“This is quite an historic day for us . . . We have a once-in-a-generation opportunity to do something really big," Gary Cohn, the former president of Goldman Sachs, who now serves as President Trump's top economic adviser, told reporters at the White House on Wednesday. Trump's desire to reform the U.S. tax code is big—clearly—but the actual plan, which Cohn and Treasury Secretary Steven Mnuchin unveiled at the press conference, was nothing more than a sketch. And even as the details remain to be filled out, there’s much reason to doubt the plan’s viability in Congress. Still, Cohn and Mnuchin confirmed a couple of important things about this Administration’s approach and intentions when it comes to taxes.
The first is that Trump wants to give himself a big tax break, and not just by slashing the tax rates that high earners and business owners face. Thanks to a leaked tax filing, one thing we know about Trump's tax history is that in 2005 he paid the federal government thirty-eight million dollars on income of about a hundred and fifty million dollars. But, because Trump had so many deductions, and exploited so many loopholes, his initial tax liability that year was much lower: $5.3 million. The only reason he ended up paying thirty-eight million is that he got caught by the Alternative Minimum Tax (A.M.T.)—a fallback mechanism that the Internal Revenue Service uses to prevent people like him from paying too little.
If Trump's plan goes into effect, the A.M.T. will be eliminated. Why? Mnuchin's explanation was that the tax code is too complex. "The A.M.T. is just another example of a … complicated set of rules," he said. If Trump gets his way, he and other rich people won't have to worry about the A.M.T. With the help of their accountants, they will be able to minimize their tax exposures in the knowledge that the I.R.S. won’t be able to undo their handiwork.
Cohn and Mnuchin also confirmed that Trump wants to blow up the personal-income side of the tax code. They didn't present it like that, of course. Trump’s proposal would cut the tax rate for large corporations from thirty-five per cent to fifteen per cent. Stressing that Trump wanted to help out small-business owners, too, Cohn and Mnuchin explained that the President’s plan would also slash the tax rate for owners of so-called "pass-through" businesses—such as sole proprietorships, S Corporations, and L.L.C.s—to the same fifteen per cent.
To people unfamiliar with the tax code, this proposal may sound reasonable. Why shouldn't a restaurant owner or building contractor who employs fifty or sixty people pay the same tax rate as Walmart, or, indeed as Goldman Sachs?
Those who stand to benefit the most from Trump's proposal, however, aren’t local businesses or owners of mom-and-pop stores—they are hedge-fund managers, private-equity moguls, real-estate investors, and other wealthy groups that organize their businesses in "pass through" partnerships specifically to take advantage of the tax code. “About half of all pass-through income flows to the top 1 percent of households (those with incomes above $693,500 in 2016),”_ _the Center on Budget and Policy Priorities said in a February report. “About 27 percent goes to the bottom 90 percent of households.”
Under the current system, high earners are obliged to pay the top rate of federal income tax—currently 39.6 per cent—on any pass-through income they receive. Cutting the rate to fifteen percent, as Trump recommends, would present them with a huge tax cut. How huge? Last year, the nonpartisan Tax Policy Center estimated that introducing a flat rate of fifteen per cent on pass-through income would reduce tax revenues by about nine hundred billion dollars over ten years. In the absence of other revenue enhancers, which are sorely lacking in Trump's plan—which is financed by issuing more debt—the burden of this tax cut would fall on future taxpayers.
There's another big problem. In setting the top rate of income tax at thirty-five per cent and the rate on pass-through income at fifteen per cent, the Trump reform would give high-income earners a great incentive to reclassify themselves as small-business owners, so they would be eligible for the lower rate. Take a senior corporate lawyer with taxable income of five hundred thousand dollars a year after deductions. As an employee, her tax liability would be a hundred and seventy-five thousand dollars. But if she reclassified herself as the sole-proprietor of a legal-consulting company, the liability would be seventy-five thousand dollars. She would save a hundred thousand dollars.
When you think about Trump’s proposal, the possibilities for tax avoidance can seem limitless. "I could form a consulting company and sell my services to the Urban Institute," Joseph Rosenberg, a senior research associate at the Tax Policy Center, which is a joint venture of the Urban Institute and the Brookings Institution, told me. "There are going to be a lot of people who would figure out that they can pay a lot less tax if they can be classified as self-employed."
The potential effect on the over-all tax system, which is heavily dependent on contributions from high earners, is alarming. In their analysis of Trump's campaign tax plan, Rosenberg and his colleagues estimated that people shifting wages and salaries to business income would reduce over-all tax revenues by another six hundred and fifty billion dollars over ten years. But Rosenberg acknowledged there was a great deal of uncertainty. “A lot depends on what is done to police that boundary" between salary income and business income, he said. "And a lot of this stuff is fairly arbitrary.”
At the White House press conference, Mnuchin acknowledged there could be a problem. But he downplayed it, saying it would be resolved in the detailed framing of the tax plan, which could take months. “We will make sure that there are rules in place so that wealthy people can't create pass-throughs and use that as a mechanism to avoid paying the tax rate that they should be on the personal side," he said. For some reason, it didn't sound entirely reassuring.