Tax Analysts Blog

Trump’s Tax Plan: Version 2.0

Posted on Aug 12, 2016

That Donald Trump revised his tax reform plan came as no surprise. His campaign had been hinting for several weeks that a partial rewrite was in the works. The presumed objectives of the revision were threefold, and it’s useful to keep these goals in mind when evaluating the details of his plan.

First, Trump needed to find some additional revenue raisers. That’s because the overall price tag of his original plan was too high. The tax provisions were projected to cost around $9.25 trillion over a 10-year budget window. That’s considered extravagant by budget hawks within the GOP ranks. Trump was able to overlook their objections during the primaries, when the larger concern was being perceived as the biggest tax-cutter in the race. With those rivals now dispatched, Trump can shift gears and think about how much his plan costs. Nobody expected his revised plan to be revenue neutral, but some concession to fiscal responsibility (however modest) was viewed as practical necessity.

Second, Trump needed to add some supply-side juice. Conservatives argue that not all tax cuts carry equivalent merit; those which stimulate investment and capital formation are generally preferable to those which do not. Indeed, many Republicans view the pursuit of positive growth effects to be the very reason tax reform is desirable in the first place -- as distinguished from progressives, who are generally more concerned with redistributive economics. (The centrist approach to tax reform would couple these priorities, although striking that balance is much easier said than done.)

Third, Trump wanted to reduce taxes on middle-class households. This follows the populist theme that served him well during the primaries. It also plays into his strategy of winning over devotees of former Democratic candidate Bernie Sanders. After all, it’s difficult to imagine Trump prevailing in November unless he makes major inroads with disgruntled blue-collar voters from swing states like Ohio, Pennsylvania, and Michigan. Note that Trump unveiled his revised tax plan at the Detroit Economic Club. Nothing screams Rust Belt like Motown. (The running joke in our office involves the fact that Detroit still has an economic club!)

The problem for Trump is that catering to each of these policy priorities is an awkward dance. Accentuating any one of three goals seems to diminish progress toward the other two. This difficulty is inherent to fundamental tax reform; it is not unique to this candidate or his distinctive mannerisms. I fully expect the presidential candidates in 2020 to grapple with these same issues. With that in mind, let’s examine the Trump tax plan, version 2.0.

1.      Trimming the Price Tag

Initially Trump had three brackets, with marginal rates of 10, 20, and 25 percent. The revised plan bumps those rates to 12, 25, and 33 percent. Conveniently, the new rates match those in the recently released GOP blueprint. The rate structure is slightly more progressive but still much flatter than current law, which has seven income brackets and a top rate of 39.6 percent.

As a practical matter, Trump’s plan features a sizable tax-free bracket. He wants to quadruple the standard deduction (currently $6,300) to $25,000 for single filers and $50,000 for joint filers. As a result, about half the population wouldn’t pay income tax. The GOP blueprint also broadens the standard deduction, but is far less generous. It would only double it, to $12,000 for single filers and $24,000 for joint filers.

CNBC television personality Larry Kudlow, an informal adviser to the Trump campaign, estimates the revised plan now costs only $3 trillion over 10 years. That’s down considerably from $9.5 trillion, but still a far cry from being revenue neutral. It is unclear what assumptions Kudlow’s estimate is based on, or the extent to which it relies on hopeful predictions about future economic growth. Neither the Tax Foundation nor the Urban-Brookings Tax Policy Center have produced revenue estimates for Trump’s revised plan, citing insufficient information.

Trump could have squeezed much more revenue out of his plan without altering the marginal rates. That could have been easily accomplished by scaling back on the zero bracket, say, by mimicking the parallel provision from the GOP blueprint. You’d think the blueprint would give Trump adequate political cover against possible criticism. But any retreat on the zero bracket -- even a partial one -- cuts against efforts to provide middle-class tax relief.

2.      Promoting Economic Growth

It’s widely agreed the U.S. corporate rate is too high. Obviously we’re talking here about the statutory rate (35 percent), which often bears little resemblance to a firm’s effective tax rate. That said, even President Obama agrees that the corporate rate should be reduced.

Trump would lower the corporate rate to 15 percent. That’s well below the OECD average, which lies somewhere in the mid-twenties. Only Ireland (12.5 percent) would have a lower rate among OECD member states. Significantly, Trump would not limit the rate to C corporations. His plan extends it to all business enterprises including partnerships, LLCs, and S corporations.

Trump’s revised plan keeps the 15 percent rate but goes one step further. It allows for full expensing of business investments. That differs sharply from current law, under which cost recovery is dragged out over a commercial asset’s useful life. Economists generally agree that immediate expensing is likely to fuel growth because it lowers the marginal after-tax cost of new investment to zero. For those seeking positive growth effects from tax reform, expensing is a big deal – possibly more important than reducing the statutory rate. Viewed in isolation, expensing has considerable merit. The downside is that it adds to the overall cost of tax reform, cutting against one of the other stated objectives.

One interesting feature of Trump’s tax plan is the elimination of deferral. Currently, the tax code generally delays imposing corporate tax on foreign-source profits until they’re repatriated from overseas affiliates. Repatriation might not occur until many years after the income was earned. This accounts for the lockout effect. By indefinitely delaying inbound dividends, firms can effectively avoid residual U.S. tax on foreign profits. Trump wants to kill deferral and tax foreign profits on a current-year basis, just like domestic profits. That would be a monumental change.

What’s odd here is the apparent disregard Trump shows for the wishes of the business community. He eliminates the lockout effect, but not in the way multinational corporations want. As a general rule, the business lobby detests accrual method taxation. Their strong preference is for a territorial regime in which foreign profits are excluded from the tax base altogether. This is the approach adopted by the GOP blueprint. It’s strange how Trump delivers such a significant rate cut for the business sector -- then adds to it with full expensing -- but sticks to his guns on ending deferral.

Another much-discussed feature of Trump’s tax reforms is the rate differential between business and personal income. Nothing in the revised version of the plan would change that. With business earnings taxed at a maximum of 15 percent, and personal income subject to a maximum rate of 33 percent, one might expect workers to incorporate themselves (say as an S-corporation or an LLC) to take advantage of the lower rates.

By way of an example, a highly compensated partner in a law firm would be taxed at only 15 percent on her allocable share of partnership profits, while that partner’s secretary could be taxed at a much higher rate on her own salary – unless the secretary converts to an LLC and likewise benefits from the 15 percent rate. Trump is clear that the business rate would apply to freelancers. That’s an odd way to address the Buffett rule or the carried interest problem: Give everybody the discounted rate, provided they incorporate themselves. The message seems to be that wage income is for suckers.

3.      Middle-Class Tax Cuts

Few observers were expecting Trump’s third revision: an expanded tax break for child care expenses. According to Stephen Moore of the Tax Foundation, another advisor to the Trump Campaign, the change was aimed at helping middle-class families who struggle with affordable child care.

The tax code currently provides similar benefits, but their scope is limited. There’s an income exclusion for the value of employer-provided child care, but relatively few employers across the country offer such programs. There’s also a child and dependent care tax credit, but it’s nonrefundable.

It’s unclear what form Trump’s new tax break would take. His speech in Detroit suggested it would be a deduction, but other statements from his campaign hint that it could be an exclusion or a credit. Such details may seem mundane, but they have a large influence on how many families would be able to benefit from the tax break.

If delivered as a deduction, it wouldn’t be particularly useful to a family that’s already in the zero bracket due to the expanded standard deduction. In that case the deduction would largely miss the poor and the middle-class and instead benefit more affluent families. (Remember, the economic value of a deduction increases proportionally with the taxpayer’s marginal tax rate.)

That calculus changes, however, if Trump’s new deduction were applied to payroll taxes -- as distinct from personal income taxes. The New York Times recently reported that the deduction could offset up to one-half of a parent’s payroll taxes. If that were the case, the tax benefit would succeed in reaching millions of households in the zero bracket. Such a move, however, could have adverse ripple effects. Any large decline in payroll tax receipts would contribute to the funding crisis faced by those government programs which depend on such funding.

Such are the trade-offs inherent in tax reform.  

Read Comments (1)

Mike55Aug 17, 2016

"It’s strange how Trump delivers such a significant rate cut for the business sector -- then adds to it with full expensing -- but sticks to his guns on ending deferral."

It actually makes a ton of sense when you think about it. Most people think full expensing creates growth/jobs. Some people think a rate cut creates growth/jobs. Nobody thinks deferral creates growth/jobs. Trump claims he will be the growth/jobs president, so this makes sense.

The lobbying pitch for deferral is that it enhances the "competitiveness" of U.S. multinationals, it's not sold the way other tax benefits are. But Trump plans to resolve any U.S. competitiveness concerns via sweetheart trade deals he expects to negotiate through sheer force of will, or hiring Carl Ichan, or something like that. Once he does that any competitiveness concern is resolved, so why would we need deferral?

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