Trump’s proposed tax rate for “pass-through” businesses is unfair

President Trump has proposed a maximum 25% tax rate on income that individuals receive from “pass through entities”.  Pass through entities are businesses that don’t pay corporate income taxes, but rather pass their net income each year through to the owners to be taxed as part of the owners’ individual tax return.  These pass through entities include S-Corporations, partnerships, limited liability companies (LLCs), and sole proprietorships.  Currently, income from pass through entities is taxed at the same rate as any other ordinary income – up to a maximum rate of 39.5%.  (President Trump’s proposal for ordinary income for most taxpayers is a maximum tax rate of 35%.)  He justifies the lower tax rate for pass through entities because, he says, these pass through businesses are the job creators.

This begs at least two questions:  Do pass through entities really create more jobs than non-pass through entities?  Even if so, why should the income of an employer be taxed at a lower rate than an employee if they earn the same amount?  Tax fairness would dictate that two people with the same income would pay the same amount of tax, regardless of source.

Regarding job creation, it is important to know that pass through entities are not just manufacturers, wholesalers or retailers, who may or may not be job creators.  They are also professionals such as doctors, lawyers, accountants. Most hedge funds and private equity funds are pass through entities.  About 95% of all businesses are pass through entities.  Of those, about 99% have revenues of less than $10 million.  The 1% of pass through entities with revenues of more than $10 million earn about 83% of all profits!  So, some pass through entities are very large, and many owners of pass through entities have very high incomes.  Is it fair for business owners to pay at a 25% rate while regular workers with the same income pay at a 35% rate?  I don’t think so.

I expect to write several blog posts on President Trump’s tax proposal.  The idea of reducing tax rates is a good one – especially if the total plan is revenue neutral and doesn’t increase our $20 Trillion debt.  This means that tax reform that reduces rates must also reduce special tax breaks for politically favored groups and/or reduce spending.  I hope that Congress, which controls all tax legislation, will not “bet on the come” – that is assume future tax revenue will increase due to future growth in the economy.  Our government uses a 10 year look forward to determine the deficit/surplus effect of any change in taxing or spending.  In recent decades, it seems that all tax and spending changes have significant costs up front with the promise of savings toward the end the the 10 year period.  Let’s not keep doing that.

Source: https://www.brookings.edu/research/9-facts-about-pass-through-businesses/

Don’t demonize Walgreens.

Don’t demonize Walgreens for taking action to legally lower its U.S. federal income taxes.  The Des Moines Register and President Obama are wrong when they say that taking advantage of this legal tax break is unpatriotic.  As the Register reported, Walgreens can save $4 billion in federal taxes over the next 5 years by changing its corporate headquarters to Switzerland.  (See Register article: “Walgreens turns back on taxpayers” 8/3/2014)

The Register asked: “How much profit does a company need?”  “How much is enough?”  They went on to list all of the benefits that Walgreens receives by operating in the U.S. They tried to shame Walgreens for their proposed action, and effectively called for a boycott of Walgreens in protest.

The Register gave lip service to the fact that the U.S. has very high corporate tax rates compared to most other modern countries, and that tax reform is needed to close loopholes and bring down rates.  That should have been the primary message of the editorial, that we need to close loopholes and lower rates, not that Walgreens might take advantage of one.

Many companies and other taxpayers pay substantially lower their taxes by taking advantage of loopholes:  Oil and other natural resource extraction industries have their depletion allowance; hedge fund managers have their “carried interest” bonuses payments.  There are many many types of tax credits and deductions that benefit only politically favored businesses.  Many unfair loopholes go to very wealthy and profitable companies and individuals.  How does Warren Buffet pay less than 20% in federal income taxes?  Loopholes.  Why do some of the largest, wealthiest, most profitable research based companies in Iowa pay no income tax?  Loopholes.  Are all of these people and companies unpatriotic because they don’t pay more taxes than required by law?

In this case, the problem is not Walgreens or the specific loophole.  It is the high corporate income tax rates in the U.S.  The U.S. needs to significantly lower its corporate income tax rates.  Otherwise, over time, companies will actually move their headquarters to lower tax countries.  Given the inherent unfairness of special interest loopholes, and given the unconscionably high U.S. federal debt, it seems obvious that we should close as many of these loopholes as possible, and lower tax rates at the same time in a revenue neutral way.

Full disclosure:  I am a Walgreens stockholder.

Link to Register editorial:  http://www.desmoinesregister.com/story/opinion/editorials/2014/08/03/editorial-walgreens-turns-back-taxpayers/13531911/

Debt ceiling compromise.

Republicans are right to not increase the debt ceiling without some action to reduce our Country’s spending deficit.  They are not right to pick out Obamacare as the only possible target.  President Obama and the Democrats are wrong to insist that the Republican in the House of Representatives pass a “clean” debt limit expansion bill.  The compromise should be to agree on spending cuts that are not specifically related to Obamacare.  The four big drivers of the Federal budget deficit are Medicare, Medicaid, Social Security and Military spending.  Any other spending cuts, although helpful, do not really solve our long-term problem.  Republicans should propose some type of binding agreement on entitlement and military spending cuts in return for passing a debt increase bill.  The real problem to be solved is that we must stop spending beyond our means.

Food Stamp reduction is okay.

Republicans propose to reduce food stamp spending by $20 billion to $40 billion over the next 10 years.  As reported in the Des Moines Register, we currently (2012) spend about $75 billion per year, up from $ 15 billion in 2001.  The number of people receiving food stamps has gone from 17 million in 2001 to 46 million in 2012.   So, the number of people receiving food stamps has gone up 170% and the dollar amount has gone up 400%!  The $40 billion in proposed cuts over the next 10 years equals an average of $4 billion per year.  That is only a 5% cut from the current record high numbers.

Under the Republican proposal, many of those who will have their benefits cut have incomes that are too high to meet the normal food stamp guidelines.  Their states allows them to automatically qualify because they qualify for one or more other safety net programs.  Others who will have their benefits cut include able bodied individuals who fail to either work or attend job training for at least 20 hours per week.

Given the improving economy, declining unemployment, and our tremendous budget deficit, these cuts appear very reasonable.  How can we ever solve our budget deficit problems if we can’t make cuts like these?

Okay to raise taxes – to close unfair loopholes!

Uncontrolled spending is the primary cause of our federal deficit and our federal debt.  The debt we are creating for our children and grandchildren is immoral.  We must cut spending.  But, that does not mean that we should not close unfair tax loopholes, even if closing those loopholes increases tax revenues.

There are many egregious loopholes that only benefit favored special interests. “Carried interest” should be taxed a ordinary income at ordinary rates, not as capital gains at 15% – 20%.  The “oil depletion allowance” should be ended.  Interest and dividends should both be taxed as ordinary income and both should be deductible by the businesses that make the interest or dividend payments.  Capital Gains should be taxed as ordinary income after the gain has been reduced for inflation.  There are many more loopholes that are clearly unfair or that only benefit special interests.  Closing unfair tax loopholes should be a part of the solution to our deficit problem.

Go ahead with Sequestration cuts

Maybe it would be best to let the Sequestration spending cuts to take effect.  It appears that elected politicians are unable to make significant cuts to any specific federal spending items.

If cuts could be prioritized, here would be my short list in order of priority:

• The Medicare eligibility age should be coupled with Social Security and they both should be gradually moved to age 70.  The federal government should not be responsible to pay for 15 – 30 years of retirement for healthy adults.  (see below)
• Freeze the dollar amount of federal spending on Medicaid – block grant the money to the states and let States decide on the priorities.  There will always be more demand than there is supply for free medical care.
• Cut military spending, in actual dollars, by at least 5%.  Let the defense department decide on priorities to give us the best defense that the budget can buy.  We would still have greatest defense on Earth.
• Eliminate the Dept. of Education – leave education to the states entirely.
• Limit farm subsidies to $50,000 per farmer maximum, $100,000 per family maximum.  Phase out all subsidies for farmers who have a Adjusted Gross Income between $100,000 and $200,000.  Require 100% of the cost of crop insurance to be charged to the farmers.  Why do we keep paying subsidies to farmers when they have record profits?  Something is wrong.
• Cut the FEMA budget by 50%, and make States pay a 50% co-insurance payment for all federal money that flows into any State.  States would be much more efficient, and there would be much less abuse and fraud.
• Eliminate subsidies and special tax breaks for all forms of energy.  All energy producers fight to protect their subsidies by claiming that the other forms of energy get subsidies and all they want is a fair playing field.  Well, lets make the playing field very fair – no subsidies for anyone.
• Eliminate spending on arts, and humanities, public broadcasting, etc.  Contributions to these kinds of organizations should be left to charitable organizations.

I’m sure the list would be different and much larger if I took enough additional time.

According to data compiled by the Social Security Administration:

• A man reaching age 65 today can expect to live, on average, until age 83.
• A woman turning age 65 today can expect to live, on average, until age 85.

And those are just averages. About one out of every four 65-year-olds today will live past age 90, and one out of 10 will live past age 95.

Obama needs to compromise.

President Obama has built his own wall to prevent agreement to avoid the “fiscal cliff”.  There is no public outcry to raise the 35% top income tax rates on those with the highest incomes.  The outcry is against the 15% – 17% average tax rate paid by the super wealthy like Warren Buffet and Mitt Romney, not against high wage earners who pay 35% on most of their income.  If the 1% paid taxes on most of their income at the current top rate of 35%, there would be no problem.  We need eliminate special interest tax breaks.  For example, carried interest (otherwise known as bonuses for hedge fund managers) should be taxes at regular rates up to 35%, not as capital gains at 15%.  Capital gains should be taxed at 15% only if the gains were earned over a much longer period of time, say 10 years.  Currently, the 15% tax rate is applied to gains on assets held for only 1 year or more.  Eliminate the home mortgage interest deduction on second homes.  Cap the  home mortgage interest deduction to loans of up to $250,000.  There are many other special cases where income is taxed at less than the top rate of 35%.  Those are the special tax breaks that we should look at ending – not raising the top rate.

Will Iowans do their fair share?

As we work to avoid the fiscal cliff and solve our federal budget deficit problem, we need to ask what we Iowans are willing to give up.  We cannot solve our deficit problem by only increasing taxes on other people or by only cutting other people’s benefits.  Here is a partial list of federal expenditures that benefit Iowans: crop insurance subsidies, ethanol subsidies, wind power subsidies, biodiesel subsidies, Medicare, Medicaid, Social Security, National Guard installations, Silos and Smokestacks national park funding, Harkin grants, student loan subsidies, mortgage interest deductions.

Will you do your part?  What cut to your current or future benefits are you willing to accept?  If we don’t solve our deficit spending problem, sooner or later we will end up with a crisis like Greece. Contact your Senators and Representative and tell him which of your benefits you are will to have cut.

End unfair tax break: carried interest

One of the most unfair income tax breaks is the 15% tax on carried interest.  Carried interest is a profit sharing bonus that is received by private equity and hedge fund managers, and general partners in real estate limited partnerships.  Carried interest bonuses are taxed at the favorable 15% capital gains rate on the theory that the manager has his own money invested, and the bonus is part of the capital gain on that investment.  The theory is wrong.  Capital gains on money invested are divided among investors based on the amount of their investment.   To the extent that a manager is also an investor, he receives capital gains just like all other investors.  Carried interest is an additional bonus paid above and beyond any return on money invested.

For example, a hedge fund manager might get a carried interest bonus of 20% of any profits that are above a 10% return to the owners.  If the investment earns 15%, the bonus would be 20% of the extra 5%.  After payment of the bonus, the net return to the investors would be 14%.  If the manager is also an investor, he would receive the 14% return on his investment just like all other investors and would pay capital gains tax on the profit just like all the other investors.  The carried interest bonus is an extra payment based on performance.  In any other business the extra payment would be called a bonus and would be taxed as ordinary income.  The fact that the manager is also an investor should not change the bonus payment into a capital gain.

Those who receive carried interest payments will fight tooth-and-nail to keep the tax break. They might even make political contributions to those they wish to influence.  But politicians need to step back and see these payments for what they are: bonuses that should be taxed just like all other bonuses – as ordinary income.

One way to help reduce our deficit.

To solve our government spending deficit problem, we must mostly reduce spending.  But, increasing revenues by closing unfair tax breaks for politically favored businesses or individuals is a reasonable part of the solution. We do not need to raise tax rates.  We do need to make sure that all similar types of income are taxed at the same rate.

One of the unfair tax breaks is the 15% income tax rate on “carried interest.”  Hedge fund managers not only charge a fee based on a percentage of assets under management, they also may get a bonus if they are successful in their investment results for their customers.  For example, they might get a bonus of  20% of the profits, if any, when profits are taken on an investment.  Under current law, it is called carried interest and is taxed at 15%.  In any other business, they would call it a bonus and tax it as earned income – at the full income tax rates of up to 38%.  This is one of the unfair tax breaks that needs to be ended.