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Trump’s Tax Plan Leaves the Swamp Untouched

His ideas don’t add up to real reform.

President Trump’s tax plan gives those of us with long memories a strong sense of déjà vu. We’ve seen this play before, and the ending is inevitably modest: a few of the pieces of a horrendously complex, unfair tax system are moved around, victory is declared, and the creatures of the Swamp—those self-serving elites that benefit from the complex, unfair monstrosity—continue raking in their billions of dollars in fees while the rest of us are burdened with billions of dollars in tax-preparation costs.

The opening act of this tax-reform play always starts with a claim that by golly, this time we’re really going to simplify the tax code. Trump’s plan calls for reducing the number of tax brackets and eliminating all deductions other than those for charity and mortgage interest; by way of compensation, the standard deduction will be doubled.

Such changes make for catchy headlines, but the reality is the tax code will still run to thousands of pages. The Tax Foundation explains the three layers of compliance complexity:

  • Title 26 of the U.S. Code, the tax statutes enacted by Congress, runs to 2,600 pages.
  • The details are left to the IRS (Internal Revenue Service), which publishes roughly 9,000 pages of regulations.
  • If you end up in tax court, there are around 70,000 pages of case law to pore over to make your case.

Simple changes like reducing the number of tax brackets skirt the core problem with the U.S. tax system: the entire tax code is little more than a clearinghouse of political bribes paid for with tax breaks and a complexity thicket that requires the services of legions of accountants, tax attorneys, software coders, and specialists in tax-avoidance strategies.

This clearinghouse and complexity thicket are intrinsically unfair, as insiders and the super-wealthy can avoid taxes via political influence and offshore tax havens. This systemic unfairness erodes the social contract’s key compact: that the playing field will be kept more or less level for all participants.

But the U.S. tax system is anything but level. The Institute on Taxation and Economic Policy (ITEP) recently published an analysis of the corporate taxes paid by Fortune 500 companies over the past eight years. Consistently profitable companies paid a federal tax rate of around 21 percent, considerably lower than the nominal corporate tax rate of 35 percent. But 18 profitable companies paid no federal taxes over the eight years, and about 50 corporations paid rates of 10 percent or less.

Immensely profitable corporations such as Apple have mastered the offshore tax-avoidance game. Others persuade (impolite term: bribe) members of Congress to include obscure tax breaks tailored to them in legislation.

So the most successful at gaming the system pay near-zero rates (saving tens of billions of dollars) while the chumps pay the top rate.

There’s another systemic source of unfairness in the tax code: the gap between the high rates on earned income (wages and salaries) and the much lower rates on unearned income—what we might characterize as income generated by capital rather than labor: rents, capital gains, and so on.

If you manage to earn $500,000 in wages, most of that income is taxed at 33 percent, and the income above $415,000 is taxed at 39.6 percent. (Trump’s tax proposal calls for a top rate of 35 percent.) Meanwhile, the top rate for long-term capital gains is 20 percent. Over time, that 15-point difference adds up.

In effect, the rich get richer because most of the lower-tax-rate unearned income flows to them.

The concentration of unearned-income-producing wealth in the U.S. is remarkable. In 2016 the Congressional Budget Office (CBO) reported that the top 10 percent of U.S. households held 76 percent of all private wealth. The bulk of the sources of unearned income are owned by the top 10 percent: stocks, bonds, trust funds, business equity, and non-home real estate.

Unearned income also avoids the 15.3 percent Social Security and Medicare payroll taxes (half paid by employers, half by employees). Self-employed taxpayers pay the entire 15.3 percent, and so all their earned income above $37,650 is taxed at a rate of 40.3 percent or higher: 25 percent federal income tax and the 15.3 percent payroll taxes. That 40 percent is double the top tax rate on unearned income.

Those with earnings above $118,500 no longer pay the Social Security tax. According to the U.S. Census Bureau, 80 percent of all households earn less than $117,000 a year, so the vast majority of wage earners pay the full payroll tax rate on all earnings.

So while the top income tiers famously pay most of the federal income taxes (the top 1 percent pony up about 37 percent of the total), the highly progressive income taxes are slightly less than half of all federal tax revenues, while highly regressive payroll taxes make up roughly a third of federal tax receipts.

In this larger context, how much impact will Trump’s signature tax cuts on the corporate rate (from 35 percent to 15 percent) or on the top earned-income rate have on the inequities of the tax system?

A lower corporate tax rate that was applied more uniformly would certainly reduce the necessity of costly tax avoidance schemes—but the current Swamp enables some companies to pay near-zero, which is a lot less than 15 percent.

As for the modest reduction in the top earned-income bracket: as we’ve seen, the bulk of the taxes paid by the bottom 80 percent are payroll taxes on earned income, and the unearned income flowing to the wealthiest 10 percent is taxed at a much lower rate than the combined payroll-income tax burden on wage earners.

This systemic unfairness of the status quo is one reason why Trump was elected: the protected few (to use Peggy Noonan’s phrase) are benefiting at the expense of the unprotected many. The only meaningful tax reforms—the elimination of loopholes, offshore tax havens, and the congressional privilege of rewarding cronies with obscure tax breaks buried in legislation; radical simplification of the code and a realignment of the asymmetry between the taxes paid on earned income and unearned income—are a political impossibility, as the protected elites have a stranglehold on the machinery of governance.

That said, it would have been refreshing if Trump’s team had called for a massive house-cleaning of a wildly unjust tax code, and a draining of the particularly fetid tax-avoidance swamp.

Charles Hugh Smith is the owner/writer of the oftwominds.com blog and has written 11 books on our economy and society, including A Radically Beneficial World: Automation, Technology & Creating Jobs for All.