NO REAL REFORM
The System Wins, You Lose, With Both Hillary Clinton and Donald Trump’s Crummy Tax Plans
No one defends our lousy tax system—but no one is they willing to buck the political donor class to systematically change it.
Let’s look at a few of the more curious aspects of the Clinton and Trump plans for individual income tax now that both candidates have put out reasonably comprehensive proposals they promise to take to Congress next year.
The bottom line: Clinton and Trump both offer conventional, predictable and minimally significant changes, not reform.
Tax Benefits for Families
Trump originally proposed to eliminate income taxes for 70% of Americans by exempting the first $25,000 of income, twice that for married couples. That promise is no longer on his website, though adopting it would make the economy more efficient and restore the original premise of the income tax, described when it was permanently adopted in 1913 (that the tax would apply only to “surplus” income—defined, back then, as money beyond what is needed to pay for necessities). It would also reduce, for a significant majority of Americans, the burden of filling out tax returns or paying to have them prepared.
Instead Trump now proposes a tax hike for poor and many middle-class parents, though his website does not call it that. Here's how: He would replace the current $1,000-per-household childcare tax credit with an unlimited deduction for childcare.
A tax credit of $1,000 is worth the same to everyone with children in the care of others. But a tax deduction has no value for most taxpayers because they do not itemize. And it is worth only 10 cents on the dollar for those in the bottom tax bracket, but 39.6 cents per dollar of income for those in the top bracket.
Trump’s plan also favors large families over small. He has five children, four of whom are grown.
The credit for childcare for children under age 12 is not adjusted for the number of children, a de facto congressional policy against large families. (As the father of eight grown children I tend to notice these sorts of subtle government policies that economically favor small families.)
Trump would switch to a deduction that provides larger benefits to larger families, but would be of no value for the roughly 70% of taxpayers who do not itemize deductions. Switching from a tax credit to a tax deduction would mean that the vast majority of working parents would face a tax increase, at least as his plan is currently sketched out.
Clinton promises new federal subsidies for childcare, noting that families below the poverty line spend 36% of their meager incomes on childcare while those just above the poverty level spend 20%.
In addition, Clinton favors universal preschool and paid family leave, which is offered to parents of newborns (often, both parents) in every country with a modern economy except the United States.
Under the Trump plan a couple rich enough to employ, say, five nannies can deduct all the costs of those nannies, presumably including the costs of first-class airfare as the nannies shuttle the tykes from mansion to mansion.
Trump has also said several times that his companies provide employees with childcare. They do not. Trump apparently confused a benefit offered to guests at some Trump resorts with childcare for Trump resort and other workers.
The Battle Over Tax Brackets
One of the economically sillier issues in politicians' tax plans is changing the number of tax brackets as income rises. In a progressive tax system—an idea invented nearly 2,500 years ago by the ancient Athenians when they created democracy—the greater one’s gains, the higher the tax rate. The moral theory of this policy is that it is society that makes economic gains possible—through protecting wealth from thieves and invading armies. Those who have more assets protected should contribute more to that protection.
Multiple tax rates add almost nothing to complexity, as Robert E. Hall, the eminent economist who co-authored The Flat Tax, once told me. Hall said he regretted that the book called for a single rate rather than a progressive rate structure.
Rates are also inherently misleading because of the complex interactions Congress has created among credits, deductions, and definitions of taxable income. Some years ago a study showed that the highest marginal tax rate in America was more than 90% and it was paid not by the rich, but by a couple age 62 through 65 who had started collecting Social Security benefits but earned enough income that Congress clawed back a hunk of their retirement benefits. Of course, unless the couple did a detailed analysis of their income taxes they would never know that, so subtle are the interactions.
Clinton would add a 9th tax rate to the current eight, which range from zero to 39.6%. On incomes above $5 million Clinton would add four percentage points for a top marginal rate of 43.6% that would apply to fewer than one in 2,500 taxpayers. She would also ask Congress to enact a form of the Buffett Rule, indicating she believes anyone with an income of more than $1 million should pay at least 30 cents on the dollar of their income to the Treasury, as recommended by Warren Buffett.
She would also in various ways reduce taxes on the middle class with only those with very high incomes paying more, assuming Congress enacted her proposals.
Trump’s latest tax proposal embraces the House Republican plan to reduce the number of tax brackets to four: 0%, 12%, 25% and 33%. Trump says he would limit deductions for high-income taxpayers except for charitable gifts and mortgage interest.
The Mortgage Interest Deduction
Trump would keep the mortgage interest deduction as it is. Clinton would limit the deduction for higher-income tax payers. (They could deduct as if they paid the 28% tax rate even if they are in higher brackets and thus would otherwise be entitled to deduct more.)
Keeping the mortgage interest deduction means a housing subsidy for the affluent and rich. The subsidy benefited only 22.5% of taxpayers in 2013 with more than half the interest deducted by the 15% of households making more than $100,000. Fewer than half of homeowners qualify for the deduction—because they make too little money, their interest payments are too small or they do not itemize deductions.
This subsidy also inflates the prices of homes as people pay higher prices to capture the tax benefit. As with many subsidies the net effect is a loss for home buyers because if the deduction were eliminated, lowering housing prices would also lower interest paid.
The Rich and the Really Rich
Neither Clinton nor Trump distinguishes much between levels of high income, say $1 million per year and $1 million per day.
In 2012 fewer than one in 1,500 taxpayers paid more than 30% of their income in federal income taxes, IRS data show. Their average income was $2.7 million. People who made much more, say $270 million, paid much lower rates because such large incomes tend to come from capital rather than labor and Congress favors capital with lower tax rates.
Since 2005, the top 400 tax returns filed each year have shown an average income above $200 million per taxpayer, twice exceeding $300 million. Under the Buffett rule the average tax rate of these individuals would rise significantly, up a third to nearly double based on recent years, but still far below the top marginal rate proposed by either candidate.
The top 400 pay relatively low rates because most of their income is capital gains—often one-time gains from sale of a business or other asset that grew in value. The top rate on most capital gains is 20%, half the top rate on salaries. Hillary’s 43.6% tax bracket wouldn’t apply to this kind of income.
The reality is that Congress, not presidents, sets tax rules and rates. The proposals by Clinton and Trump—while quite different—are just tinkering around the edges and vote-seeking, not real reform of a system that has become so complex, burdensome, and capricious in how it treats taxpayers with the same income that no politicians defend the system as it exists. Then again, no one seems willing to actually reform it, either—because too many in the political donor class have an interest in preserving this or that provision.
Pulitzer Prize winner and recipient of an IRE medal and the George Polk Award, David Cay Johnston is author of five books. His new book, The Making of Donald Trump, was published on Aug. 2, 2016. His next one will be The Prosperity Tax: A New Federal Tax Code for the 21st Century Economy. Johnston is a Distinguished Visiting Lecturer at Syracuse University College of Law and Whitman School of Management, and also writes for The Daily Beast and Tax Notes.