Grading Trump’s Tax Reform Plan

Today President Trump and Congressional Republican leaders released a “framework” for tax reform, which you can read here. The framework is more an outline than a plan; while its principles are generally good, a lot depends on how Congressional committees fill in the details. And then, of course, it remains to be seen what will actually get through Congress. So far, leadership’s track record is not encouraging.

Here are some observations on the framework’s major features:

The plan increases the standard deduction and consolidates the current seven tax brackets into three, at 12%, 25% and 35%. Grade: Incomplete. There is no indication where the bracket lines will be drawn, which makes a big difference to most taxpayers. Also, the document holds out the possibility that “[a]n additional top rate may apply to the highest-income taxpayers to ensure that the reformed tax code is at least as progressive as the existing tax code.” This is a poor idea: the current tax code is the most progressive in the developed world, and needs to become less so.

It eliminates the alternative minimum tax. Grade: A. This change is long overdue.

It abolishes most itemized deductions, including for state and local taxes. Grade: A. There is no reason why low-tax states should subsidize high-tax states, and no reason why the federal government should underwrite state and local profligacy.

It repeals the estate tax. Grade: B+. The estate tax is paid only by people who have paid way too many taxes already. The “death tax” is widely unpopular, and doing away with it is a political plus.

It establishes a 25% top tax rate for “small and family-owned” proprietorships, partnerships and S corporations. Grade: ? Frankly, I don’t understand this one. The idea is to help small business owners, but it is hard to see a consistent rationale. Does it mean that lawyers working in proprietorships or small partnerships, for example, will have a 25% top rate? The document says, “The framework contemplates that the committees will adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.” I don’t get it.

It reduces the corporate tax rate to 20%. Grade: A-. The ideal corporate tax rate would be 0–one of my law professors once remarked that the only intellectually respectable argument for the corporate income tax is that it employs a vast army of accountants and lawyers–but this is an important step in the right direction.

It allows expensing of capital investments other than structures for at least five years. Grade: C. Along with the cut in corporate tax rates, this will generate a surge of capital investment that will boost the economy in both the short and long term. But unless I am missing something, depreciation makes more sense than expensing, and there is no exigency to justify a temporary holiday.

It reforms taxation of international corporations. Grade: B+, I think. The idea is to facilitate repatriation of profits earned overseas to the United States. Prospectively, there will be no income tax on dividends paid by foreign subsidiaries to U.S. parents. That’s good, and, once again, long overdue. The framework provides for a transition to that system, but the description of the transition mechanism is too sketchy to evaluate. The plan also will “[tax] at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations.” This would make our tax system more like everyone else’s, and is intended to eliminate the incentive to headquarter companies overseas. Again, the details are absent.

Overall, the concepts of the framework are good, although it is disappointing that the top personal rate is not reduced more, and may not be reduced at all. Important details remain to be filled in, and it is not clear whether House and Senate leadership have agreed on them or not. Moreover, what leadership agrees on isn’t necessarily what can pass. If anything remotely resembling the framework becomes law, it will give the economy a major boost, so the Democrats will fight it tooth and nail. Consequently, I assume that once again, a handful of Republican senators will be able to exercise a veto. Moreover, blue state GOP Congressmen (unlike the Senate, the House still has some Republicans from high-tax states) are likely to rebel against elimination of the state tax deduction.

So it’s a good, albeit imperfect, set of proposals, but at this point it is impossible to say what, if anything, will ultimately pass.

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