Not all 15 percent tax rates are the same

My last post on the 500-word scrawling that has amusingly been called Trump's tax "plan" was quite critical of the proposed 15 percent rate for "business" income, which potentially includes any income that one can contrive to have paid to a business entity (including any state-law entity such as an LLC of which you own 100%), rather than directly to oneself as a wage. I noted that, in practice, this is likely to result in an upside-down rate structure in which rich people commonly pay 15% while their employees pay tax at higher rates. And I noted that it in effect penalizes being an employee who gets paid a salary directly, as if this were a crime that needed to be punished or at least discouraged.

But some readers may have asked: What about the capital gains rate? It was 15% for a while, although it's 20% now. Is the proposed 15% business rate worse than that?

The answer is very clearly Yes. Now, there are some cases in which the 15% capital gains rate works exactly the same way as the "business rate" would - allowing high-earnerrs who have flexibility over cash flow, are well-advised, etc., to get the same result as above. Hedge fund managers can often do this, and it underlies the "carried interest" controversy.

But it's harder to do the capital gains trick than it would be to take advantage of the small business loophole. So less people are able to do it. Plus, there's a whole lot of other stuff mixed in to the capital gains category that has a case for more favorable treatment,

Depending on the particular facts, complicating issues may include the following:

--Capital gain on selling corporate stock gives rise to double taxation if the income is taxed at the corporate level - sometimes a big if.

--There may be nominal inflationary gain mixed in.

--To the extent that capital gain merely reflects earning the normal rate of return on capital, there are arguments for taxing it at a lower rate than that which is economically labor income or rents.

--The capital gains tax is to some extent, and in many cases, a voluntary tax. Hence, the Laffer curve can actually kick in at politically conceivable tax rate levels (e.g., by the time the rate gets into the 30s). This problem is greatly exacerbated by the tax-free step-up in basis for appreciated assets at death, which means the tax can be permanently avoided, rather than merely being deferred. That rule ought to be fixed, but as long as it isn't it constrains how high the capital gains rate should be.

This is not necessarily to defend a 15% or even 20% capital gains rate, especially if we have options at hand beyond just raising the rate, designed (for example) to reduce the feasibility of shoving labor income into the capital gains basket.

But at least we are in the realm of complicated issues and policy tradeoffs - which is not the case with respect to a general 15% "business rate."

It's true that, if we enact a significantly lower corporate rate, it's important to think about the corporate versus non-corporate business tax rate relationship. But (a) the corporate tax is to a degree, albeit imperfectly, more about globally mobile capital than the "business tax," (b) the response should focus on limiting use of the corporation as a tax shelter to escape individual rates on labor income and rents - not extending this problem even further, and (c) corporate income still potentially faces shareholder-level taxation, via the taxation of capital gain and dividends.

Great example of how the "business rate" works: Kansas has idiotically, and to its great detriment, enacted a version of what Trump now wants to do. The Kansas rules actually exempt so-called business income, since state rates are much lower than federal to begin with.

In response, Bill Self, the coach of the Kansas University basketball team, who gets paid $3 million per year, restructured a bit so that 90% of his salary would be "business income' that was exempt from the Kansas income tax. Gruesome details here.

Enacting the 15% business rate, especially in light of Trump's personal stake in the matter (so far as we can understand it despite the lack of transparency), and in light of the Kansas experience, would be straight-out looting and fiscal sabotage, not a policy move that is reasonably debatable or defensible.