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