Policy Oct 11, 2017

Ana­lyz­ing the Trump Tax Plan

A for­mer act­ing direc­tor of the Con­gres­sion­al Bud­get Office explains the impact on the deficit, cor­po­rate tax­es, and pass-through income.

retrorocket from iStock

Based on insights from

Janice C. Eberly

Donald Marron

Pres­i­dent Trump announced his plan for tax reform last month, stir­ring a fresh debate among econ­o­mists and pol­i­cy­mak­ers. Most of the crit­i­cal details will be hashed out in Con­gress, but the plan’s broad out­line calls for sweep­ing, con­tro­ver­sial reforms, such as low­er­ing the cor­po­rate rate by 15 per­cent, cut­ting tax rates for the high­est earn­ers, and elim­i­nat­ing a host of deductions. 

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Jan Eber­ly, a pro­fes­sor of finance at the Kel­logg School and for­mer chief econ­o­mist of the U.S. Trea­sury, sat down with Don­ald Mar­ron, direc­tor of eco­nom­ic pol­i­cy ini­tia­tives at the Urban Insti­tute and for­mer act­ing direc­tor of the Con­gres­sion­al Bud­get Office, to dis­cuss what the new tax plan includes, what it doesn’t, and who may end up pay­ing more. 

This inter­view has been edit­ed for length and clar­i­ty.

Jan Eber­ly: Let’s start with the tax plan that just came out, which is more of a frame­work than a plan. What fea­tures in it do you think are most like­ly to become law, if any? 

Don­ald Mar­ron: First, I think you’re right — it’s a frame­work. Call­ing it a plan would be gen­er­ous. There’s a lot to be filled in. 

I expect, for exam­ple, that low­er­ing the cor­po­rate tax rate will be part of the final plan. But low­er­ing it to 20 per­cent, as the cur­rent frame­work pro­pos­es? It’s hard to see how you make the math work in terms of bud­getary effects. Twen­ty-five to 28 per­cent has been where most polite con­ver­sa­tion has been. 

Jan Eber­ly: Based on the desire for the reform to stay revenue-neutral? 

Don­ald Mar­ron: Rev­enue-neu­tral with an aster­isk. In Wash­ing­ton, we tend to focus on a 10- year bud­get win­dow. And there are poten­tial reforms that might increase rev­enue in the first 10 years, mak­ing it eas­i­er to achieve rev­enue neu­tral­i­ty with­in those years, but might not con­tin­ue to deliv­er mon­ey lat­er on. 

For exam­ple, there’s about two and a half tril­lion dol­lars of cor­po­rate prof­its sit­ting in for­eign bank accounts that hasn’t been taxed yet because it hasn’t been repa­tri­at­ed to the Unit­ed States. Almost any fun­da­men­tal reform would attempt to rem­e­dy this, per­haps allow­ing the tax­es to be paid over sev­er­al years. That would pro­vide a chunk of rev­enue that would help smooth the first 10 years. 

Jan Eber­ly: And what about on the per­son­al side? There’s lots of dis­cus­sion about low­er­ing the top rate from 39.6 per­cent to 35 per­cent, and rais­ing the bot­tom rate from 10 to 12 per­cent, which I think sur­prised a lot of peo­ple because it’s such a ter­ri­ble sound bite. 

Don­ald Mar­ron: Well, we cur­rent­ly have sev­en tax rates, and this pro­pos­al wants to take the sev­en and col­lapse them into three, with a top rate of 35 percent. 

There was also some inter­est­ing lan­guage in the frame­work about pos­si­bly adding a fourth tax brack­et for high­er-income folks. This idea of a fourth brack­et might be a lever for Con­gres­sion­al com­mit­tees to off­set some of the tax cuts that would oth­er­wise go to the high end. 

The chal­lenge with doing rev­enue-neu­tral tax reform is that for every win­ner, there’s a los­er. And the losers real­ly notice.” —Don­ald Marron

Jan Eber­ly: What are the oth­er ways in which tax­es are being cut at the high end? What about the issue of pass-through income”? 

Don­ald Mar­ron: Pass-through income applies to part­ner­ships, LLCs, and oth­er kinds of busi­ness­es that don’t pay tax­es direct­ly them­selves. They’re cur­rent­ly taxed at the per­son­al income rate — which is at most 35 per­cent in the new pro­pos­al. The new frame­work pro­pos­es that pass-through income be taxed at a max­i­mum rate of just 25 percent. 

Jan Eber­ly: This wouldn’t help any­one who’s not already in that high-income category. 

Don­ald Mar­ron: That’s right. In order for you to ben­e­fit from this, you have to be in a high enough tax brack­et that a max­i­mum of 25 per­cent matters. 

The net effect is that 90 per­cent of the ben­e­fits go to the peo­ple at the top of the income dis­tri­b­u­tion. It’s very, very tilted. 

And there are two oth­er big issues here. One is, what counts as busi­ness income? Draw­ing those lines dri­ves tax geeks nuts. 

The oth­er issue is, if you actu­al­ly did this, would you cre­ate a giant incen­tive for peo­ple who are cur­rent­ly salaried employ­ees to turn them­selves into LLCs? Would lots of pro­fes­sion­als LLC them­selves” and con­tract back with their cur­rent orga­ni­za­tions? How should the rules be writ­ten so that doesn’t happen? 

Jan Eber­ly: And what about at the low end? It seems like there are a lot of changes there, too. 

Don­ald Mar­ron: The pres­i­dent says he wants to dou­ble the stan­dard deduc­tion — the amount of income you can earn with­out being sub­ject to tax. How­ev­er, the plan also elim­i­nates per­son­al exemp­tions. So it’s not as though you are going to have twice as much income that isn’t taxed; I’ve seen num­bers clos­er to a 15 per­cent increase in the amount of income that isn’t taxed. But then if you earn more than that, you are start­ing off at the 12 per­cent rate rather than 10 percent. 

In addi­tion, there’s an inter­est­ing group of peo­ple who are high-income but not super high, who could see a tax increase, because they lose item­ized deduc­tions, includ­ing state and local deductions. 

Jan Eber­ly: That’s a very polit­i­cal­ly pow­er­ful constituency. 

Don­ald Mar­ron: Yes. I sus­pect they will be shap­ing what actu­al­ly comes out of Congress. 

Jan Eber­ly: The deduc­tions are inter­est­ing. One can think of elim­i­nat­ing state and local deduc­tions as a blue state” tax. But anoth­er big piece of this is deduc­tions for real estate tax­es, which are spread across states more uni­form­ly than state income tax­es. And it doesn’t look as if all the red states are going to think this is a great idea. 

Don­ald Mar­ron: Right. As you say, it isn’t just income tax­es, it’s prop­er­ty tax­es, too. And it’s worth not­ing that even in blue states, there are red dis­tricts. So in terms of build­ing a coali­tion, there are Repub­li­cans from New York and Cal­i­for­nia who may have concerns. 

Jan Eber­ly: In terms of increas­ing the deficit: What­ev­er the num­ber turns out to be — one and a half, two tril­lion — this plan paves the way for a 1.5 tril­lion dol­lar tax cut, which is far from rev­enue neu­tral. How big an issue is that? 

Don­ald Mar­ron: On our cur­rent tra­jec­to­ry, accord­ing to the Con­gres­sion­al Bud­get Office, our debt will rise from about 75 per­cent of GDP to about 90 per­cent. So we already have huge deficits fore­cast, and a tril­lion and a half dol­lar tax cut would add sig­nif­i­cant­ly to those. Even­tu­al­ly — giv­en the demands brought on by an aging pop­u­la­tion and health­care costs — we’re going to have to find more rev­enue for the Unit­ed States, rather than less. A big tax cut now would move us away from where we need to go. 

Jan Eber­ly: What changes would you pro­pose to the tax code to address the chal­lenges in the economy? 

Don­ald Mar­ron: We have this strange cor­po­rate tax code, which has a high statu­to­ry rate of 35 per­cent, and then lots of deduc­tions and excep­tions. It’s a sys­tem where being cog­nizant of tax pol­i­cy is incred­i­bly impor­tant for busi­ness­es. And that just can’t be the right sys­tem to have. What you real­ly want is a sys­tem where the cor­po­ra­tions spend most of their time think­ing about how to run good, prof­itable, social­ly respon­si­ble busi­ness­es, and spend much less time think­ing about tax. 

I also think we can remove dis­tor­tions in the code that favor cer­tain kinds of invest­ment over oth­ers. If you’re invest­ing your mon­ey in a sin­gle-fam­i­ly home, the tax code basi­cal­ly sub­si­dizes you to do that. Where­as if you’re invest­ing in a busi­ness, it varies. In gen­er­al, it would be ben­e­fi­cial to equal it out so that the tax code was more agnos­tic about an invest­ment — though you can make a good argu­ment for a tax code that encour­ages research and devel­op­ment, or dis­cour­ages some types of polluting. 

Final­ly, I think there are good argu­ments for the Earned Income Tax Cred­it, which is in essence a sub­sidy for low- and mod­er­ate-income work­ers. It has some design issues, but expand­ing the EITC would be ben­e­fi­cial for labor sup­ply and for get­ting peo­ple on the career-path ladder. 

Jan Eber­ly: Those all sound like com­mon-sense solu­tions. Why has there been so lit­tle action on tax reform, espe­cial­ly on issues that seem to gen­er­ate bipar­ti­san support? 

Don­ald Mar­ron:. It’s fun to talk about reduc­ing the cor­po­rate tax rate, and it’s fun to talk about expand­ing the EITC. But then you have to dis­cuss which tax breaks to get rid of in order to pay for these things. The chal­lenge with doing rev­enue-neu­tral tax reform is that for every win­ner, there’s a los­er. And the losers real­ly notice. 

Jan Eber­ly: Right. The 1986 tax reform is an inter­est­ing exam­ple where pol­i­cy­mak­ers kept it all behind closed doors. They didn’t want to give the losers too much input. 

Don­ald Mar­ron: It’s hard to do this stuff in sunshine. 

Jan Eber­ly: Is there any­thing you wish the broad­er pub­lic under­stood about tax reform? 

Don­ald Mar­ron: I wish there were a broad­er appre­ci­a­tion of using a car­bon tax as a way to raise rev­enue for the reforms we want to make to the tax code and also to dis­cour­age the emis­sions dri­ving cli­mate change. 

If you made pol­lut­ing expen­sive, com­pa­nies would do less of it. At the same time, it can raise rev­enue in a way that is not as harm­ful for the econ­o­my as many of the oth­er ways we raise mon­ey. I would love for car­bon tax to be a larg­er part of the conversation. 

Featured Faculty

Janice C. Eberly

John L. and Helen D. Russell Professor of Finance and Faculty Director, Kellogg Public-Private Initiative

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