Saturday, December 09, 2017

There is no reason why

Patricia Cohen, in today's NYT, has a nice piece discussing the pass-through rules. It's called "Tax Plans May Give Your Co-Worker a Better Deal Than You."

Opening paragraphs:

In most places, a dollar is a dollar. But in the tax code envisioned by Republicans, the amount you make may be less important than how you make it.
Consider two chefs working side by side for the same catering company, doing the same job, for the same hours and the same money. The only difference is that one is an employee, the other an independent contractor.
Under the Republican plans, one gets a tax break and the other doesn’t.

The article then explains the rule's regressivity, its penalizing being an employee for no known reason, its treating some professions more favorably than others for no known reason, and its strong inducement to artificial tax planning.

Somewhere in the middle, it quotes me as saying that the House version "might be the single worst proposal ever prominently made in the history of the U.S. federal income tax."

In fairness to the negative merits of the Senate version, it hadn't at that point been developed yet, so I couldn't compare the two.

I think any fair-minded reader will agree that the rest of the article, both before and after my quote, offers a lot of support for my statement. We think of the tax system as aiming to address efficiency, equity, and simplicity. The passthrough rule, in either version, unambiguously makes all three worse.

There is no rationale for the provision. To move towards equalizing passthroughs' tax treatment with C corporations? But C corporations face a second level of tax. Plus, business owners can simply incorporate if they like, without its inconveniencing them in any significant non-tax way.

For job creation? The chef who gets the low rate is a job creator, and the other isn't? Qualifying for the lower rate has no link to job creation.

It involves second-guessing of the market, based on what theory of market failure it isn't entirely clear. Why not let pretax prices guide appropriate investment and labor choices, as happens with neutral tax treatment? It's incoherent as industrial policy.

What defenses have been, or can be, offered for it? There really are none. Jared Walczak of the Tax Foundation is quoted as saying that the provision might make sense theoretically in a vacuum. But I take him to agree with me that the actual proposal is bad, as he follows this up by noting that it's difficult to distinguish between wage income and business income. I would add that it doesn't even make sense theoretically or in a vacuum.

Business income IS wage income insofar as it reflects the labor of the business owner. Anything else that we want the owner to do, such as reinvesting or whatever, can be addressed via rules aimed at that particular activity (e.g., expensing for capital investments, which the bills have on top of the passthrough rules).

What if employees save, and the bank loans the money to people who want to found or expand their businesses? That has less merit, because the Republicans in Washington know more than the capital markets?

The article mentions that the proponent's "idea is that these [the pass-through] businesses will reinvest those higher returns and stimulate growth."

If that's the goal, stimulate investment! Or is this actually just a call for redistributing money to people whom it is thought have a greater marginal propensity to invest? Then why not just give more money to rich people, without running it through the passthrough structure?

The balance of the article then gives us a taste for all the incredible "job creation" that the passthrough rules will ostensibly encourage. E.g., "staff lawyers on salary suddenly turn into partners" so they can get the passthrough rate. High-earning dentists do better still by becoming C corporations that are taxed at 20%. (The tax bill has no guardrails for that either.)

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