Tuesday, November 28, 2017

Perhaps it figures

The Senate is currently working on its version of the most plutocratic and fiscally irresponsible federal tax legislation in U.S. history.  Also probably the sloppiest and most poorly designed ever. (I can vouch for this going back to 1981, and before that the nature of the process probably prevented this sort of malfeasance.)

Nonetheless, as McConnell hunts for 50 votes, the impetus, as the New York Times reports, is to make it more plutocratic still. Senators Johnson and Daines are demanding larger tax benefits for passthroughs, which supposedly - but not actually - are treated worse than C corporations in the bill. More on that in a moment.

Buying Johnson's and Daines' votes would definitely cause the legislation to be both more plutocratic and even more poorly designed. The passthrough provisions don't, and as a matter of basic design really can't (especially in the abbreviated timeframe) have even remotely adequate guardrails. They are a tax lawyer's Full Employment Act for all sorts of tricks that I have discussed in prior posts, and I suspect that I am just scratching the surface.

Whether giving more goodies to passthroughs would also make the legislation still more fiscally irresponsible depends on how they do it. Johnson and Daines propose taking at least some of the lost revenue out of the hides of C corporations, via repeal of the state and local (income?) tax deduction for such companies. This actually is not entirely lacking in rationality, if one takes it as given that state and local income taxes shouldn't otherwise be deductible, but it's a hard sell optically, plus it would further undermine state and local governments along the same lines as repealing the deduction for individuals. (But that's a separate debate.)

C corporations are probably right to be a bit nervous here. Apart from the insistence on giving them a 20 percent rate and territoriality, they are, as Willy Loman would have put it, liked but not well-liked by Congressional Republicans. It's the super-rich pass-through owners who are well-liked. And while there is clearly an immense willingness to do harm to middle-class and poor taxpayers, for the former at least there are concerns about the political optics.

In any event, as I noted above, it's also false that the passthroughs (or more precisely, their owners) are being treated worse than if they operated C corporations. We know this for a very simple reason: they would simply restructure to be C corporations if they thought that would benefit them.

Some of them are already incorporated under state law, and have simply elected to be taxed as S corporations (which are treated as passthroughs). And even for the rest, there is really no significant business reason not to do this. They don't even have to use states' corporate law statutes, since other flexible entities, such as limited liability companies (LLCs) can readily serve as C corporations for federal income tax purposes, with just minimal planning.

Why wouldn't they want to do this? Well, the reason TO do it, obviously, is to get the 20 percent corporate rate, in lieu of the higher passthrough rate that even the House bill offers. But then they would face the second level of tax, upon receiving corporate distributions. The tax cost (or tax-induced inconvenience) of doing that offers the only credible reason why they wouldn't choose to incorporate.

The argument is therefore being made in bad faith, whether or not Senators Johnson and Daines (who are not generally considered the Senate's two leading tax minds) are aware of this.

Here's a further amusing snippet, from Richard Rubin and Siobhan Hughes in the Wall Street Journal, concerning Johnson's arguments for additional passthrough rate cuts:

"Mr. Johnson said the rate disparity ... would cause pass-throughs to change their legal status and become traditional corporations. He said that would cause revenue losses that congressional estimators haven't accounted for; it wasn't clear Monday what those estimates assumed."

It's unclear how (or if) Johnson thinks this can be reconciled with his claiming that the passthroughs are disfavored. But it's actually plausible that if passthrough owners did convert, this would cause revenue losses within the period being measured by the official score, even if the present value of their tax liabilities increased (except, in that case they presumably wouldn't convert to begin with). The second level of tax might often be incurred after the close of the estimating period, and the forecasts aren't infinite-horizon.

Another way of putting this is that conversion to C corporation status might be less bad fiscally over the long run than within the ten-year estimating window. But, from the standpoint of what Johnson is trying to argue, he's still trapped in nonsense. They're not disfavored if they can readily convert, and if they don't want to convert then they're evidently not disfavored even under their current organizational form as passthroughs.

1 comment:

HB said...

The counter argument is that much of the typical corporate shareholder base pays little to no tax (foreign shareholders w/r/t capital gains, tax-exempts, tax-advantaged retirement plans, and retail shareholders in lower tax brackets).