The Double-Taxation Bogeyman Rides Again

by Neil H. Buchanan

The sales job for the White House's non-plan to change the tax system is not going well, by all accounts.  As usual, Donald Trump's lack of focus has distracted everyone, as he flits from one personal feud to another and circles back around to his obsessions with destroying the health care system and building his expensive and pointless wall.

Even so, I stand by my prediction that at some point Trump and the Republicans will pass something that -- no matter how limited or small it is -- they will call "sweeping tax reform," and the supposedly hostile press will play along.

After all, this is a group of people who held a Rose Garden celebration merely because they managed to pass a (terrible) health care bill through one house of Congress.  Imagine their victory lap even if they have done nothing more than, say, change the exclusions for the Alternative Minimum Tax or the depreciation rules for capital investment?  Imagine the lies that their in-house economists will tell of how this new bill will trickle down to the paychecks of "the forgotten people."

Although I am predicting that the talk of a big rewrite of the tax code will end in failure, it is nonetheless interesting and important to keep track of what is happening while the farce plays out.

There is one misdirection play in particular that might actually be used by both Republicans and Democrats for different purposes.  In separate areas of the tax debate, both sides might claim that they are right because it is ever so important to avoid "double taxation."  They will both be wrong.

I hasten to add that this is not one of those columns where the writer piously claims that "both sides do it" and pretends to be above it all by blaming Republicans and Democrats alike for our political dysfunction.  Anyone who has not noticed that it is the Republicans who have gone off the deep end is either naive, stupid, or evil.

Instead, I am talking about double taxation here because it can be wrongly invoked when discussing at least two issues that are currently up for debate.  That those two opportunities for sophistry happen to be split between the two parties, rather than the usual case where Republicans lie and Democrats ask them to be reasonable, is pure happenstance.

The two policy proposals that will provide the best opportunities to scream about double-taxation are the Republicans' desires to eliminate the state-and-local tax deduction and to repeal the estate tax.

Before getting to those proposals, however, we have to ask what double taxation is (or what people think it is).  A tax "base" is, to put it in nontechnical terms, the thing that is taxed.  Sales taxes are taxes on retail sales.  Property taxes are taxes on real property.  Income taxes are taxes on income.  Estate taxes are one type of tax on wealth.  And so on.

Double taxation occurs when the same base is taxed twice (or more).  That could happen if, for example, a person buys an item from a store and pays the sales tax and later receives a tax bill for an amount that was determined based on the price of the item that they bought in the store.  Same base -- sales -- two tax bills.  Double.

That sounds bad, but is it?  If you had a choice of living in two states, one of which taxed sales twice at 2 percent each time while the other taxed sales once at 10 percent, you might well choose to live under a double-taxation regime.  What matters to you is how much total tax you pay -- and, I should emphasize, what you get for the taxes you pay, in the form of roads, schools, fire protection, and so on -- not the form in which you have to pay them (the annoyance of writing a second check aside).

Is this a real-world story, or merely an academic concern?  In fact, international tax treaties are to a large extent designed to prevent two countries from taxing the same base twice.  If I earn money in Austria by working as a guest professor, I pay the higher of the tax rates in the U.S. and Austria, but I do not pay the sum of those taxes.

So far, so good -- except that even that example is not really about double-taxation.  If, for some reason, the U.S. and Austria both had a 25 percent tax rate on lecturer's salaries when the money is earned by their citizens at home but a 10 percent rate when their nationals earn the money abroad, even a double-tax system would still only add up to 20 percent.

In short, the real issue is not double-taxation at all.  Coming at it from another angle, consider the state of Maryland, which has designed its state income tax as a two-part system.  (I will use rounded numbers here for simplicity.)  The state levies a tax of 5 percent on residents' incomes, and then each resident's county levies another income tax, usually 3 percent.

Double taxation?  Sure, but so what?  The state could just as easily impose an 8 percent state income tax (in reality, the state collects both taxes anyway) and then "share" three-eighths of that revenue with the counties, distributed on the basis of total county incomes.  That would be single taxation.  Do you feel better now?

And here is where the Democrats come in.  One of the Trump proto-proposals is to eliminate the federal deduction for state and local taxes.  As has now been widely discussed, that proposal would harm high-tax states, most of which (like Maryland) are "blue."  Indeed, this is most likely the reason that Trump and the Republicans like the idea.

I have heard some opponents of this proposal say that the state-and-local deduction prevents double taxation.  A person never really has the income that the state collects in taxes, these people say, so it should not be part of the federal tax base, because we want to avoid double taxation.

Again, no one who understands taxes could honestly care about double taxation.  The base for both the Social Security and Medicare taxes is pretty much the same (earned income), which is a subset of all income, so the Social Security, Medicare, and federal income taxes amount to triple taxation, and if you include state income taxes, you have at least quadruple taxation.

Yet none of that means anything, because (like Maryland does with its state and county taxes), the U.S. tax system could be set up as a single tax -- collected by the feds or the states -- combining all of those taxes, and (with appropriate adjustments, credits, and so on) substantively it would be the same as our current system.

To be clear, I oppose repealing the state-and-local tax deduction, but not because doing so would amount to double taxation.  My objection is that the people who would be hit with that tax increase are not the people who should be paying more in taxes right now.

Upper middle-class professionals in, say, Winnetka (Illinois) are doing much better than middle-class people, but the vast majority of the income gains since the end of the Great Recession have gone to the infamous "1 percent" -- indeed, mostly to one percent of the 1 percent -- not to the better-than-average earners in blue states.

Moreover, taxes are only one side of the story.  The states that currently gain from the existence of the state-and-local tax deduction are, almost without exception, also the states that on net pay more to the federal government than they receive in federal benefits.  Mississippi is a net recipient of federal money.  California is a net payer.

So the reasons to oppose the Republicans on this issue have nothing to do with double taxation.  The simple fact is that Republicans are trying to use the tax system to punish the people who vote against them -- and to ramp up the irony that already exists by making their "get the government off my back" voters even bigger beneficiaries of federal largess.

The other area where cries of double-taxation always ring out is the estate tax.  There, however, we do not even see double taxation in a technical sense.  The current system does not tax the same base twice.  It taxes two different bases: income and estates.

Opponents of the estate tax claim that "the money in my estate has already been taxed," because they want to paint a picture of large estate holders having paid all of their taxes year after year and then prudently putting the money into their estates.  The reality is that, even for people who do not inherit the original estates that they later turn over to yet another generation of people who chose their parents wisely, almost all of the money in the estates that are big enough to tax (which currently means a minimum estate of $10.98 million) is in the form of investments that have never been taxed.

But again, no one should care about whether "this money has already been taxed."  We choose to tax different bases for different reasons, and the best reason to tax large estates is to put a (very small) speed bump in the path of the increasing concentration of wealth in the country.

It is also useful to remember that every dollar we collect from one tax is a dollar that we do not collect from a different tax, so the existence of an estate tax makes it unnecessary to increase income taxes or to eliminate spending that voters care about, such as disaster relief or health care subsidies.  (Again, we can see the Republicans' true agenda here.)

We could, if we wanted to do so, eliminate the estate tax and change the income tax so that it collects revenues on all untaxed gains upon a person's death.  That would, according to Treasury estimates a few years ago, actually collect more money from wealthy decedents than the estate tax does.  Somehow, I doubt that this is what Trump and the Republicans have in mind when they complain about double taxation and the estate tax.

The point is that double-taxation is a meaningless distraction.  We choose different tax bases for different reasons, and then we set rates against those bases in order to collect revenue (cognizant of behavioral incentives created by taxes).  Limiting ourselves to a system with no double-taxation (including the bogus version that Republicans say the estate tax represents) would be an elevation of form over substance.

The U.S. is, contrary to Trump and the Republicans' repeated claims, not "the highest taxed country on earth."  Far from it.  Combining all of the various taxes that are collected at all levels of government, the Tax Policy Center found: "In 2015, US taxes at all levels of government represented 26 percent of GDP," whereas the average for the richest countries in the world (OECD members) is 34 percent.

What ultimately matters to people is their standard of living, which is determined not just by their after-tax incomes (which, in turn, is only partly determined by their aggregated tax rates) but also by the benefits that they receive from living where they live.  And the countries that have the highest net tax rates also happen to have the highest standards of living (and the least inequality).  My gosh, it's almost as if we get what we pay for.