Top Heavy

Donald Trump’s Tax Reform Plan Won’t Really Reform Anything

While the president talks a big game about real relief, he’s expecting a compliant Republican Congress to deliver still more favors to the already favored donor class.

Drew Angerer/Getty

Within a month, Donald Trump says he will put forth his tax plan, which the president tweets will be “phenomenal.”

What the Trump plan will not be is tax reform, at least not in any meaningful way.

Nothing said by the president or his surrogates suggests that they have any intention of reworking the basic structure of our income tax system, individual or corporate, so that it raises the most revenue with the least economic interference. Nor can we expect Trump to rework taxes based on ability to pay—the basic principle of all successful income and wealth tax systems going back nearly 2,500 years to ancient Athens where democracy and progressive taxation were invented as foundational twins of Western civilization.

Rather, Trump tweets and—his surrogates talk of vaguely of—“major tax reform that will massively reduce taxes on our workers and businesses.” But from what we can see so far, the broad policies we can expect from a compliant Republican Congress would deliver more tax favors to the political donor class.

That suggests a replay of the 2001 and 2003 tax cuts under President George W. Bush. They were so top heavy that more than 12 percent of the tax savings went to just one in a thousand families, my analysis of IRS data found.

The tax plan Trump proposed when he was a candidate would add at least $7.2 trillion to the federal debt in just a decade, the latest analysis by the Tax Policy Center shows. Its computer model has proven reliable over the years in projecting the revenue effects of tax code changes.

Combine big new tax cuts with Trump’s promises of massive increased spending on the military, for a wall on the Mexican border and for mass deportations and you get a huge increase in the federal debt, which candidate Trump complained is already much too big.

Trump & Co. talk mostly of tinkering with tax rates, especially giving big new tax breaks to individuals at the top and to some multinational corporations. In this we see another bait and switch by Trump, as he did when campaigning against Wall Street and then appointing a half-dozen Wall Street veterans to top federal positions.

Help for the Donor Class

Of course, Trump would not be the first politician to promise fundamental tax reform and deliver something else. Congress has made hash of our tax code, nearly 6,500 pages long in the official government version, through layers of tax favors for the political donor class. But candidate Trump claimed that as a rich man he was immune to influence from donors.

Because of favors, individuals and businesses with the same income currently pay radically different amounts of federal income tax. For example, Congress in 2014 imposed a federal income tax on working married couples once their gross pay exceeded $20,300 (for a married couple, with a standard deduction and two exemptions). But a couple whose only income is dividends and long-term capital gains could collect $73,800 before owing any income tax. A purely domestic corporation is taxed on its profits, but a multinational with the same profits can legally pay nothing by converting domestic profits into royalties paid to its offshore subsidiaries thanks to a one-line change in the tax code in 1986. See “What If You Were Taxed Like a Multinational?” for more on this.

Some of the wealthiest Americans live well while paying little to nothing in federal income taxes. Six of the 400 families reporting the largest incomes in 2009, an average of $202 million each, paid no federal income tax.

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Each year in this century on average 24 of the 400 largest tax returns had income taxes ranging from zero to a dime on the dollar of income. In 2014, 410,000 families enjoyed incomes of $1 million or more, with 444 paying no federal income tax, my analysis of IRS data tables shows.

Real Reform for the 21st Century

America needs real tax reform because the tax system was designed more than a century ago for an industrial economy in which the most valuable assets were physical things, such as buildings, manufacturing equipment and durable goods. That’s no longer true. Today, ideas have become the most valuable assets. Much of the wealth created in America today consists of formulas—mathematical formulas that run computers so we can bank or watch movies on our cellphones, and chemical formulas for modern drugs and automobile engines that can run a million miles when properly maintained.

Our corporate income tax, adopted in 1909, and our individual income tax, adopted in 1913, were designed for their times. They levied profits earned from physical assets and cash wages. Indeed, America has one of the most efficient tax systems in the world—for the economy of 1960.

But we don’t live in the 20th-century economy where workers wait in line for an envelope holding dollars and pennies, and corporate wealth is held in immovable objects like factories and machinery.

We live in the 21st-century economy in which the most valuable workers are paid in ways our tax system fails to properly recognize and where the most valuable assets are ideas. The accountants and economists call these intangibles. It’s easy to tax hard physical assets, especially when they can’t be moved like a pipeline, a railroad, or a big electric power plant. Taxing intangibles requires real reform, a deep structural reworking of our tax system.

The Trump plan, based on what the president and his surrogates have said so far, will not address these deep structural issues. One key missing piece is a tax principle called realization.

Realization Explained

When your employer cuts your paycheck you “realize” that income for tax purposes, even if you never cash the check. But under rules set by Congress many of the wealthiest Americans delay realizing their income for tax purposes for years or even decades pass.

You can get an idea of this from the annual disclosure statements General Electric makes about the pay of its top executives. CEO Jeffrey R. Immelt earned almost $37.3 million in economic income in 2015, but just $9.6 million of that showed up on his W-2 wage statement, the amount GE reported to the government as his gross pay for tax purposes. The rest of Immelt’s income is deferred (mostly in his executive pension plan) or is in the form of the right to cash in stock later.

Private-equity and hedge-fund managers get an even better deal. Some of them make a billion dollars or more each year in performance pay. They can defer their performance pay back into their funds with no current tax liability. These deferrals continue as long as the funds stay in business, which could be a half century or more.

In effect these favored workers get to borrow at zero percent interest from Uncle Sam, an amount equal to the income tax they would otherwise pay immediately.

Think about how much more you would have if Congress gave you the same deal. You would retain all the income taxes ever withheld from your paycheck so long as you invested the money rather than spending it. If you earned just 4 percent and enjoyed a 35-year delay on each year’s taxes you would, after ultimately paying the tax, have more wealth than the amount of the taxes.

These are just a few of the basic problems with our federal tax system being out of sync with the economic order. Our tax system can be updated. Doing so requires deep analysis to understand the 21st century economy so that our tax system flows from that economy, rather than throwing sand in the gears of commerce as it does now, favoring some industries and occupations while giving a free—or nearly free—ride to others.

Simplistic promises about cutting tax rates fail to address these core issues, which damage our economy.

President Trump didn’t create these issues, but he ran for office promising fundamental reform. Now he and his surrogates just talk tax relief. America doesn’t need more shifting of tax burdens to please the donor class. It needs real reform. Under Trump I don’t believe we will get it.