Tuesday, November 14, 2017

What If We Were Only Trying to Improve the Tax Code?

by Neil H. Buchanan

Imagine a world, not at all like our own, in which the Republican majorities in Congress had decided to update the tax code in a way that truly deserved to be called "reform."

Rather than proceeding from the firm commitment that they must cut taxes on large corporations and the superrich (especially the "lazy rich"), Republicans instead could have approached the tax code realistically and productively, noting that it must necessarily be complicated -- because life is complicated, and people want the tax code to take into account life's realities -- but doing everything that they can to repeal or change tax provisions that simply do not make sense.

Again, that is most definitely not what Republicans are actually doing.  They have proposed a melange of unrelated changes to the tax code that will hit various groups of taxpayers, but this is only happening because Republicans imposed restrictions on themselves that required them to offset some of the huge revenue losses that their dearly desired regressive tax cuts will create.

Even so, there is an interesting -- if entirely coincidental -- possible overlap between what Republicans have proposed and what responsible legislators might have proposed.  It is thus useful to think about a few Republican proposals from the standpoint of whether they are defensible ideas on their own merits, ignoring the undeniable fact that these changes are up for debate only because Republicans are hellbent on delivering huge windfalls to their mega-patrons.

In a recent column, I noted that only by redefining the word reform to mean "change in various uncoordinated and unprincipled ways" could we describe the Republicans' tax proposals as reforms.  One could try to argue that punishing blue states and rewarding red states is a "principle," I suppose, but that would again be mere wordplay that tries to put an absurd spin on shameless political opportunism.

One of the results of this Republican desire to find sources of revenue while inflicting maximum pain on people who are not hard-right true believers is that they have targeted tax provisions that benefit upper-middle-class people (the denizens of comfortable suburbs and exurbs who are turning in increasing numbers against the Republicans).

In turn, those people are understandably worried that they are the ones who will ultimately pay for the Republicans' attempt to (as Senator Lindsey Graham has described it) use this tax bill to prevent Donald Trump from being impeached.  (It is all very complicated, you see.)

Speaking as one of the people whose taxes would rise under any imaginable final version of the Republicans' plans, let me be clear.  There are plenty of good reasons to raise taxes on plenty of people, very much including me.

There are, most importantly, unmet and neglected needs that only the federal government is capable of addressing.  If someone told me that my taxes were going to go up, and the money would be used to rebuild Puerto Rico or to bring back the Children's Health Insurance Program or make college affordable to more young people, I would say, "Paying more is never fun, but that sounds like a good plan."

What the Republicans are proposing is, of course, nothing like that.  They have found various ways to increase taxes above where they would otherwise be for many people, all for the benefit of the richest people and the largest corporations.  If you said to me, "You must pay more taxes in order to allow heirs of estates worth more than eleven million dollars to be even more comfortable," I might become a bit irate.  Republicans are, in fact, saying that to me.  I am a bit irate.

But as I noted above, perhaps the Republicans have -- for all the wrong reasons -- blundered their way into a few good ways to save money.  The tax geek in me is always tempted to analyze proposed policy changes for their economic and behavioral effects, so I will indulge myself here by temporarily focusing on the trees rather than the forest.  (Given the reverse-Robin Hood nature of everything that Republicans stand for, I guess that the forest in question is the bizarro world version of Sherwood.)

Consider three proposals that might arguably be good policy in the sense that they could eliminate tax provisions that provide benefits to the already comfortable -- not the richest of the rich, but people who could be thought able to afford a tax increase if doing so were otherwise an improvement in the tax code.

First, Republicans have proposed eliminating tax deductions for the expenses of attending college.  Given that university educations are mostly sought out by upper-middle- and upper-class kids, one could imagine that federal education incentives might be well-meaning but misdirected.

Again, even if that were true, that would not be a reason to take these benefits away from the children of $250,000-per-year professionals in order to reduce tax rates for millionaires and billionaires, but the game here is to ask if there is a prima facie argument for eliminating a tax provision.  What to do with any saved money is a related but separate debate.

The fact is, however, that the changes that Republicans are discussing in the area of higher education would be truly perverse.  The prior congresses that provided, for example, a deduction for student loan interest were actually quite parsimonious and careful, limiting those tax benefits only to truly middle class people, completely phasing out the deductions for joint filers with $160,000 of income or more.  Also, the interest deduction is limited to $2500 annually (saving a family in the 25% tax bracket $625 per year).

Even in the immediate term, then, eliminating these tax benefits does not target the upper-middle class.  Unless one believes former Senator Rick Santorum -- a man who decided that losing his reelection bid in a landslide was the perfect opportunity to become a permanent presidential also-ran -- who once said that the desire to send more American kids to college made Barack Obama a "snob," there is nothing good about this.

In fact, this is exactly the opposite of good policy.  We should be expanding both tax-based and direct-spending support for higher education, especially for those people who are currently least likely to attend college.  I realize that Republicans love to hate universities, but higher education continues to be the only plausible path forward for improving the lives of lower- and middle-class Americans.

So the Republicans' proposals to save money on higher education fail even to pass the initial test of tax policy, which is whether the current policy is misdirected toward people who do not truly need it.  Swing and a miss.

Another surprising proposal from Republicans is to eliminate the deduction for medical expenses.  Again, this provision has already been restricted by previous legislation.  A taxpayer can deduct only those medical expenses that exceed ten percent of her income.  This means that if a person whose income is $50,000 has $5700 in medical expenses, she can deduct only $700 (the amount by which her expenses exceed $5000, which is ten percent of her income).

Even then, such a person is likely to be in the 15% tax bracket, so her tax savings would only be $105.  That would surely be devastating to lose for someone whose life has been turned upside down by a serious medical problem, but it seems fair to describe it as the very least that the government could do to help -- as opposed to, say, creating a health care system where such out-of-pocket expenses simply never happen.  (See, for example, all other advanced countries in the world.)

Even so, there is a way that this provision might have ended up being more of a boon to upper-middle- and upper-class taxpayers than to people further down the distribution.  The fact is that a person who makes $50,000 per year might not even be able to pay $5700 for extraordinary medical expenses, because she simply does not have the money.  In other words, maybe this tax deduction is not useful to the middle class because high medical expenses are literally killing them.

One consequence of the current tax debate is that policy analysts and journalists are looking more deeply into the evidence regarding the Republicans' proposals, which means that we do not need to rely on supposition to determine whether a tax provision is good for middle-class people.

And it turns out that the medical expense deduction is a literal lifeline for middle class people.  A recent New York Times article put it in stark terms:
"According to an analysis in January from the Joint Committee on Taxation, most taxpayers who claim the deduction have incomes below $100,000, with about 40 percent below $75,000. More than half of those who claim it are older than 65, according to AARP, the lobby for older Americans. They often face staggering medical and long-term care costs."
That article also noted evidence from AARP that the average Medicare recipient has $5680 per year in out of pocket costs.  In total, people deduct almost $90 billion per year in medical expenses and only receive about $10 billion in reduced taxes.

So the "only upper-middle-class people benefit from this deduction, so it's not immoral to eliminate it" story again goes out the window.  Repealing the medical expense deduction would be both regressive and inhumane.

Finally, what about the proposal to change the tax treatment of alimony?  This might be a perfect example of an improvement in tax policy even for people who were not desperately looking for ways to pay for tax cuts for the Koch brothers.

Currently, alimony is a deductible expense for the payor spouse and taxable as income to the payee spouse.  Almost always, the spouse who is receiving alimony is in a lower tax bracket (which is why she is the one who receives the alimony).  A monthly $2000 alimony payment saves $700 in taxes for a payor spouse in the 35% tax bracket, but it brings in only $200 in tax revenues from a payee spouse in the 10% bracket.

What would happen if we eliminated this $500 net revenue loss to the federal government?  The simplistic answer is that the upper-middle-class payor spouse is $700 worse off, and his ex is $200 better off (while the federal government now has $500 to send to a corporation as a tax subsidy).

But is this really what would happen?  Would the payor spouse -- who has more money and presumably good legal representation, especially compared to a spouse who cannot afford a good lawyer -- really just sit tight and agree to the same alimony deal?  Or would he say that he is only willing to pay $1300 in alimony, leaving the lower-middle-class ex-wife to be the person who effectively refunds $500 to the federal government?

It is possible that some divorce negotiations could turn out better for the payee spouses, but at the very least it seems likely that those vulnerable parties would bear some significant amount of the brunt of the Republicans' proposed change in the tax code.

That is not to say, of course, that the current approach is the best way to handle alimony.  I am merely pointing out that what looks like a policy that would help the weaker party at the expense of the stronger party can do the opposite in real life.

In short, even if we limit ourselves to assessing the Republicans' tax policies on the basis of whether they are progressive in the sense of hitting the upper-middle class rather than the middle class, the changes to the tax treatment of college and medical expenses are truly bad, and the change to alimony is also very likely to have perverse consequences.

Maybe the better approach would be to start at the top, where the real growth in inequality has taken place since 1980 (which was, not coincidentally, the beginning of the Reagan era).  Republicans' pretense that they are concerned about the middle class and are thus taking aim at the people a bit further up the scale is a misdirection play.  For Republicans, it is always about helping the very rich, first and foremost.


John Barron said...

This is kleptocracy on steroids. The plutocrats bribe the kleptocrats, and receive a return on investment that would make a hedge fund manager envious.

The quickest fix to the tax code would be to abolish our regime of worldwide taxation in favor of a water's edge system, imposing a 25% flat tax on street income, apportioned on the basis of sales. (You'd need a few anti-abuse provisions, but Treasury can draw those up.) This would put our tax burden on par with China's and Canada's, and our friends at Apple would actually pay taxes.

This would raise corporate tax revenue enough to pay for real tax breaks for the middle class.

Our tax data-gathering system is good enough already for the IRS to generate pro forma returns for 90% of taxpayers; all we would have to do is get rid of the dizzying array of quadratic equations we have to solve to file them. Simplifying compliance would put H&R Block and TurboTax out of business, and make everyone's life easier.

David Ricardo said...

Since the post was written the issue of medical costs and deductions has become much more complicated. It now looks like repeal of the ACA mandates will be part of the tax bill, with varying consequences.

1. The deficit will be reduced by $300+ billion, leaving those funds to fund greater tax relief for middle income families

2. ACA will effectively be destroyed as healthy people drop out, raising health care costs for everyone. These higher costs will almost certainly more than offset any tax savings.

3. This will exacerbate the burden of the loss of the medical deduction.

In other words, think of the bill as now the worst of all possible worlds.

Unknown said...

I am not a tax expert, so comments would be welcome, but what about the following...

1) invert the Capitol gains and earned income tax rates or at least put them on the same footing. I see no reason to preference unearned income over earned. Of course keeping tax deferred and free retirement accounts like 401K's still immune to taxes.

2) A wealth tax on all personal assets held in excess of $30m, per couple, of 2%. According to the National Bureau of Economic Research the top .1% of families (160,000 families) have an average asset base of $72.8m. Taxing this at 2% would generate $137 Billion a year in additional revenue, while limiting income inequality.

Joe said...

Money isn't my thing but I don't trust the current people in power with it.

David Ricardo said...

The United States has limited wealth taxes at the state/local level. Primary is the real property tax, and many locations have an intangibles tax, an inventory tax and an automotive tax. But a broad based wealth tax at the federal level is simply not opeationally possible.

A braod wealth tax produces signficant costs in both compliance and enforcement. And there is the fairness issue along with the valuation/assessment problem for assets which do not have a readily ascertainable market value. Corruption in the assessment area can be significant, witness the recent revelations about the Cook County assessors office.

We have an income tax because it is the most efficient method to provide for government revenue. That doesn't make it fair or simple; it could be but the GOP wants to move in the opposite direction.

Unknown said...

David, the complexities was why I set the minimum threshold so high. Most asset taxes I am failure with start to apply around $500,000-$1m which of course makes them subject to horrendous manipulation and expensive compliance costs rarely justified by the return. But once you start talking about $30m or more I would think the numbers start to swing. Valuation of stock for instance is simplistic, high value real estate is as well, just look to the property tax rolls.

I didn't consider it before but certainly there would be some difficulty in appraising closely held businesses, unique items, etc. But it isn't that hard to come up with a solution. For unique items use the insured value, for a closely held company use any one of the already existent process for divorce, estate tax, etc. Heck lets be generous and always use the method that results in the lowest number.

Shag from Brookline said...

Might Greg Rubin's "solution" include as a guide "Antiques Roadshow" "experts'" opinions of value for insurance purposes? Consider the adversarial aspects of " ... the already existent process for divorce, estate tax, etc." that requires substantial time, competing opinions of experts and ... [drum roll] ... attorneys' fees, all values to be resolved as of year-end. I understand that Donald J. Trump long before the 2016 campaign had suggested a form of "wealth tax." Recall that Trump sued for libel a person who challenged Trump's personal wealth claim as grossly higher than it really was. Trump lost.

Shag from Brookline said...

How has the Trump "populist" base responded to the Trump tax "plan" and the House and Senate's versions thereof? The Republicans' "Donor" base has apparently told them "You better pass this, or else!" The "or else" suggests no more campaign contributions. Perhaps Trump's "populist" base is not aware that the Senate and House versions of the Trump tax "plan" benefit primarily the rich. The Senate and House, following Trump's lead, are including in their versions repeals of the ACA mandate that might just impact Trump's "populist" base. Will Steve Bannon challenge this effort on behalf of the "populist" base? I haven't seen signs of it.

Many object to paying taxes, including in Trump's "populist" base, which may not be paying that much in taxes, reflecting their "forgotten" status economically that made them "populists." Perhaps the Republicans might include a provision in their bills that would exclude lottery winnings from taxable income as a sop to Trump's "populist" base, even though the odds of winning the lottery are slim, but as long shot hope for their "forgotten" status.

John Barron said...

They voted for Obama. They got taken. They know it. Then, they voted for Trump. They got taken. They know it. Had they voted for Hillary, they would have been taken. They know it. Our owners would never have allowed them to vote for Bernie. And they know it.

Our owners have it all. But they want more.

The people aren't stupid. Only powerless.

David Ricardo said...

One might think the Trump populist base is apprised of the fact that the tax plan benefits large corporations and wealthy individuals given that

1. Polls show very weak support for the plan


2. The donor class is having to run false and misleading advertising to gin up support for the legislation.

To put things in real world perspective, take Walmart. Reported Income Before Tax for FY 2017 was about $20.5 billion


which means the decline of the corporate tax rate from 35% to 20% would give them about a $3 billion windfall. To be fair everyone is sure that money would be used to increase wages for the hourly employees and not a dime of it would go to increased dividends or higher executive compensation.

You can fool some of the people all of the time, but it may be that the people you can fool all of the time is a shrinking pool of the electorate.

Shag from Brookline said...

That $3 billion Walmart windfall might result in "political tithing" of $300 million annually for Republicans' political campaigns to make sure the windfall continues.