Tuesday, December 12, 2017

The passthrough rules versus consumption taxation

My last two blogposts addressed the incoherence of the passthrough rules, and their having no discernible underlying policy rationale (even one that is wrong) that can be stated at a more general level than "liked by the Congressional Republican leadership."

Let me put the same point in another way. Do the Congressional Republicans agree that a pure, full-fledged consumption tax, which is often described as exempting "capital income," would adequately address the pro-growth aims that the passthrough rule supposedly has?

A pure consumption tax is supposed to hit all consumption equally. It's economically equivalent to a wage or labor income tax, if those terms are defined broadly enough, leaving aside transition issues and the like. And such a tax, of course, taxes all labor income the same. (It may have graduated rates for a particular individual, as may a progressive consumption tax that is applied at the individual or household level, but that's a different point.)

The passthrough rule, by contrast, is premised on taxing some labor income at lower rates than other labor income. And despite some gesturing towards favoring the use of capital - from the disfavoring of personal service businesses, and for that matter the House bill's half-baked set of rules about electing your ratio of capital in the business - that is what it does. It taxes some labor income more favorably than other kinds, while also favoring rentiers (in the House bill) so long as they own businesses rather than owning financial interests in businesses that yield nonbusiness interest and dividends. (Yes, that's exactly as coherent as it sounds.)

The terms capital and capital income are not 100% clear, so one could define rents (extra-normal returns) as part of capital income if one likes, although my old friend David Bradford always used to say that in some sense they have got to be labor income. But he would agree that we're getting into semantics here. And there is no coherent principle that I can imagine, including those that I would disagree with, under which rents should be specially tax-favored. If anything, they can be taxed more highly without discouraging people from reaping them.

So if the passthrough rules ostensibly are in some way concerned about using capital, but they make distinctions and provide special tax benefits that would be unavailable in a system that exempted capital income, what exactly is the intent here?

I think the best one could do with this question, but I don't know that it can really be treated as a part of legislative intent, is to think about it as follows. A lot of the Congressional Republicans seem to believe that some people - the "job creators" et al - are superior to other human beings. They should be rewarded for being superior. And given their superpowers, this is bound to benefit the plebes somehow, someway. (Although why do they need the special tax breaks if they have such superpowers?) So they see some people, who may to an unsurprising extent overlap with their donors (or themselves before they entered politics) and say that these superior people, these Ayn Randite benefactors of all humanity, should be rewarded for their superiority by paying taxes at lower rates.

I can almost imagine a Ryan or Hatch saying: I don't know how to define these people in the abstract, but I know them when I see them.

This of course is not only anti-democratic and anti-egalitarian, but also anti-free market, insofar as it ends up distorting economic activity since we can't label the favored ones innately but only by observing what they do &/or report for tax purposes. But it's the best I can do at trying to define the subjective intent, whether or not the cognizable legislative intent, that underlies the promulgation of these rules (insofar as it is not simply crass and corrupt).

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