The GOP Tax Reform’s True Target

unified_frameworkTaxes form the backbone of the relationship between government and the governed, revealing most starkly what we value as a society. Spoiler alert: We value business owners and investors.

The most dramatic proposal to emerge from “The Unified Framework For Fixing Our Broken Tax Code”  announced last Wednesday from GOP leadership in Congress and President Trump is the drop in the top corporate tax rate from 35 percent to 20 percent. Other provisions to encourage more investment and business growth include:

  1. A one-time low-tax incentive for on-shoring money held by corporations overseas,
  2. The option for faster expensing of capital investments over the next five years, to incentivize further investment and lower corporate taxes, and
  3. Because 95 percent of businesses are organized as LLCs and LPs subject to “individual pass-through taxation,” paying individual (aka personal) tax rates, the proposed framework would lower top tax rates for such businesses to 25 percent, well below the proposed 35 percent top personal tax rate.

The net effect of this sweeping tax reform would dramatically lower the burden of taxes on businesses. Initial estimates of lower tax revenues as a result of the proposal cite $5 trillion less in revenue, and possibly $1.5 trillion in increased federal debt, over the next 10 years.

Do not get overly distracted by proposals regarding household or individual taxation, because the framework’s central bet is the following: If businesses are the job creators and businesses make most investments in this country, then businesses will be the engine of economic growth and national economic strength. Treat businesses well, and plentiful jobs, higher salaries, increased investment, and national prosperity will follow. That’s the guiding theory of this tax reform. If that theory turns out to be true, this reform will be hailed by future generations as a smashing success.

On the individual and household side, the proposal would reduce the need for most itemization on a tax return by doubling standard household deductions, and it proposes three individual and household tax brackets, with an option for a fourth bracket, targeted at higher earners.

Also on the individual side, the proposal would eliminate the Alternative Minimum Tax, and the estate tax, which only affects 0.2 percent of deceased’s estates. These two proposals would only benefit high earners (subject to the AMT) and the very wealthy (subject to the estate tax), respectively.

So what to think about this proposal?

First, let’s talk about simplification, a stated goal of reformers. Simplicity in a new tax code doesn’t derive from a smaller number of tax brackets, but rather from eliminating itemized deductions, loopholes, and abolishing the AMT.

paul_ryan_white_people
#PaulRyanSoWhite

Perhaps cleverly, but ominously, the framework does not specify whether and how certain deductions popular with businesses and households will survive or not. We know many targeted tax breaks (aka loopholes) must be eliminated, however, to make up revenue lost by lower corporate and household tax rates overall.

That is left, as of now, to the future sausage-making congressional committee process. The basic problem is that everybody likes to keep their own loopholes (which are job-creating and fair, naturally) while eliminating everybody else’s loopholes (which are unfair and benefit special-interests, naturally). There’s a fight to be had there.

The more sweeping the loophole-elimination, the closer we get to the Shangri-La of tax reform: tax filing on one single page, prepared in less than an hour, without hiring a tax specialist. But it’s politically challenging to eliminate loopholes to which specific powerful constituencies have become attached. Getting to simplicity, therefore, won’t be simple.

Next, let’s talk politics.

The political stakes of tax reform could not be higher for the Trump Presidency. This is his legacy moment, as well as the legacy moment for House and Senate GOP leadership.

For many, President Ronald Reagan’s signature triumph was the Tax Reform Act of 1986, forged in compromise with a Democratic House led by House Speaker Tip O’Neill. Top tax rates came down, the code was simplified, the bull market in stocks roared. We remember Reagan’s presidency as a time of increasing national prosperity. Could Trump make this his legacy too?

The political body-language between the President and the Republican leadership of Mitch McConnell in the Senate and Paul Ryan in the House has always been one of mutual wariness and uncomfortable tolerance, at best. The calculation for the fiscally-oriented wing of the Republican party, led by Ryan, is that all of it will have been worth it if they can accomplish comprehensive tax reform in 2017. If they can pull it off, the historic legacies of Paul Ryan, Mitch McConnell, and Donald Trump are dramatically bolstered.

Finally, how to react personally, to upcoming tax reform?

If you are already a business owner, this is a thrilling tax reform proposal. Like seriously, chills and fist-bumps all around. By now you’ve probably already posted on Instagram with LOLOLOL OMG <3 <3 <3 Paul Ryan 4-Eva written in red lipstick font over a selfie of you in a bro-hug with your investors.

paul_ryan_workoutBut if you are currently a salaried employee, what’s in this reform for you? Consider this: If you are a wage earner, rather than a business owner, the framework suggests you are basically doing it wrong. The current proposal to change so-called pass-through taxation of small businesses like LLCs and LPs from top rates like 35 percent to a top rate of 25 percent means that everybody (and their mother!) should earn money only through a business like an LLC or an LP, not through a salary paid by someone else.

I, for example, need to stop charging money personally for my writing, and rather quickly open up “The Smart Money Business Columnist Thing LLC,” a financial opinions consultancy business, and sell my columns to the newspaper as a business service. My income tax rate could be a lot lower that way, under the latest proposal. You need to do the same.

The framework says vaguely that it “contemplates that the committees will adopt measures to prevent the recharacterization of personal income into business income,” but, well, we’ll see. In the meantime, wage earners, open up your LLC and become a business owner.

 

Please see related posts:

Adult Conversation about Income Tax Policy

Death Tax is my Favorite Tax

 

 

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A Budget Discussion Thats Not Stoopid

As of last week, your income taxes are all filed. Congrats! Or, like me, you got an extension. Boo!

federal_spendingIn either case, it’s a good week to think about what our tax money bought this year. And since we’ve all been promised federal tax reform this spring or summer from a unified legislative and executive branch it’s also good to reflect on how the federal government spends our tax dollars now, and how it might spend them in the future.

A simple way to understand federal government spending is to compare it to a household. I don’t mean governments should be run like households – they shouldn’t – I just mean that we taxpayers can understand numbers that resemble the size of our expenditures in our own life. Otherwise you know, a billion here and a trillion there, it can get confusing.

The median household income in 2015, according to the US Census, was $55,775. With simplicity as my goal I prefer an easier, rounder number. So let’s just say instead of the median, we have $100,000 to spend each year as a household.

Looking at the federal government as a household with $100,000 in annual income, here’s where all the money goes, rounded to the nearest hundred dollars.

  1. Our federal government household paid $33,300 for a combination of Social Security, unemployment payments, food assistance, housing assistance, welfare, and labor costs. All of these are considered “mandatory” in the sense that they are promised payments, and not voted on in a budgetary process each year by Congress.
  2. We paid $27,400 on Medicare and other federal health-care costs. This is also “mandatory” and outside of the annual budgeting and decision-making process. The bill just comes in the mail and we pay it, no questions asked.
  3. Our household paid $15,800 for military expenditures. This is considered “discretionary” spending, so Congress must approve an annual budget for setting this amount.
  4. We spent $6,000 on debt interest, our household credit card. This is not discretionary if we ever want to be able to borrow again.
  5. Lastly, everything else cost $17,500 in 2015, also part of the “discretionary” part of the budget approved by Congress. That includes everything from veteran’s benefits to transportation, and from energy and the environment to education and international affairs.

 

So…what do we think of that? If you were in Congress looking to rein in spending as the majority party, what would you cut?

On the real political spectrum there are numerous (I won’t say there are fifty) shades of grey on the topic of federal spending. But to oversimplify into black and white shades, we could say that a prototypical left-of-center voter will say “hands off Social Security and Medicare,” while a prototypical right-of-center voter will say “hands off the military.”

sacred_cowsAnd I mean, ok, sure, we all want security from foreign threats, security from catastrophic medical expenses, and security from eating cat food in our old age. So again I’m simplifying people into these two Left and Right buckets.

But since entitlement reform (Social Security, Medicare, food, unemployment and housing subsidies) and Defense budgets then become sacred cows to the Left and Right, all budgetary discussion becomes really stoopid, really fast. Elected officials don’t want to turn off half the electorate by promising to actually get serious about spending cuts, so they talk about stoopid stuff.

It’s stoopid to focus on some bad art you don’t agree with funded by the National Endowment for the Arts. It’s stoopid to complain about pointy-headed liberals getting PBS funding. It’s stoopid to focus on “waste, fraud and abuse” as a real source of cost savings in the federal government. These are mere pimples on the butt of the federal government’s spending.

We need to get more like Willie Sutton and his bank robbery strategy. Why do we need to talk about cutting entitlements and defense, Mr. Sutton? “Because that’s where the money is!”

where_the_money_isIf you’re not willing to discuss cutting both entitlements spending AND defense spending then I don’t know what to tell you except you’re not invited to my birthday party and your ideas about fiscal responsibility are stoopid too.

Having gotten that off my chest, let me say one or two sentences about why each of the three biggest sacred cows – Social Security, Medicare, and Defense – should be targets for cost-cutting at the federal level. I honestly don’t know the best way to do it. I’m just saying we could spend less on all three.

Social Security – when this program was first enacted in 1935, the average lifespan in the United States was just under 62 years. Maybe logically, people became eligible for Social Security at age 62. Would a newly-designed Social Security program set 80 as the right starting age for benefits? Maybe. Furthermore, in 1935 a 65 year-old beneficiary could expect to live until age 74, on average. Now, a 65 year-old could expect to live until age 82, on average. While that’s good news, it also means the program is far more generous, far longer, than originally intended. Sorry folks, we need to raise the eligibility age further.

Medicare – We spend 30% more than the 2nd highest-spending country-per-capita (Switzerland), and typically about double what rich countries like Canada, France, Japan spend on healthcare overall. Strangely, we have notably worse outcomes in terms of life expectancy, infant mortality and other major chronic problems such as heart disease and diabetes I don’t personally pretend to know how to cut spending and raise outcomes. And anyway, who knew health care policy could be so complicated, right? But surely we could learn a thing or two from other countries about how to bring costs down while improving health outcomes? (But please don’t call me Shirley.)

Defense – We not only pay more for defense than any other country – and three times more than #2 spender China – we pay more than the next 8 countries combined.

defense_spendingPaying too much for one’s military – to enforce global peace – is how empires always fall. Ask the Romans, the Spanish, and the English.

No more sacred cows. No more avoiding. Do the real cost cutting if you want to be taken seriously, and face the political consequences. Everything else you say about federal government cost-cutting is a joke and we’re not stoopid.

 

 

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Carbon Dividends?

Conservative_case_climate_changeEarlier this month, a blue ribbon panel of US statesmen released “The Conservative Case for Carbon Dividends,” as a way to address climate change, reduce US regulations, and to provide additional funds for working-class people.

The first interesting thing about the proposal is to note the resumes of the authors, each of whom boasts serious conservative policy bonafides.

Harvard economist Martin Feldstein, Ronald Reagan’s Chairman of the Council of Economic Advisors, joined with Harvard economist Gregory Mankiw, who held the same post under George W. Bush. Hank Paulson, Treasury Secretary under W, joined with Secretaries of State James Baker (under W) and George Shultz (under Reagan). To round out the conservative business credentials, Thomas Stephenson a partner at Sequoia Capital and Rob Walton, the former Chairman of Walmart, respectively, also authored the proposal.

The proposal is bold, conservative, and has a little something for everyone.

First, something for you climate-change people.

If you’re concerned about the melting ice cap, rising sea levels, and irreversible damage worldwide, the proposal would tax carbon-emitting industries at a starting rate of $40 per ton at the point of production – such as a refinery, a coal mine, or a port. The obvious economic incentive here would be to reduce the production of carbon emissions. In addition, taxes on carbon would ratchet upward over time.

“The idea for a tax on carbon dioxide emissions from industry has been on the back-burner for a long time among climate scientists and professionals in the oil and gas business,” says Kelly Lyons, professor of Biology at Trinity University in San Antonio, “and it’s something we could all get behind.”

climate_changeThe conservative authors argue that Obama-era regulations – a mishmash of auto-industry emissions targets, punitive regulations on coal production, financial incentives for “green energy,” and the occasional symbolic pipeline-squashing – lead to business uncertainty, higher costs, and executive branch overreach. And then it’s inevitably followed by back-lash and/or repeal, as is happening now. A carbon tax, by contrast, addresses the entire problem at once and puts a known, predictable, price on carbon reductions for the entire economy.

To gain popular buy-in, next the authors propose distributing the carbon tax revenue back to American families in the form of a dividend – rather than to fund government programs. Money, obviously, appeals to wide swathes of the left and right. The proposal estimates a family of four would receive $2,000 in the first year. As the carbon tax rate increased over time, the dividends would increase as well.

The authors note the dividends would offset higher consumer costs due to the carbon tax. Just as importantly, I’d say a dividend makes for good political optics.

The Treasury Department estimates that the bottom 70 percent of households would be net beneficiaries, financially, from carbon dividends.

Third, in what I interpret as a nod to the current direction of trade policy proposals, the authors call for a “border carbon adjustment” fee that somewhat resembles proposals for something I wrote about recently, the “destination-based cash flow tax with border adjustments.” In the carbon-dividend context, however, the point of a border adjustment fee is not necessarily nationalist trade policy, but rather to nudge other countries to also get with the program of reducing their carbon emissions.

Finally, to attract the support of a traditional conservative base, the carbon dividend would almost completely replace or phase out the EPA’s suite of regulations regarding carbon dioxide emissions. The business rationale for this plan rests on the idea that less regulation, replaced by predictable market signals, would spur investment in the private sector. The authors claim the freer market approach stands in contrast to traditional Democratic solutions of larger government and greater regulation.

Ok, so let’s be real for a moment: “carbon dividends” is a clever rebranding of “carbon tax,” which forms the core of this proposal. The tax would raise costs for energy producers such as coal and oil and gas extractors.

As part of this rebranding, the authors chose the fiscally conservative approach of redistributing funds collected going back in the form of “dividends” to taxpayers, rather than using the revenue stream to fund existing government programs.

Dr. Lyons doesn’t love the dividends approach, noting that “not everyone would agree that dividends should be sent back to consumers rather than invested in research and development on solar and wind, although I can see why giving people money back makes political sense.”

Do I think this idea will pass a unified Republican Congress and Executive branch, despite its thoughtful conservative origins? A key Trump cabinet member could be a natural ally.

Rex Tillerson, Secretary of State and formerly the CEO of Exxon, has backed the idea of a carbon tax, at least when compared to a mishmash of federal regulations on the oil and gas industry.

No doubt under a Republican president Jeb Bush, John Kasich or even Marco Rubio, these blue ribbon statesman would be guiding a conservative consensus toward a cleaner energy future. But that, right there, is probably the most interesting thought inspired by this conservative proposal.

liberty_under_waterAnother way to view this carbon tax proposal would be as a reminder – and a metaphor for – the true power of Establishment Republicans right now.

Shultz. Baker. Feldstein. Paulson. Mankiw. That’s a batting order of heavy hitters, a murderer’s row of Republican Statesmen. They made the Reagan administration what it was. They made the Bush Administrations what they were.

Which is to say, the Republican Establishment is now like a coastal city of the future, swamped and under water. The Establishment has been covered by the rising tide and heated rhetoric of an “America First” populism that disdains markets, globalization, and science.

I’d say this thoughtful conservative idea doesn’t have a snowball’s chance in Haiti of ever becoming law.

 

A version of this post ran in the San Antonio Express News and Houston Chronicle.

Please see related post:

Border-adjustment Tax – An untested idea

 

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DBCFT – An Untested Tax Policy For Strange Days

paul_ryan_tax_reformWith Congress and the White House unified under the same party, radical corporate tax reform is coming our way very soon. Although some reform is welcome, this is a column about the part of the reform that worries me the most, known by the non-mellifluous label “Destination-Based Cash Flow Tax With Border Adjustment.”

Let’s say you are a tax-policy maker in Washington and you wanted to address two problems at the same time with US businesses that make money overseas. The first problem might be that US multinationals leave a big pile – an estimated $2 trillion – of profits overseas, which they do in order to avoid having to pay our relatively high 35 percent corporate tax rate. The second problem might be that you want to create more jobs here by encouraging an “America First” approach to global trade. You would do that by giving US corporations tools to export more stuff, and maybe import less stuff, to encourage businesses to expand in the US, create jobs, and help our trade balance.

DBCFT

The solution among tax nerds is this so-called “destination-based cash flow tax with border adjustment.” It’s a mouthful, I know. The Twitterati have shortened it to #DBCFT for the newspaper readers who want to follow along this debate, in real-time.

But DBCFT is NOT just for tax nerds, it’s the core of House Speaker Paul Ryan’s “A Better Way,” the proposal that sets the blueprint for the major tax reform that’s likely to pass with Donald Trump in the White House.

DBCFT says that US companies would not get taxed on sales revenue generated outside of the country, only revenue made on sales inside of the country. It also says that US companies would pay taxes on the full value of all their imports into the US, rather than deducting import costs like other ordinary business costs.

A_Better_WayThis reform would take care of the accumulated $2 trillion pile of cash, since US multinationals would not pay US taxes on revenues generated overseas. They could onshore future profits with no consequences. Presumably some tax amnesty plan would bring in the existing pile, and there would be no incentive to create a new pile offshore.

DBCFT also appears to offer a massive subsidy to exporters through tax breaks. Like, if Apple earns $1000 in profit (to use numbers absurdly small and simple) from sales in Europe, it would owe Uncle Sam nothing, rather than the current up-to-35 percent rate, or $350. Without that tax burden, big exporters like Apple can turn around and sell stuff even more cheaply than foreign competitors.

Mission accomplished, right? On-shored profits and strengthened export businesses! Everything’s good?

Actually, we don’t know for sure.

A tax plan like this has never been implemented.

We have some economic theory about why everything will be fine – which I’ll explain in a moment – but it’s also fair to say that a massive shift like this could have unpredictable consequences. DBCFT is untested in reality, and like a lot of what’s happening in other policy areas, things could get weird.

Former Treasury Secretary and economist Larry Summers argues that DBFCT could have at least two big troubling consequences.

The first worry is that big exporting companies might generate negative tax bills in perpetuity – meaning a big tax refund every year – which seems super odd, and maybe something the US government wouldn’t really allow.

The second troubling consequence is that companies that import a lot of stuff which they then sell inside the US might have tax bills that are equal to – or bigger than – their entire amount of profits – also a weird result. It wouldn’t feel good – or be financially sustainable – to pay more in taxes than you even earned as a business.

This is scary, and potentially highly disruptive for a company that depends on imports to produce its product.

Think of the kittens?!?

Maybe a small business example can help illustrate this problem for importing companies that sell only in the United States. I have a buddy in San Antonio whose online business delivers disposable cat litter boxes to households, based on an online monthly subscription plan. GoGoGato imports Chinese-manufactured litter boxes from Canada, and then ships them to anywhere in the United States. So, he has significant import costs, and purely domestic sales.

GoGo_GatoLet’s say each imported litter box cost him $5, which he retails for $25 each, and manages to eke out a $1 profit (remember, he has shipping, marketing, packaging, and storage costs) on every box shipped.

At a 20 percent corporate tax rate (the new Paul Ryan-proposed rate) on his $1 in profit, he’d owe $0.20 in taxes on every box he sold. But under DBCFT, the $5 cost of each box imported from Canada would not be tax deductible. Instead, suddenly GoGoGato would owe taxes on $6 – That’s the $5 import cost, plus his previous $1 profit. Instead of owing $0.20 in taxes per box, he’d owe $1.20 in taxes per box, more than his entire profit per box. That’d be a business killer for GoGoGato. Litter-ally.[1]

UC Berkeley economist Alan Auerbach, an advocate for DBCFT, argues that the fears are overblown. The economist’s view is that the tax change would cause an immediate upward move in the value of the US dollar compared to other currencies, which would leave importers and exporters equally well-off from before the change.

How does that work? A strengthened US dollar – the economic theory goes – boosts imports and suppresses exports, in roughly equal proportions to the tax benefits and costs caused by DBCFT. That’s the theory anyway, which Auerbach and other tax policy experts like Kyle Pomerleau at the Tax Foundation say make fears about DBCFT overblown.

The fact that economists say “Don’t Worry!” isn’t stopping retailers, however, from heavily lobbying against the tax proposal.

With the example of even a small business like GoGoGato, it should not be surprising that big-importing retailers like Wal-Mart are gearing up to fight DBCFT.

America First?

Ready for one more potential problem with DBCFT? Summers further argues that if the US dollar appreciates by 20 percent versus other currencies as a result of DBCFT, it might cause disruptive effects on world markets. Heavily-indebted emerging market countries, for example, could find their dollar debts 20 percent more expensive to pay. Financial chaos could ensue.

In an “America First!” world we might not care about the potential devastation our tax policies cause. I would argue, however, that we brush off the risks of untested tax changes at our own great peril.

[1] I apologize.

 

 

Please see related posts:

Corporate Tax Reform is Coming

How to Evade Taxes Offshore – Wyly style

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Paul Ryan’s Upcoming Corporate Tax Reform

Paul_ryanHere’s a relatively safe policy prediction: We will get major Federal corporate tax reform in the next year. Here’s a sneak preview of that reform, especially the parts that I like. Other parts I think are kooky or wrong, but for that critique you’ll have to wait for a few more days.

Normally I’d recommend ignoring policy wonk papers published many months ago back in the midst of a Presidential campaign. However, with a House, Senate, and Executive branch unified under the same party, much of this stuff in Paul Ryan’s June 2016 proposal known as “A Better Way” (aka “the Blueprint”) will likely become law.

Before you decide to ignore tax reforms to focus on the sick Twitter burns, “alternative facts,” and the claims and counterclaims of “Fake News,” let me just stake the claim that tax law is the hidden architecture of our world. This, right here, is the stuff that really matters. Mike’s Second Immutable Law of Taxation states that if you want to know what a society’s real values are, follow its tax laws. (I’ll remind you of Mike First Immutable Law a little later on.)

According to Ryan’s “A Better Way,” the goals of corporate tax reform are:

  1. Spur additional capital investment in the US
  2. Discourage corporate indebtedness
  3. Reduce corporate “double-taxation” of profits
  4. Bring US tax rates in line with international tax rates
  5. Simplify the cost of tax compliance with the IRS
  6. Improve the IRS’s customer-service orientation, and
  7. Reduce the stockpile of overseas corporate profits held by US companies.

All of these sound like reasonable goals to me.

A_Better_WayTo spur business investments, the Blueprint recommends allowing businesses to deduct the full cost of purchasing tangible and intangible assets in the year purchased. Previously, when a business invested in a thing – Iike, I don’t know, let’s say a new tractor – the business would depreciate, or spread out over time, the cost of the tractor, over many years. The effect is to give businesses an additional tool for reducing their current tax bills. That seems like it probably would help spur more business investment.

To further help businesses, and to bring US taxes in line with international rates, the Blueprint proposes a drop from a top (C-Corp) corporate tax rate of 35% to a far more modest 20% flat rate, and a drop to 25 percent for sole proprietorship and partnerships, which make up most small businesses. Before you angrily shout “Corporate give-away!” let me make the case for this one.

The justification for this drop has many parts. First, the average corporate tax rate of developed countries is 24.8 percent, far below the US, which has the highest top corporate tax rate among our peer group countries. Ironically, the US also collects proportionately less corporate taxes than peer group countries. So, we have high tax rates, but low tax collection – a bad combo.

Now, our current top corporate tax rate of 35 percent – compared with the average of roughly 25 percent elsewhere – probably overstates the differences. That’s because corporations in other countries may pay fees and licenses and other taxes that US corporations do not, and also because large US corporations are skilled at tax avoidance strategies. We should expect that skilled tax avoidance because of Mike’s First Immutable Law of Taxation, which states that “every tax action causes an opposite tax-avoidance reaction.” Understanding that immutable law, we should favor tax rates that cause the least amount of tax avoidance behaviors.

A main justification for the corporate tax rate drop is to bring us in line with international tax norms. Why should we care about that? First, because in an interconnected world, US corporations operate at a competitive disadvantage under their higher tax rate.

Second, US multinationals have figured out that they can avoid being taxed on overseas profits at our more punitive 35 percent rate by one of two methods. The first method is that some corporations leave their money earned overseas in a kind of international tax limbo. The result is an estimated $2 trillion in untaxed US corporate earnings held overseas. Large corporations have been waiting for tax rates to drop, as now seems imminent, or for a kind of one-time corporate tax amnesty to incentivize them to onshore their profits. This all seems much more likely to happen with upcoming tax reform, and will also give a one-time boost to the US Treasury.

Burger_King_tim_horton
Burger King merged with Tim Hortons

Other companies have decided to merge with – or be bought by – foreign corporations in order to avoid US tax rates, in what’s called a “tax inversion.” Burger King famously did this with Canadian-based firm coffee chain Tim Hortons. Minnesota-based Medical device giant Medtronics was ‘bought’ by Ireland-based Covidien, a smaller medical device company that allowed the US company to relocate to a lower-tax country.

From my perspective, you really can’t blame the leaders of corporations for doing either of these things, when faced with a massive corporate tax rate difference. In order to be responsive to shareholders, top executives have to seek legal ways to minimize their taxes. All of which is to say, bringing top US corporate tax rates closer to international norms seems like an important and overdue reform.

To discourage corporations from taking on debt, the Blueprint proposes eliminating the tax deduction for paying interest on debt. The household analogy here would be the popular mortgage interest tax deduction, which somewhat encourages homeowners to take on larger mortgages than they might otherwise take on, which is also something I kind of hate. The idea in the corporate world is that by eliminating deductions for debt interest payments, corporations will be nudged into taking on less debt. In addition, the Blueprint argues, this elimination, paired with the upfront deduction for capital investments described above, encourages current investment, but not through excessive borrowing.

Finally, the Blueprint proposes modernizing and streamlining the IRS. This seems like one of those things that’s easier said than done, but by all means, let’s try to make this happen as well.

I have plenty of mean things to say about other aspects of the Blueprint tax reform, but I’ll save that for a future post.

 

A version of this ran in the San Antonio Express News and Houston Chronicle.

 

 

See related posts:

How to Evade Taxes Offshore – Wyly Style

Death and Taxes and Fairness

Taxes and the Carried Interest Loophole

Real Estate Tax RantThe Problem of Tax Code Complexity

Adult Conversation about Income Taxes

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School Finance And My Tax Bill

school_taxI got my real estate tax bill in the mail recently, and noted with horror that more than half of my annual chunk of flesh goes to my local school district. That chunk for schools got 16 percent bigger this year compared to last year, and on November 8th we’re being asked to vote yes for a bond and a “TRE” to make that wound permanent. As I finance guy, I like to understand why.

The immediate “why” dates back to a May 2016 ruling by the Texas Supreme Court that variously described the state public school finance system as Daedalean, Byzantine, Augean, and an “ossified regime ill-suited for 21st Century Texas.”

Clever classical references notwithstanding, the court also declined to intervene, found the system met “minimum constitutional requirements,” and referred future financing changes back to the state legislature. Immediately following that decision, school districts like my home district of San Antonio ISD began scrambling to find sources for much needed funding. Hence, my increased tax bill, and the ballot question to ratify that increased bill.

SAISDResidents in the San Antonio ISD residential area – like me – are asked to vote November 8th for two increased funding items. The first is a run-of-the-mill $450 million bond vote, the proceeds of which are limited by law to capital improvements like renovations of school buildings.

The second vote, for a Tax Ratification Election – or TRE – is a bit more unusual and offered me a window into the weird world of public school financing. Since bond money proceeds can only be spent on buildings – the “hardware” of education – TRE money pays for for improvements in the “software” of education, such as educational programs.

The need for this particular TRE vote arises from the peculiar funding rules and history that govern public school finance in Texas.

History of funding

Both nationally and in Texas, we initially fund schools at the municipal and county tax level rather than at the state or national tax level. This results, naturally, in huge inequalities in school funding based on property tax and property value differences across cities and towns.

Next, at least in Texas, we sue the legislature over unequal funding levels, as happened in 1989 when Edgewood ISD along with others won a state Supreme Court case based on this inequality.

The state then created mechanisms for roughly equalizing the distribution of money, primarily through a state fund called the Foundation School Program (FSP.) Money for the FSP come from a combination of state allocations and funds recaptured from property-wealthy districts, such as I described in Houston ISD last week.

Even though the burden of funding still sits with locals, in 2006, the state legislature ratcheted downward the amount of tax that local districts could raise, from $1.50 to $1.00 per $100 in property tax value. For example, a $200,000 house taxed at $1.00 per $100 in tax value would generate $2,000 in school taxes, rather than the previous $3,000 in taxes at the $1.50 rate.

That would normally be great because – “Hey look! Lower taxes!” – but the state legislature realized subsequently that if local districts don’t tax enough, the state would have to make up the difference with the FSP (state money). So that had to be undone, or else we’d have to raise more state taxes. Also, in the case of Texas in particular, a statewide income tax or “Ad Valorum Tax” is unconstitutional, so taxing decisions have to be – or at least appear to be – made at the local rather than the state level.

Between the 2009 and 2013 legislatures, a system emerged to incentivize more local taxation, presumably to relieve the legislature from providing more funds at the state level. As local districts raise more revenue locally, approaching $1.17 per $100 of property value ($1.17 is the new state cap on local taxation) the state will match some of that money through the FSP.

And that increase in property tax to capture matching state funds for your local school district are what’s at stake on the ballot in San Antonio ISD, and where many other school districts in Texas will look to raise money in the future. The $0.13 bump on my ballot of $1.04 to $1.17 per $100 property value will increase taxes on a $200,000 home by $260 per year.

My school district hopes to ratify the tax raise to the tune of about $15.6 million from local taxpayers, with the promise of about $16.5 million in matching state funds from the FSP.

Is that clear? Or clear as mud? This kills me with how confusing it is.

Look, I’m pretty good at bond math, cash flows, and spreadsheets. I have watched live presentations on the bond and TRE question; I’ve watched multiple video presentations online; I’ve read the entire 100-page Supreme Court ruling from May 2016; and I’ve sat down for long one-on-one conversations with SAISD officials – and I still find this ballot question incredibly confusing.

By state law, I understand this has to be a ballot question for voters, but honestly, there is no way for informed citizens to actually understand and vote on this other than an unsophisticated choice between: “Public Schools (Good!)” or “Taxes (Bad!)”

And that’s upsetting to me. When an issue is as confusing as public school finance is in Texas, you should always ask yourself – who benefits from the complexity and who loses?

I complained about this complexity to Seth Rau, SAISD’s Legislative Coordinator, who assured me, depressingly, that Texas is right in the middle of the pack nationwide when it comes to school finance complexity. Rau joined SAISD in 2015 from Nevada – as did Superintendent Pedro Martinez – where school finance is just as confusing. According to Rau, 45 of 50 states have tried to settle school finance problems through lawsuits. So I guess we don’t have a monopoly on “Daedalean,” “Augean,” and “Byzantine” systems here in the Lone Star state.

Full disclosure: public school finance feels very personal for me, with two kids in San Antonio ISD. As a parent of a first grader and sixth grader, I pinball between frustration with and empathy towards my school district, which at times appears intent on undermining positive student outcomes and at other times seems like it’s doing God’s Work Here On Earth under near-wartime conditions.

 

A version of this post ran in the San Antonio Express News and Houston Chronicle.

 

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