Patiently awaiting the Golden Years

Tax reform for Christmas?

By Randall Poulton | Dec 07, 2017

When the person who owns the newspaper I write for asks for help understanding tax reform, I am happy to do my best to oblige! Several of the concerns Mr. Brower raised in his recent column are similar to what I have heard elsewhere, including Maine Public Radio and a certain paper carrying the name of Maine’s queen city in its banner.

In this column I will offer some insights that should help folks better understand the impacts of the proposed tax reform bill. First, let’s start with a few facts about who actually pays federal income tax:

  • The 44 percent of filers who have an AGI (Adjusted Gross Income) of less than $30k pay very little, or no, taxes.
  • The 17 percent of filers who have an AGI over $100k (“the rich”) pay 80.6 percent of the $1.7 trillion the IRS collects annually.
  • The rest of us, the 39 percent with an AGI between $30k and $100k (what I call the middle class), pay only 18 percent of taxes.

Given this taxpayer playing field, it very easy to see why the proposed tax cuts benefit “the rich.” Since the rich pay 80 percent of the taxes, it would be hard to cut taxes without benefiting those making over $100k. And, it is hard to give someone who pays nothing a tax cut!

Bottom line: When you hear “half the benefits go to the top 1 percent,” remember the top 1 percent pay almost half the taxes!

So, how about the middle class? How do we fair under the proposed tax reform? Well that depends. If you own a “second home” and have couple of big mortgages, then you very likely currently itemize. In your case, there may not be much under the tree for you this Christmas.

But for most middle class taxpayers, it will be a very merry Christmas indeed. As currently proposed, the standard deduction doubles to $12,000 per taxpayer. With this higher standard deduction, most people will no longer need to itemize, which makes filing your taxes easier. Plus, a family of four making $50,000 per year will get a tax cut well over $1,000. And a retired couple like us should do even better. Sounds good to me!

So what about the estate tax change? Or better said: The estate tax exemption doubles — so what! You know who pays the estate tax? Only very rich people with very dumb accountants. That is why the amount collected via estate taxes is tiny, well less than 1 percent of all tax revenues.

Loopholes make avoiding the estate tax ridiculously easy. The prime tools are various trusts. For example, assets placed in an irrevocable trust or a charitable trust are not counted in the estate tabulation and therefore are exempt from estate taxes. Easy-peasy.

I would be in favor of a more comprehensive reform of the estate tax. How about, the first $100k of the estate is tax free and then everyone pays 10 percent. No loopholes. But that idea is not on the table.

This brings us to the proposed tax rate on passive income and pass-through income (I know, your eyes just glazed over, but stay with me for a minute). Almost all Maine businesses are small and legally organized as type S corporations.

Type S corps do not pay taxes directly. The net income (or loss), and the attendant obligation to pay taxes, is passed through to the individual business owner(s) on a pro-rata basis. If you own 10 percent of the business, you (and the IRS) get a K-1 statement telling you how much 10 percent of that year’s profit is worth. That pass-through amount goes on your 1040 form and becomes part of your AGI, along with wages, interest, dividends, etc.

Right now, the tax on these business profits can be as high as 47.5 percent (39.6 percent federal plus 7.9 percent state). That is wrong.

Starting and owning a company is risky. Most businesses fail. When and if you have a good year, sending half your profits to the tax man is too high. Reducing the federal tax on the first half-million dollars of pass-through income to 15 percent or 20 percent makes sense to me. This will mean the very rich still pay the top rates, while small business owners get a nice Christmas present.

What about the corporate tax rate? One way to mitigate the high tax on pass-through income is to organize your business as a type C corporation. Unlike S corps, C corps pay taxes directly. The problem is, at 35 percent, our corporate tax rate is the highest in the world!

Tax the rich sounds good, but smart C corps will move to countries where the business environment is most friendly. For example, Starbucks funnels profits through its Amsterdam office. This move to the Netherlands allowed Starbucks to cut its tax burden by up to 30 million euros, paying only 2.6 million euros in corporate tax on a profit of 407 million euros, a rate of less than 1 percent.

And that’s why Apple’s foreign headquarters are in Ireland (60 percent of Apple’s profits come from sales outside the USA). Sen. John McCain recently castigated Apple as “one of the biggest tax avoiders in America.”

If we do not change our corporate tax rates, big companies and very wealthy people will continue to move their money to the land of lower taxes — count on it. Just like your rich uncle moved to Florida to avoid Maine’s income tax, corporations move to countries where taxes are low. Either we reduce our corporate tax rates or we can sit back and watch potential tax revenues and good jobs continue to move offshore.

Another complaint about the proposed tax reform is the tax cuts for individuals “expire” in five years, while the tax cuts for businesses are “permanent.” This criticism is the height of partisan spin and agenda-driven reporting. While the proposed reform lays out a 10-year plan, focusing on what might happen years from now ignores reality in favor of scoring political points.

The fact is, no law is permanent, unless it is in our Constitution (and even the Constitution has been amended 26 times!). What one Congress does, the next one can undo, modify or extend. History tells us tax laws are changed frequently and nothing is permanent. Remember, up until the passage of the 16th Amendment in 1913, there was no federal income tax at all!

Generally, Republicans want less government and lower taxes. Democrats want more government freebies and raise taxes (or borrow money) to cover their generosity. I expect this cycle to continue.

That brings me to the hand wringing that the proposed tax cuts will increase our national debt. The popular amount to wail about seems to be $1.4 trillion over 10 years — not $1.4 trillion per year as previously stated in Mr. Brower's column! (Editor's note: A correction has been issued.) The truth is our economy is very complex and no one, on either side of this issue, knows how the proposed tax cuts will work out.

Similar tax cuts have led to increased tax revenues in the past, but the factors that influence our economy are many and dynamic. Trump’s team says the tax cuts will pay for themselves. Maybe he will be proven right.

I agree it is best to prepare for the worst, so let’s examine the dire “$1.4 trillion in 10 years” forecast. Recently, the nonpartisan Congressional Budget Office said Obamacare will cost taxpayers $1.34 trillion over the coming decade, essentially the same amount as the worst case for the proposed tax reforms. Where is the outcry?

And, under Obama, our national debt grew $8 trillion in eight years! My point here is, even if the doomsayers are correct, and the tax cuts increase our debt by a $100 billion a year or so, it is far from unprecedented and, in the short term, nothing to worry about.

I say give the tax cuts a try. If, after a few years, certain elements of the reforms do not work, fix the problems.

Lastly, there is the fictional claim that the tax cuts will “gut Obamacare” (if only that were true!). The one and only thing the tax reform package will do is end the requirement that citizens must buy health insurance or pay a penalty (a special tax).

If the tax bill passes and this repeal survives, it is likely that some people will choose to stop paying for health insurance. Certainly folks who are suddenly eligible for “expanded Medicaid” will opt for that free (to them), taxpayer-funded, health insurance! And others will choose to drop Obamacare because the premiums are too high or the coverage too sparse. My Obamacare policy is a complete rip-off and the real gutting of Obamacare cannot happen soon enough for me.

All I want for Christmas in more money in my pocket. The proposed tax reforms will do that so I am all in. And, if the lower taxes on corporate profits trickle down to the middle class, that is yet another present under the tree.

Randall Poulton lives in Winterport. He writes a monthly column for The Republican Journal.

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