Albin Lohr-Jones/Sipa USA via AP Images
This article appears in the Summer 2018 issue of The American Prospect magazine. Subscribe here.
Despite a full-court charm offensive by the White House, its media surrogates, and big corporations that benefit most from the 2017 Republican Tax Act, the public stubbornly sees the truth: that President Trump's tax bill was designed for big, profitable corporations and the wealthiest Americans.
Two “big lies” drove the Trump tax cuts—the claims that corporate taxes were especially high, and that the president's tax overhaul would be geared toward the middle class. The development of the Trump tax plan was the embodiment of the man himself: a moving target, vaguely defined, constantly changing, and sometimes reversing itself abruptly.
In 2015, then–presidential candidate Donald Trump declared “tax reform” a central plank of his campaign platform, making a number of claims that subsequently fell by the wayside. For example, he said his plan would take 75 million Americans off the income tax rolls without adding a dime to federal deficits. Later in his campaign and after taking office, Trump released more iterations of his tax plan, including one on a single, double-spaced page. While details about individuals' taxes changed over time, his desire to reduce the corporate tax rate to the lowest in the developed world remained constant.
The Big Prize: Corporate Rate Cuts
Cutting the corporate rate has been a Republican talking point for decades. But this push has always been built on the inaccurate assertion that our corporate taxes are among the highest in the world. Until January 1 of this year, the federal corporate income tax topped out at 35 percent on paper, a rate higher than statutory rates imposed by other Organization for Economic Co-operation and Development (OECD) nations. But due to copious loopholes in the federal tax code, many corporations paid significantly less.
Our corporate tax rules allow many of the biggest companies to shelter much of their income from tax. As a result, even though our statutory federal tax rate until recently was higher than most other nations', corporate tax collections as a share of the U.S. economy have generally been below the OECD average.
A series of detailed studies by my organization, the Institute on Taxation and Economic Policy (ITEP), show that the biggest and most profitable corporations have, as a group, been able to shelter nearly half of their profits from tax. Our most recent study showed that between 2008 and 2015, 258 consistently profitable Fortune 500 corporations paid an average effective tax rate of 21.2 percent, and 100 of these companies avoided paying even a dime of federal income taxes in at least one profitable year during this eight-year period.
Further, more than half of big, profitable multinationals paid a lower foreign tax rate on their foreign profits than the U.S. rate they paid on their domestic profits.
For clear-eyed observers, the diagnosis for this dual ailment—an above-average nominal tax rate, and a below-average effective tax rate—has always been clear. Get rid of the giveaways for industries and companies with lobbying muscle.
The tax code is laden with tax breaks as targeted as the “NASCAR tax break,” which allows owners of racetracks to write off the cost of renovations faster than they wear out, and as overbroad as the research and experimentation tax credit, which routinely rewards companies for making investments they would likely have made anyway. There are internally inconsistent tax breaks that nominally encourage both the development of fossil fuels and the exploration of alternative energy sources. And the tax code includes utterly ineffective provisions, such as the accelerated depreciation tax break that allows companies to write off their capital investments faster than these investments wear out.
The first sensible step toward true corporate tax reform must be to conduct a ruthless audit of these corporate giveaways and weed out loopholes, no matter how politically fraught the process may be.
Unfortunately, the Trump administration chose to take the easy route by cutting the statutory rate and leaving in place most loopholes that allow corporations to reduce their effective tax rate. This certainly wasn't for lack of a target-rich environment. The accelerated depreciation tax break alone, for example, could have been the basis for a program of rate reduction. This deduction is supposed to incentivize economic development but instead has primarily rewarded companies for making investments they had been planning all along. The Tax Act, on balance, gives big corporations even more latitude to avoid paying income taxes than they had before.
The war over corporate tax reform has a second front: the treatment of foreign income. Big multinationals have shifted trillions of dollars out of the United States and into foreign tax havens, emboldened by a provision of the old tax law that allowed companies to indefinitely postpone taxes on their allegedly foreign profits until those profits are repatriated, or brought back to the Unites States. In many cases, the foreign destination of these profits is an accounting fiction. In 2012, the most recent year for which data are available, U.S. multinationals reported that 59 percent of their subsidiaries' foreign profits were earned in ten small tax-haven countries, including Bermuda and the Cayman Islands. In some cases, they reported profits in these countries that exceeded the nations' entire GDP, a clearly impossible feat.
Here as well, the sensible policy solution is ending deferral and requiring companies to immediately pay a residual U.S. tax on income shipped abroad, taking away the incentive for companies to park their profits offshore. Instead, the Trump administration shifted to a territorial tax system, under which income moved abroad will be largely outside the reach of the U.S. tax system. While the new law creates “guardrails” designed to prevent abuse of this new frontier of tax avoidance, these provisions are complex and untested, and now are in the hands of an agency, the Internal Revenue Service (IRS), that has seen its ability to enforce existing laws hamstrung by a decade of budget cuts.
Personal Income Tax: Giving with One Hand, Taking with the Other
While the Trump administration has always prioritized corporate tax cuts, the president has told the public a very different story. The White House and its allies insisted the tax overhaul would cut taxes for middle-income families and increase them on the rich—including the president himself. Last November, Trump told a Missouri audience that this “is going to cost me a fortune, this thing, believe me,” and repeatedly claimed more generally that the “rich will not be gaining at all with this plan.” House Speaker Paul Ryan claimed that the plan would be built around middle-class concerns: people “who are low- and middle-income, they're the ones who are literally living paycheck to paycheck, who are worried about losing their job or they haven't gotten a raise in years. This is about them and not about people who are really high-income earners getting a break.”
These claims contain a half-truth and a proven falsehood. In the short run, the new tax law will provide some tax cuts to many American families. Over the plan's first five years, between 2018 and 2023, close to 75 percent of the new law's tax cuts ($740 billion out of $1.07 trillion) will go to individuals, not corporations. The plan shaves a few percentage points off all rates except the bottom, which remains 10 percent. More salient for middle-income Americans are a big boost in the standard deduction, from $13,000 to $24,000 for married couples, and a doubling of the credit most families get for each school-age child, from $1,000 to $2,000.
But what the Tax Act gives middle-income families with one hand, it takes away with the other. The new law repeals personal and dependent exemptions, increasing taxable income for a family of four by $16,600 in 2018. Many itemized deductions are pared back substantially: the deduction for state and local taxes (SALT) is capped at $10,000; the mortgage interest deduction is capped; and deductions for casualty and theft losses, employee business expenses, and union dues are eliminated outright. Deductions for moving expenses, tuition and fees, and alimony payments are also repealed.
So even in the short run, the tax swap offered to middle-income families—bigger standard deductions in exchange for lost exemptions and itemized deductions—makes the president's middle-class-tax-cut claims an empty promise. Some families stressed by high housing costs in higher-tax, blue states like California and New York will likely see a federal income tax increase as soon as this tax year, thanks to the tax bill's sharp reduction in the itemized deduction for state and local taxes.
But the best-off Americans generally don't face the same trade-offs. For the wealthy, the deal is sweetened with a trio of tax breaks that are largely irrelevant to working families: a deduction for “pass-through” business income, estate tax cuts, and a sharply weakened alternative minimum tax.
Most businesses in America now operate as pass-through entities, which are not required to pay taxes as entities on their income, but instead pass their profits through to their owners, who individually pay income taxes on their share of the profits. The Tax Act creates a new deduction for 20 percent of “qualified business income” of these pass-through businesses. This provision has never been tested at the federal level, but has been well-documented as an utter failure as a state tax reform. A similar tax cut, pushed through by Kansas Governor Sam Brownback in 2012, had no discernible effect on the state's economic growth, but did major damage to the budget, forcing Brownback to eventually accept the repeal of the pass-through break. By all accounts, the main effect of the Kansas experiment was to encourage enterprising Kansans, including University of Kansas basketball coach Bill Self, to start their own sham pass-through businesses so that they could restructure their wages as business income, eligible for the tax break.
Incredibly, the federal tax law now includes a provision with the same harmful tax avoidance incentives, but also adds more tax-dodging opportunities for unscrupulous businesses. The new law weakens the alternative minimum tax (AMT), a backstop tax designed to ensure affluent taxpayers cannot use tax breaks to zero out their tax obligation, by increasing the amount of income exempt from the tax.
Ensuring the wealthy keep more of the riches they will accrue as a result of the new tax law, the Tax Act also dramatically increases the estate tax exemption. As though exempting 99.8 percent of estates from tax weren't enough, the tax law doubled the estate tax exemption for married couples from $11 million to $22 million in 2018.
On balance, these tax changes reshape our tax system in a way that bears no resemblance to the president's promises, but rather in a way that seems tailor-made to benefit Trump personally. Far from validating Treasury Secretary Steven Mnuchin's claim that Trump's tax would result in no “absolute tax cut for the upper class,” the new law reserves the biggest tax cuts, by any measure, to the wealthiest few. The top 1 percent of Americans will see, on average, a tax cut equaling 2.7 percent of their income in 2018. The next richest 4 percent will enjoy an even larger tax cut, averaging 3.5 percent of income. Middle-income Americans will see a 2018 tax cut about half as large, as a share of income, at 1.5 percent.
Short-Term Tax Cut, Long-Term Tax Shift
If President Trump's middle-class tax cuts are a complicated mix of cuts and increases in the short run, the longer-term picture is quite clear: Trump will increase personal income taxes on just about everyone. After 2025, when every last one of the new law's tax cuts for individuals will expire, the only remaining effect of the Tax Act on working families will be an across-the-board tax increase, thanks to the new law's (permanent) adoption of a less-generous measure of inflation. Each of the tax breaks middle-income families rely on, from exemptions to deductions, will gradually lose their value over time. And when taxpayers file their 2026 income tax returns, they'll be paying hundreds of dollars more than they would have if Trump's plans hadn't been enacted. Needless to say, the corporate tax cuts in the new law have a much longer shelf life. Virtually all of the corporate cuts are permanent.
This double standard—a temporary visa for the individual tax cuts, and permanent residency for corporate breaks—is the product of a hard fiscal reality: Republican tax writers were unable to convince congressional revenue estimators that their tax cuts would pay for themselves. After a congressional budget resolution defined the upper bounds on this tax cut—$1.5 trillion over ten years—lawmakers immediately set about finding a way to squeeze as much tax-cutting as possible into their $1.5 trillion box. Their solution is sacrificing every last dime of the tax cuts for families, in the long run, to achieve permanent tax cuts for big corporations. The individual-side tax cuts are all set to expire at the end of 2025, leaving only huge corporate reductions as the permanent legacy of Trump's tax-cutting ambitions. Congress cannot remedy this problem without either scrapping the law and starting from scratch or blowing a bigger hole in the federal budget.
This double standard does not mean, however, that we should make the individual cuts permanent, as many Republicans have suggested. The fact is that even the individual cuts are on balance regressive, as well as a pretext for spending cuts to defray the cost of enlarged deficits.
These temporary individual provisions are sometimes called the “middle-class” tax cuts, but most of their benefits actually go to the rich: a cut in the estate tax, the new deduction for businesses that are mostly owned by the richest 1 percent, and cuts in the top income tax rate, to name a few.
An ITEP analysis zeroed in on these temporary provisions and examined what would happen if Congress extended them at least through 2026. It found that 65 percent of the benefits of that extension would go to the richest fifth of Americans. This is nearly as unfair as the current law, which provides 71 percent of its benefits to the richest fifth of Americans in 2018. In other words, anyone who opposed the Tax Act should not be deluded into thinking that the temporary provisions are the “good” parts of the law and therefore should be made permanent. What makes far more sense is for the next Congress to start from scratch and think about enacting a genuine tax reform.
Hastily passed and sloppily assembled, the Tax Act seems likely to spur growth only in one area of the economy: the tax-planning industry, for whom the new law resembles a full-employment guarantee.
But there's a path forward that is even more apparent in light of the new law's flaws. The next Congress should do what President Trump claimed he would: root out the many tax breaks available only to the wealthy and to big multinationals, making it so that middle-income families and small businesses can operate on a level playing field. Ending the experiments with a territorial tax system and pass-through tax breaks, achieving permanent reforms on the individual side so that families can have stable expectations about how vital services will be paid for, and creating a simpler tax code are all attainable goals. And each can be meaningfully advanced by dismantling the Trump tax law.
