Tax Reform: Target the Whales, Not the Minnows

Keith Srakocic/AP Photo

Individual income tax forms printed from the IRS website

Does anyone remember the “performance pay” loophole? This was the statute in the tax code that let corporations deduct unlimited sums of performance-based CEO pay from their taxable income. Closing the loophole was a popular rallying cry for Democrats during the 2016 election cycle, who argued that taxing businesses on their executive compensation expenditures would raise revenue and help rein in excessive CEO pay.

But 2016 came and went, and the shock of Donald Trump’s election took my attention away from incremental reforms that had seemed so promising just a few years prior.

Unsurprisingly, then, I hadn’t thought about the performance pay loophole in a while­ until it came up at a lecture I recently attended. Hearing those magic words triggered a sinking realization: I’m pretty sure Donald Trump closed the performance pay loophole. I checked, and he did. As it turns out, the 2017 Tax Cuts and Jobs Act (TCJA) was such a massive tax cut for corporations that it ended the performance pay loophole and seemingly no one noticed. Few news stories were written about the unexpected and ironic nature of the provision’s demise, and politically neither side was eager to claim victory.

Perhaps I was naïve, but the performance pay loophole’s sudden irrelevance surprised me given how much ire the loophole generated during the Obama years. Considering the contrast in magnitude between Republican tax reform and some opposing tax reform ideas on the left provides a useful scale by which to reassess the relative importance of small, narrowly targeted tax breaks. As much as they benefit corporations and the wealthy, in the grand scheme of the U.S. tax code, do loopholes really matter? The answer I have arrived at is “No.”

Compared to the massive rate cuts of the TCJA, the dollar figures it represented meant so little that it simply vanished from collective memory. In raw dollar amounts, loopholes rarely represent enough value to raise substantial revenue or meaningfully shift behavior. In the most optimistic of estimates, ending the CEO pay loophole was projected to raise $5 billion in annual revenue, while estimates by the Joint Committee on Taxation placed the figure under $1 billion per year.

Compare that to the preferential treatment of capital gains and you’ll find a tax preference worth almost 25 times more, with 68 percent of its $160 billion going to the top 1 percent every year. Taxing CEO compensation expenditures is undoubtedly better than not taxing them, but the revenue is a drop in the bucket and no one seriously anticipates this minimal tax hit will cause corporations to meaningfully scale back CEO pay.

Likewise, during the 2012 cycle, President Obama championed closing a loophole that effectively subsidized the purchase of corporate jets. It was good politics, but the math didn’t add up to the messaging: Closing the jet tax loophole was projected to raise just $2 billion over 10 years. For comparison, Hillary Clinton’s 2016 proposal to return the estate tax to its 2009 levels was projected to raise more than $400 billion. Notably, another small private-jet provision became the source of media coverage during debates over the TCJA, illustrating the outsized cachet these provisions often carry.

As unpalatable as CEO tax breaks and private-jet subsidies might be to egalitarian sensibilities, policymakers and voters should be discerning about their actual impact; often, loopholes are targeted as a nod toward economic equality or populism, but lack the economic significance to meaningfully deliver on such an agenda.

Stitching loopholes closed is messy and often ends up favoring wealthier taxpayers with highly paid tax lawyers who are able to shift income into other protected areas. Accountants describe this as the loophole cycle: Tax professionals design a scheme to reduce tax liabilities for their clients, government actors create a patch to stop them, and the process repeats.

As Tax Policy Center analysts suggested to Hillary Clinton during the 2016 cycle, bold and direct attempts to raise rates on the rich, such as her proposal on estate taxes, are a far more effective approach to revenue generation than the numerous loophole closures and housekeeping measures included in her 2016 platform.

Americans seem to agree. For the last several years, news outlets including Politico and Reuters have estimated public support for higher taxes on the wealthy at around 75 percent. Since 1992, Gallup has consistently found that the vast majority of Americans believe that the rich pay too little in taxes. Even more extreme plans, like Alexandria Ocasio-Cortez’s 70 percent tax rate on incomes over $10 million, found 60 percent support in a recent poll by The Hill. I’m not always one for polling data, but that’s a pretty consistent finding and a pretty high percentage.

And yet, looking to 2020, a majority of Democratic candidates are already shaping their platforms around more gimmicky, targeted policies. Cory Booker has spent much of his time on the campaign trail trumpeting the promise of another TCJA policy—“Opportunity Zones” grant a tax preference for income earned on investment in economically distressed communities.

It’s a worthwhile goal, but neither the creation nor destruction of tax loopholes is an efficient means of affecting change. Analysts at the Tax Policy Center have been critical of the plan, including it on their “Lump of Coal Awards” for the worst tax policy ideas of 2018, and pointing out that the program’s benefits will be minuscule compared to its costs, with much of the difference likely ending up in the pockets of wealthy development firms.

Of the leading Democratic presidential candidates, only Elizabeth Warren and Bernie Sanders have come out swinging for substantial tax increases on the rich. The simple and obvious truth is this: For the last 70 years, both parties have broadly conspired to lower taxes. The Republicans often led the charge, but Democrats pushed back with suspicious frailty, and often on rather insubstantial targets.

As a result, much of what we have in the tax code is really just what we have left. Democrats who believe that social priorities are worth spending on would be fools not to seize this moment and fight for more. 

The performance pay loophole struck a special chord with me because, as a research assistant at a progressive economic-policy think tank, I typed the phrase into more bulleted lists of policy solutions than any human being rightfully should. If you had asked me in 2015 what specific provisions of the tax code I hoped a presidential candidate would address, performance pay would have certainly made the top three. But in 2019, if Democrats want to craft meaningful proposals to combat inequality and raise revenue for underfunded social priorities like infrastructure, education, and health care, then an appreciable hike in top income tax rates, as well as more aggressive taxation of wealth, inheritance, and capital income would be far more efficient and fruitful.

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