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WSJ: Get Rid of the Wealth Surcharge!

The Wall Street Journal weighs in on the surprise surcharge that the Republicans presented in their tax plan — and subsequently defended when it was discovered. I have reposted it below in its entirety, because it is excellent:

You know Republicans are intellectually confused when they send out press releases defending a top marginal income-tax rate of nearly 50%. Yet that’s what they were up to this weekend as they tried to justify their bubble bracket tax rate of 45.6% after our criticism on Saturday.

We called it a stealth tax rate because it’s buried in the fine print of the Ways and Means proposal. It also isn’t part of the tax simplification story Republicans are selling by publicly claiming the House reform shrinks the individual code to four rates from seven. But caught out by our reporting, they are now denying that the fifth rate is stealthy while defending it as good policy.

The 45.6% is a bubble rate because it applies to tax-filing couples who make between $1.2 million and $1.6 million (above $1 million for single filers). The surcharge is intended to claw back any benefit these filers get from the new 12% income bracket that applies to income of less than $90,000 for couples ($45,000 for single filers).

Republicans apparently think it’s unfair for people to pay the same rate on the same dollar of income. So their surcharge applies the 39.6% rate to those first dollars of income for those more affluent taxpayers, which adds about six-percentage-points to the top rate and gets to the 45.6% bubble rate.

Add that to the 3.8% ObamaCare surcharge that Republicans are keeping as part of tax reform, and these taxpayers would now have a top marginal rate of 49.4%. Add state and local taxes, which would no longer be deductible against federal taxes (a policy we support), and these mostly Republican voters would in many states pay a marginal rate (on the next dollar of income) close to 60% and an effective rate (total share of income) higher than they do now. Keep in mind this is Republican tax policy.

It’s no surprise, then, that Republicans are resorting to Democratic arguments that this is no big deal because these taxpayers can afford it. They’re also claiming this is kosher because the 1986 Reagan reform also had a bubble rate of 33% in addition to a top rate of 28%. But a bubble rate of 33% is a lot lower than 50%, which was the top rate before Reagan’s 1986 reform.

And as we wrote at the time (“Gephardt Soap Bubble,” Sept. 25, 1989), Reagan’s bubble rate was also a mistake. It greased the skids for raising the top marginal rate to 31% from 28% as part of George H.W. Bush’s tax increase in 1990. Democrats argued then that the wealthiest shouldn’t pay a lower marginal rate than the merely affluent, and the bipartisan deal was the 31% top rate for everyone.

If the Kevin Brady-Paul Ryan 45.6% bubble bracket becomes law, this will soon become the new top rate for everybody—perhaps when Nancy Pelosi is Speaker after 2018.

The other Republican defense is that this bubble surcharge raises some $50 billion over 10 years to pay for pro-growth tax cuts elsewhere. But these rate increases never raise what they claim because people change their behavior. The political truth is that the estimated surcharge revenue is really going to finance the huge increase in the family tax credit that costs $640 billion over 10 years. This family credit will also be refundable over time, which means it will be paid as a welfare check to people who don’t pay taxes.

In other words, Republicans are embracing higher tax rates a la Democrats to redistribute the money to non-taxpayers a la Democrats. Remind us again why college-educated suburbanites who are successful in business or the professions and are unenthralled with Donald Trump should vote Republican?

The best solution would be for Ways and Means to clean up this surcharge mess when it marks up the bill this week. Failing that, we need a cleanup in aisle two, which is the Senate Finance Committee.

Did the GOP Create a 46% Tax Rate?

Politico is reporting that there is a surcharge in the new Republican tax plan for high income earners. As described,

“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.”

But in the new plan, House Republicans want to claw back some of that benefit for individuals who earn more than $1 million, or couples earning more than $1.2 million.

Here’s how it would work: After the first $1 million in taxable income, the government would impose a 6 percent surcharge on every dollar earned, until it made up for the tax benefits that the rich receive from the low tax rate on that first $45,000. That surcharge remains until the government has clawed back the full $12,420, which would occur at about $1.2 million in taxable income. At that point, the surcharge disappears and the top tax rate drops back to 39.6 percent. This type of tax is sometimes called a “bubble tax,” because the marginal tax rate effectively bubbles up for a brief period before falling back to a lower level.”

Besides the obvious frustration that the GOP plan did not restore the Bush tax cuts and roll back the highest bracket permanently to 35% , having yet another surcharge on the wealthy is inexcusable. The Republicans can do better, and yet they succumb to the class warfare rhetoric that the rich must “pay their fair share.” Hopefully this will be eliminated in the final bill that gets voted on.

 

House Releases Tax Reform Bill Draft

The House Republican tax reform plan has been released. Here are the highlights:

The top individual rate for high-income earners will stay at 39.6%

The corporate rate will be cut to 20%

Tax brackets will go from seven to four: the rates will be: 12, 25, 35 and 39.6%

The standard deduction will increase for single filers to $12,000 and joint filers to $24,000 , so that those filers below those thresholds will pay no income tax.

The child tax credit will increase from $1,000 to $1,600 per qualifying child. There will also be a new family credit (considered an expansion of the child tax credit) that provides a $300 credit for each parent to help with everyday expenses.

The mortgage interest deduction remains fully intact for currently existing mortgages. In contrast, those purchasing a home in the future will only be allowed to deduct interest paid on the first $500,000 of the total cost of their mortgage.

Retirement incentives for 401(k)s and IRAs remain unchanged.

The estate tax will be fully repealed but not for six years. Between now and then, In the interim, the estate tax exemption will double.

A deduction for state and local property taxes will be capped at $10,000.

Once the House Ways and Means committee begins to gather feedback , changes will inevitably be made with a hopeful time frame of Thanksgiving for a final bill and vote.

Republican Tax Writers Should Know Better

The stated intent of the new proposed Tax Reform Package is to grow the economy while providing tax cuts and simplification for the middle class. Forget the fact that as the most progressive tax system in the World, our lower and middle classes already carry a substantially smaller tax burden than in any other country. Just note that the principal middle class tax cuts being proposed is simple political theater and do little or nothing to simplify the tax law, grow the economy, or help the taxpayer.

The lawmakers have proposed nearly doubling the standard deduction from $12,700 to $24,000 for married couples and from $6,350 to $12,000 for single filers. On paper, that sounds good. It provides a tax reduction for those who do not itemize their deductions, though it is neutral for those who will continue to itemize. It has no benefit for economic growth – it just reduces taxes owed.

The tax proposal goes on to get rid of personal exemptions.  Currently, taxpayers can claim a personal deduction of $4,050 each taxpayer and dependent. The exemption functions just like the standard deduction in that it reduces the taxpayer’s taxable income for the year. Eliminating the exemption would cause a net tax increase to most taxpayers, but the tax writers seem to be trying to offset this by increasing the child tax credit. This credit has the same effect as the exemptions had – that is, to reduce the tax for individuals, with more benefit going to those households with more dependents, and with no additional contribution to the economic growth of the economy. But since credits are always more complicated than deductions in its operation, this swap of credits for exemptions is a change for the worse.

It should be noted that one reason Congress is pushing for the tax credit instead of exemptions is that the credit can be “refundable”. That means that even if a taxpayer has no tax to pay, the credit would be sent to him in a refund. As such, this is not part of our tax structure – it is simply welfare Government spending wrongly dressed up as a tax reduction.

Thus, these changes really don’t simplify the tax code; it merely shifts formulas and amounts around.  In fact, since credits are more difficult to implement than deductions, this actually adds complexity to the Tax Code. A far better solution would be to eliminate the Child Tax Credit, and use the standard deduction and exemptions to reduce the tax burden (using exemptions to the extent that you would like to confer a benefit to larger families).  

The Obnoxious Problem of Miscellaneous Itemized Deductions

There is a very real problem within the Internal Revenue Code (IRC) that deserves attention. The IRS generally requires that hedge fund investors pay taxes on huge amounts of “income” that does not exist. This is derived from rules that require investors to pay tax on investment income while denying them an offset for the expenses that were incurred to generate that income. That is the very definition of inequality.

It is simply not uncommon for hedge fund investors to pay tax rates of 70-100% or more on the hedge fund income they earn.

Yes, you read that correctly. 100% or more. In fact, in my practice I see  clients every year forced to pay more taxes on an investment than that investment earned. True, it is a small percentage of people affected in any given year, but this does not mitigate the blatant unfairness. How does this injustice take place?

It follows from what is the most inequitable provision of the current tax code, namely, the severe limitation on the ability to deduct the necessary expenses incurred by a hedge fund operator (or any individual taxpayer for that matter) in order to earn income: investment fees and expenses, accountant’s fees, legal fees for collecting a settlement, etc.

The tax code requires those expenses — which include virtually all operating expenses of private equity hedge funds, including fees to the operators — to be listed under the category of “miscellaneous deductions”.

However, these deductions may not be claimed until and unless they reach 2% of the taxpayer’s entire income. The upshot of this is that most taxpayers do not get to benefit from these deductions. To add further insult to injury, that even if investors have expenses which exceed the threshold, these expenses become addbacks for the dreaded alternative minimum tax (“AMT”).

This taxpayer abuse then certainly discourages investment and is a major source of inequity in the code. If Congress were ultimately concerned with reforming the hedge fund industry, this problem — the inability to deduct necessary expenses incurred while earning income — would be the right one for Congress to fix.

Dealing with the Ten Year Budget Reconciliation Issue

A major problem in constructing tax legislation is the “No deficit after 10 years” problem.

It takes a 60 vote majority in the Senate to pass permanent legislation. A key exception is what is known as “budget reconciliation”, whereby financial budget items, including tax changes, can pass with a simple majority vote. But this requires that any proposed legislation cannot produce a deficit after 10 years. To satisfy this requirement, legislation often contains a provision that it will terminate at the end of the tenth year.

The Bush tax cuts of 2001 (and 2003) was the poster child for that problem. Tax rates were reduced in 2001 and 2003 using budget reconciliation This required that the lower rates would automatically expire (sunset) in 2011 so as to comply with the “no deficit after 10 years” issue. Everyone ignored the cuts which then became a big headache and political battle when the time came to renew them –  or let them expire.  After ten years, the lower rates suddenly terminated for those most important for growing the economy, creating one of the largest tax increases and worst economic recoveries in history. This disaster has made Congress hesitant of passing badly needed tax cuts and reform in fear of the 10 year spring back. But this does not to be so.

The best way to deal with sunset clauses within the tax code is to extend them annually during the budget process so that we don’t enact a tax change and then forget about it over time. This is something to consider as Congress embarks on potential major reforms  to the tax code in the coming months.

Trump’s tax reform proposal includes a major pro-growth change to depreciation rules. The change would allow for claiming an immediate deduction for the cost of new equipment, without having to spread the write–off over many years.  This would be a boon to the economy. But due to budget constraints this change would likely be scheduled to terminate after 10 years. That should not be allowed to happen. Instead Congress should examine the policy yearly, and extend it out an additional year  from that date. This way the tenth year will never come and there will be no unnecessary tax battle.  This process could continue until there are the votes to make the provision permanent.

Schumer’s Hypocrisy on State and Local Taxes

It is virtually impossible to defend the part of the Internal Revenue Code that provides for a deduction for individuals who pay State and Local income taxes (“SALT”). The deduction is simply a subsidy for those states who levy high income taxes on their constituents.  It actually incentivizes those states to levy high taxes, knowing that their constituents will have their federal taxes reduced as their state taxes go up. But this is patently unfair to constituents who live in low tax states, whose share of the federal tax burden therefore goes up.

Senator Chuck Schumer is leading the attack against proposed Tax Reform legislation that would eliminate the deduction for SALT. But since there is no rational argument to attack the proposal directly, he argues that the tax deduction is fair because NY (and other big blue states) send much more tax money to Washington than they get back.  

But this is hypocrisy of the highest order. It is Schumer’s own preferred legislation that causes this imbalance. He has successfully advocated for policies that greatly increase the size of the federal Government (sends money to DC), that increase the welfare state (benefits going disproportionately to the poorer parts of the country), and substantially raise the tax burden on the wealthy (many of whom live in NY). So he created the problem and is now asking to be bailed out?

As I have repeated many times before, If Kansas ever gouged its farmers, or Texas ever gouged its oilmen, like New York legislators (like Schumer) gouge their financial community, they would be run out of town!

 

Eliminate the State and Local Deductions

With President Trump proposing to eliminate the Federal tax deductions for state and local taxes, there has been an outcry from states that allow this deduction currently. The biggest criticism is that it creates “double taxation” because it forces individuals to pay two separate taxes – federal and State – on the same income- without giving any relief against the federal tax in recognition of the tax paid to the State. Without the deduction, Lawmakers warn that tax bills will rise substantially for their citizens.

However, the truth is that these attacks are nothing more than an attempt to shift the focus away from affected states (like New York, New Jersey, and California) who are failing their fiduciary responsibility to its taxpayers. They currently levy a very high level of taxation upon its citizens. The deduction is simply a subsidy that masks the egregious overspending of the state which creates the situation in which high taxation is necessary to feed the body politic.

Why should the federal government have to subsidize some states at all? If the residents of these states think that high (some would say ludicrously wasteful) government spending paid for by very high taxes is the right way to run a state, it is certainly their right. But these residents also have no right to ask taxpayers of other states to subsidize them. And that is exactly what happens when the federal tax code enables some states to reduce their federal tax — via the state and local tax deduction — simply because they pay high taxes to their states.

So yes, although the proposal will hurt some citizens, it is essentially and simply a reform that puts all taxpayers around the country on a level playing field, especially if it helps to reduce federal tax rates across the board. If lawmakers are so concerned with their affected taxpayers, they should aim to reduce the scope and size of their state governments and the wildly out of control spending that created it, instead of expecting other citizens to subsidize their irresponsibility.