A New Republican Idea: Raising Taxes on the Rich

What a crazy day for Republican Presidential candidates as related to their tax positions!! Donald Trump wants to raise taxes on the wealthy and Kasich (the supposed mainstream candidate) still thinks that you can grow the economy through spending cuts!

For now, I will just discuss Donald Trump truly anti-establishment position. He appeared in a town hall meeting on the Today show this morning. During the segment Savannah Guthrie asked Mr. Trump if he believes that taxes should be raised on the wealthy (see about 16:52 of the clip). He said he does, including on himself. That must have been a shock to the Republican base!

Mr. Trump’s bombshell is a window into the main idea I discussed in my introductory post. There is a “huuuuge” difference between the absolute rates and effective rates. This problem is very evident in the corporate tax world.  However, Mr. Trump’s statement shows it is just as prevalent with individual taxes.

Almost everyone (other than tax professors), especially the candidates (including Trump here), discuss taxes as related to absolute rates and not effective rates. For example, we can make the stated tax rate 75% or 90%. This stated rate means very little because that rate is applied to an adjusted gross income number. What really matters is how adjusted gross income is determined.  Rates do matter, but only if gross income and adjusted gross income are fairly similar (I’m look at you middle America).

To explain this let’s use an example.  Assume Mr. Trump’s gross income is $100, we do not take a rate (let’s use 40%) and multiply that by the $100 for $40 in tax due. We first allow a series of above-the-line (non-phased out) deductions to that gross income. In Mr. Trump’s case, this allows him to reduce his income to zero. Richard Rubin of the Wall Street Journal has done a great job writing about how Mr. Trump has reduced his taxes (to what number we don’t know since he will not release his returns).  From Rubin’s research, Mr. Trump uses from the usual, depreciation deductions, to the unusual, goat herds.  Even if Mr. Trump wanted to raising his stated rate to 100%, it would not matter; his effective tax rate might still be zero.  100% of zero is zero (for those math geeks, the formula is: 100% * 0 =0)

I know that it is easier to talk about taxes absolute terms rather than the more nuanced approach that I want.  But by ignoring the nuance, the second order problems remain unexamined.  For example, which group benefits from the ability to lower rates through above-the-line deductions?  Only those who have large losses (or deductions) from business. Yep, business owners that receive K-1s (e.g., Mr. Trump).  That is not the average mom and pop nor the average employee.  A basic W-2 employee gross income is fairly well correlated with the adjusted gross income.

This disconnect is pervasive in the discussion of taxes.  For example, in the article I just wrote for Forbes on Elizabeth Warren’s tax simplification plan, I mention this same phenomenon as related to the impact of that program.

Raising Mr. Trump’s rate is feckless unless it is tied to meaningful reforms related to the deductions. If the goal is to make everyone bear a greater responsibility for the cost of running the country, raising rates alone will have a disproportionate effect on wage earners. The disconnect between the rate and the number that the rate is applied (e.g., the AGI) stops meaningful discussion of the issue.  Maybe that is the goal, but I don’t think so.

Is it too “ivory tower” to want a full discussion of rates?  Would it really have been that hard for Matt Lauer to follow-up Mr. Trumps answer with, “Really, Donald?  Your rate or the amount you pay in taxes?”

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