Wednesday, April 26, 2017

Preliminary thoughts on the Trump Administration's tax "plan" - what's the rationale for an "employee surtax"?

Perhaps the Trump tax proposal shouldn't be taken too seriously, as it's apparently being rushed out to meet the self-imposed "100 days" deadline and may face mixed prospects at best on the Hill. But when an administration actually claims it wants to do something, it can't just be laughed at as non-serious, even if the proposal is in fact a joke substantively. After all, they're showing us who they are. And what's more, who knows what might end up happening?

That said, suppose the Trump plan includes a 15% rate for corporations and "small business," defined as all passthroughs as well as proprietorships - i.e., non-employee business and labor income generally. And suppose there are neither serious revenue offsets nor significant efforts to limit tax planning that takes advantage of the disparity between the twin 15% rates and the higher (up to 33%?) rates that would still apply to individuals.

Point 1, this seems likely to be such a huge revenue loser that the growth effects might be negative, given fiscal drag from the extra deficits and debt.

Point 2, the Trump tax plan brings to mind the gabelle - the infamous French salt tax, from before the French Revolution, from which nobles were exempt. Given the degree of correlation between income levels and likely ability to take advantage of the 15% passthrough/small business/non-employee rate, it would frequently apply higher marginal rates to people at modest income levels than to those at high income levels.

Think of a law firm in which the partners pay tax at a 15% rate, while the associates, paralegals, and secretaries pay at higher rates (up to 35%). Or think of a high-priced surgeon who pays tax at a 15% rate, while the secretary who answers his phone might pay tax at a higher rate.

The reason I analogize it to the gabelle, rather than just saying the rate structure is upside down, is because one could conceptualize it as being equivalent to having a generally applicable 15% rate, plus (once the marginal rate for employment income gets above that level) a special surtax or penalty tax that applies only to employees, and thus effectively fines or punishes people for having this status. The self-employed, like pre-revolutionary France's nobles when they used salt, are exempt from the employee surtax.

True, entitlement to the lower rate is not perfectly reverse income-correlated. Uber drivers would presumably get the 15% rate. And high-paid CEOs, to the extent they were getting cash salary, would presumably reach the 33% marginal rate. But the "employee surtax" of up to 20% is one from which proportionately more "nobles" than "commoners" would be exempt.

Depending on how the plan defines non-employee income, I suppose it's possible that law professors could start claiming the 15% rate as to their Schedule C income, such as from consulting. So there's that.

Point 3. Why have an employee surtax? This is not only regressive, but inefficient. It interferes with people's making normal business arrangements on a pretax basis. It creates a large tax penalty for employment, as opposed to other ways of earning labor income. Apart from the pure tax planning aspects of trying to avoid employment status, it could shift actual business arrangements in wasteful directions. Indeed, if employment status is tax-penalized enough, I wonder if the incidence could start to shift a bit. This is the scenario in which employee wages have to rise, pre-tax, in order to make up for the tax penalty. It's municipal bonds in reverse - they generally offer less pre-tax than, say, corporate bonds because the income is exempt. In this scenario, employees would be getting more pre-tax than the self-employed / independent contractors because they were in effect subject to a special "employee surtax."

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