Friday, December 22, 2017

How Will Democrats Respond to the Republicans' Tax Travesty?

by Neil H. Buchanan

Possibly the most infuriating aspect of the tax circus that we have witnessed over the last few months is the Republicans' insistence that they are doing something difficult.  This is a "big win," say the Republicans, and the supposedly skeptical press prints headlines like "McConnell Gives Trump Gift to Celebrate Tax Win" and "U.S. House to Vote Again on Tax Bill, Trump on Verge of Win."

I suppose the press justifies this by saying that the Republicans view it as a win, and the Democrats voted against it, making it accurate to score this as a W for the Republicans.  The problem is that this framing continues to ignore the fact that the Republicans can do whatever the hell they want to do.  They temporarily have the numbers to pass anything they want in both houses of Congress, limited only by whatever rules they decide to continue to impose on themselves.

In other words, even if this bill is a victory for Republicans in some sense, it is hardly something that should be hailed as a mighty accomplishment in the face of tall odds.  This is merely Republicans doing what Republicans have always wanted to do (after beating each other up for a few months).  They have done nothing that requires skill, unless not tripping over their own feet counts as a skill.

This reminds me of a joke I once heard from a Canadian friend.  Unknown to most Americans like me, there is a genre of humor in the Great White North called "Newfie jokes," which makes Newfoundlanders the butt of jokes by pretending that they are all backward, slow, unsophisticated, and so on.  (For U.S. readers, this would be the equivalent of jokes at the expense of people from New Jersey, Alabama, and Ohio combined.)

Anyway, the joke is that a Newfie hockey team's opponent is unable to get to the rink because of a snowstorm.  The Newfies take the ice and (this being a joke) begin to play the game with no opponent.  They skate around furiously until finally scoring a goal early in the third period, at which point they celebrate their first goal of the year.

It is not that the Democrats are not in the arena, but it is as if they are prevented from having a goalie or skating within fifty feet of the Republicans.  In order to score, all the Republicans have to do is score.  They have the numbers, and there is nothing the Democrats can do but try to convince their colleagues across the aisle not to do what they are doing.  Republicans do not care, and they do not have to.

That we are this late in 2017 with the Republicans celebrating their first putatively big victory is pathetic and represents what a former Republican president once called "the soft bigotry of low expectations."  They managed to agree on a particular noxious combination of tax changes that massively favor corporations and the super-rich (especially the idle rich), and they did so by exposing all of their "principled" and "moderate" brand-name politicians as poseurs.  Can you feel the winning?

This is not to say that the non-Foxiverse media have been kind to the Republicans.  There have been plenty of good articles written about various jaw-droppers in the bill, and there has been no shortage of coverage of the deeply corrupt non-process that Republicans used to get their way.

Yet even top reporters insistently repeated inane Republican talking points, including uncritically repeating the idea that Republicans wanted to "collapse the tax brackets to three, from seven, in part to achieve their goal of simplifying the tax code so that people could file on a postcard."  For the umpteenth time, tax simplification has nothing to do with brackets, and even a one-rate system would require tax tables.

While the Republicans take their participation-trophy-equivalent victory laps, what should the Democrats do?  Obviously, the starting point is to continue to emphasize that the new law is a bad joke.  It is actually good for Democrats that the Republicans are making such a big deal about themselves right now, because this will make it even easier to remind voters that the Republicans celebrated as they took from the have-nots and gave to the haves.

At the polls in 2018 and 2020, this tax disaster promises to be a big win for Democrats, not Republicans.  I am by no means a political consultant (thankfully), but the public relations on this are going to be extremely favorable to Democrats, especially because even the tiny tax reductions that non-rich people will receive for a few years will not even kick in until a year from now.  This is all about framing, and a stroke-the-rich tax bill is never an easy sell politically.

There is, of course, already a healthy discussion on the left about how to proceed on both politics and policy.  Probably the most important question is whether the Democrats should push for outright repeal of the bill or should be more strategic about it.  New York Times columnist David Leonhardt, ever the cautious center-left voice, argues that there are some good things about "a dreadful tax bill," and Democrats should keep the good things.

Leonhardt's prime example, jarringly, is the cut in the corporate income tax rate.  Sure, Leonhardt says, cutting from 35 percent to 21 percent is plenty bad, but he believes that the old rate was too high, so Democrats should not commit to simply returning to the status quo ante.

Putting aside my disagreement with Leonhardt's assertion that the world truly needed a reduced corporate tax rate, this is in some sense a false choice.  Of course the Democrats, if they are ever back in control of the government, would not say that the tax code circa 2017 was the best it could possibly be.  

This is not, by the way, the same as Republicans saying that they wanted to get rid of the Affordable Care Act but keep the popular stuff.  Republicans had never shown any interest in protecting people with preexisting conditions from being dumped by their insurers, and there was no conservative constituency for keeping under-26-year-olds on their parents' health care plans.  Their late embrace of those provisions was merely Republicans being opportunistic in the face of new political realities.

By contrast, Democrats would be planning to change the tax code even if Republicans had never managed to push this disaster across the goal line.  Taking back some of the ground that Democrats have given away on the estate tax since 2001 would be a good start, and creating a more meaningful kind of minimum tax regime (along the lines of the so-called Buffett Rule) has long been on the radar screen for progressives.

Democrats are thus saying something like this: "We were at point A, and Republicans have now moved us to point B, whereas we want to be at point C.  Do we go back to point A on our way to point C, or do we go directly to point C?"

It might seem obvious that the right answer is to go directly to point C, but I am not so sure.  It is similar to the choice that Democrats faced when they had to deal with the so-called fiscal cliff five years ago.  President Obama was desperate to prevent the imminent expiration of the Bush Tax Cuts (which Obama and the Democrats had extended for two years at the end of 2010) because the resulting tax increases would have been politically unpopular.

I argued at the time that the Democrats should have allowed the cuts to expire (pointing out that the expiration was part of the Republicans' original plan) and then used the ensuing political pressure to their advantage.  "The Republicans made your taxes go up.  We want to reverse that, so let's now pass a good bill."  The return to the old regime (point A in my formulation above) would have been more likely to get Democrats where they wanted (point C).

The situation is a bit different now, because point B (the new Republican tax law) is either not set to expire (corporate tax cuts) or will expire several years down the road (the small pro-middle-class provisions).  Even so, the Republicans' bill is such a juicy target that it will be easy for Democrats to run on a "repeal the whole damn thing" platform while promising not to stand still thereafter.

It is important to remember that the Democrats might just as easily lapse into infighting as the Republicans did during the ACA repeal efforts this year, with pro-business centrists like Leonhardt arguing to a standstill with liberal egalitarians like me.  Politically, getting from point B back to point A would almost certainly prove easier than figuring out what point C includes, and it will be all too easy to allow the perfect to become the enemy of the good.

And honestly, even if the Democrats were not able to pass something better, they would still have accomplished something simply by negating this insane bill that the Republicans have now rammed through the government that they completely control.  The tax law that has existed up until now is by no means great, but it is immeasurably better than where Republicans are now taking us.


David Ricardo said...

l am not sure that Mr. Buchanan's argument here is nothing but academic, since Democrats will be unable to do anything until they have a House majority, a Senate majority and a Democrat in the White House. So mid to late 2021 is the earliest we are looking at here.

Another aspect of the politics of the tax cut is that Republicans have rigged the withholding regime to score a small victory in 2018 at the expense of a big loss in 2019. As one of the few people who have read all of the Conference Report, I noted that with respect to the elimination of personal exemptions, the Treasury has the option of deferring the impact of that until the 2019 withholding tables.

This was done to maximize the decrease in withholding in February when employees who file new W-4's will have lower withholdin because of the lower rates and dependent tax credits but not see that offset in part by the loss of personal exemptions. But in 2019 when employees file their 2018 return they may be substantially underwithheld and so see a big tax bill. Also those families that have teenagers turn 17 in 2018 will also see a problem in 2019 when the file because the child tax credit will have gone away for them.

So yes, even the few people fooled by the $1000 bonus will catch on.

Shag from Brookline said...

Regarding the reduction in the corporate tax rate, it has been my understanding that the old higher rate was not that significant in that corporations had many loopholes to reduce their effective corporate tax rates. To what extent, if any, does the Trump/GOP Tax Act of 2017 eliminate such loopholes? Will the new lower rate continue to reduce actual corporate tax payments because of loopholes?

David Ricardo said...

It is difficult to know the exact effective corporate rate but several sources put it at 20 to 22%, close to the new statutory rate. But the variance around that rate is very high. For firms like Wal-Mart who have little IP and capital expenditures as a percentage of assets the effective rate is close to the statutory rate. For tech companies or capital intensive companies, like Google or telecoms the effective rate is close to zero. So the new tax law will affect different corporations in highly different ways.

With respect to the loopholes for specific industries, those seem to be largely intact. The two largest general loopholes involve (1) the ability to move taxable income to low tax jurisdictions and (2) accelerated depreciation. Google and Apple for example have capitalized foreign subs in low tax/zero tax countries by contributing their IP and by charging a high royalty fee to domestic operations they have caused taxable income in the U. S. to be very low and so U. S. effective taxes are well below the statutory rate. The income that is generated offshore will now be able to be repatriated and future off shore income will face very low rates. So corporations that have near zero effective rates should be able to continue with them.

The big winners will be retail like Wal-Mart who will see their effective rate decline from the low 30% to the low 20% range.

The interesting thing is what will happen with depreciation.

Changing depreciation lives is only a change in timing. Over the life of a depreciable asset the total depreciation expense is the same regardless of the length of the life or the rate of depreciation each year. Allowing full expensing of capital investment merely takes the total depreciation expense and puts it in one year instead of several years. The tax benefit of depreciation is just moved up. In a low interest rate environment this benefit is rather limited.

It is not clear how much corporation execs understand this. Certainly policy makers and shakers do not. A corporation which fully expenses capital investments and has a high investment rate in 2018 and a low amount in 2019 will have a low tax bill in 2018 but a high one in 2019 relative to current law. Over the total period the total tax bill is unchanged from expensing. But lawmakers and corporate execs probably do not know this.

So in the end the corporate rule changes are not likely to be a big stimulant to investment, particularly if foreign tax regimes are also lowered. Superficial analysis, ie, congress, acts as though competing countries will stand still. They will not.

The big losers, revenues and the social programs they support.

Shag from Brookline said...

Query: How might IRC Section 482 be applied to address some of the game playing with IP to keep more corporate income stateside?

David Ricardo said...

In theory Sec 482 should have prevented the manipulation of income among jurisdictions by folks like Amazon, Apple etc because it gives the Treasury very broad authority to change a company's accounting for transfer pricing between domestic and foreign controlled entities. (The code section itself is an unintelligible single paragraph, the regulations go over 100 pages). In practice it does not for two reasons.

1. Multi-national companies employ economic consultants to develop transfer pricing studies that purport to comply with the regulations even as they allow near total discretionary transfer pricing activity


2. It is extremely costly and time consuming for the Service to challenge transfer pricing by a specific company and because Congress has severely reduced IRS compliance resources Treasury has allocated its resources away from Sec. 482 enforcement.

So Sec. 482 has been essentially de facto repealed which is why these tech companies and multi-national manufacturing companies have an effective tax rate far below 35%.

(Personal point: My family goes crazy when I bring this stuff up. Around our house Happy Hanukkah is replaced with “shut up Dad”).