competitive versus other off-shore options. Furthermore, income generated overseas won’t be taxes as “American” which drove many companies to “invert” and move their headquarters elsewhere to escape this black hole. The rate for cash profits earned overseas will be 12%, and only 5% for “illiquid” assets.
Furthermore, a 5-year window for 100% business expensing will bring more businesses back to America since it acts as an incentive for capital investment. That’s the detail which makes it sweeter for businesses.
So the good news here is that businesses may have more cash to hire workers in the U.S. and pay them well. At least in certain industries and certain locations. It will make billionaires like Jeff Bezos even richer. Maybe he’ll shoot for HQ3?
I share Erickson’s concern that the GOP might end up shedding the best parts of this tax package in exchange for basically nothing. Another concern is that the Senate may decide to build in another attempt to repeal Obamacare to this effort, and doom it to death.
As for the details, it’s a bit chilling that there are these little pockets of “gotchas” and take-backs on some of the bill’s best features. We will have to see what else turns up.
It’s a good start to give business a chance to build. What we really need is a concomitant reduction in spending, with a goal toward balancing the budget. But to this administration and Congress, that’s crazy talk.
We all know that tax cuts in election years serve one overriding purpose. So what the GOP really wants out of this is a pat-on-the-rear-end toward re-election.
The House tax bill released Thursday preserves the carried interest tax break — paid to private-equity managers, venture capitalists, hedge fund managers and certain real estate investors — despite President Donald Trump and GOP leaders’ promise to do away with loopholes for the wealthy.
Patterns of radical tax reform and subsequent GOP success could be on the horizon in upcoming elections
Half a Tax Reform – WSJ (behind paywall)
House Republicans released their tax bill at long last Thursday, and we wish we could say it repeats the Reagan reform of 1986. The Ways and Means draft is instead a much-needed and pro-growth reform of business taxes marred by a mess on individual taxes that makes that part of the code even worse than it is now. *** The good news is that the House finally grasps the nettle of corporate-tax reform that Barack Obama ducked and has hurt the U.S. economy for years.
House Republicans claim the tax plan they introduced Thursday keeps the top individual rate unchanged at 39.6 percent—the level at which it’s been capped for much of the past quarter-century. Thanks to a quirky proposed surcharge, Americans who earn more than $1 million in taxable income would trigger an extra 6 percent tax on the next $200,000 they earn—a complicated change that effectively creates a new, unannounced tax bracket of 45.6 percent. It hasn’t been advertised by Republicans, who have described their plan as maintaining the current top tax rate of 39.6 percent.
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