Republicans Always Lose the Tax Fairness Debate, and Trump Turns It Into a Rout

The news coverage of The New York Times’s blockbuster report on Donald Trump’s taxes has been extensive. Although much of that coverage has been extraordinarily good, one persistent error has been repeated even by neutral sources.

Many reporters, and even some left-leaning pundits, have taken to saying that what Trump did is “perfectly legal.” The fact is that we simply do not know whether that is true. Because Trump refuses to release his tax returns (thus arrogating to himself an exemption from the norms of transparency that have long guided presidential candidates), there is no way to say whether Trump’s tax strategies were legal or illegal.

The source of the “perfectly legal” assertion is that a specific item on Trump’s 1995 return, the suddenly infamous “net operating loss” deduction (NOL), is most definitely legal. No one would claim that it is illegal to take an NOL (or any other) deduction when one is entitled to it. But that is not the whole story.

Even so, this is the argument that Trump’s campaign is now pushing, at least half the time. In the Vice Presidential debate on Tuesday, for example, Trump’s running mate Mike Pence asked Tim Kaine incredulously whether he did not take the deductions to which he is allowed. The message: You can’t fault a fella for playing by the rules, because you’d surely do the same thing.

“Nothing to See Here” versus “Look at that Genius!”

As I wrote shortly after the Trump tax story broke, that defense runs directly counter to the Trump team’s other defense, which is that he used his unique genius to craft super-special strategies that no one else knows about. The problem is that such strategies are like miracle diets or cures for baldness. They do not exist.

Many people want to think that there is something magical out there that no one else knows about, but the reality is that tax strategies that “only this one guy knows about” are typically either false bluster or illegal. To its credit, George W. Bush’s Administration did an excellent job of shutting down some very aggressive tax shelters in the 2000s, shelters that carried the stench of too-good-to-be-true tax miracles.

The only alternative, then, for Trump is to say that he did not do anything illegal, but that he can use parts of the tax code that other people cannot, because he is a real estate developer. He is not crooked, in other words, so much as he benefits from special treatment.

In Trump’s case, we do not know whether his claimed NOL deduction in 1995 was legitimate. Even if it were, we do not know whether his “loss” was an actual loss (one that reduced his net worth) or was merely a paper loss. If it is a paper loss only, then Trump would be getting a tax advantage even though he never really lost money.

Is that illegal? Maybe, and maybe not. For those who want to dive into some hypothetical tax strategizing, David Cay Johnston (the Pulitzer Prize-winning tax journalist) recently described some possible ways in which Trump might have used his putative losses to generate tax savings. Similarly, Max Ehrenfreund of The Washington Post offers a nice description of how real estate investors receive special treatment under the tax code.

Again, because of a lack of information, it is not possible to say whether Trump cheated on his taxes. It is only possible to say that there are ways in which he might have stayed within the law, but if he did, the parts of the tax code on which he relied—while well known to tax professionals and thus not a sign of any “genius” on Trump’s part—are not the kind of things that benefit people like Mike Pence and Tim Kaine, much less middle-class Americans.

Ultimately, therefore, the overarching issue raised by the Trump tax flap is what it means to be “fair” in taxation. And that is a political argument that Trump will never win, just as his party has been losing the tax fairness argument for decades.

The nothing-to-see-here approach to defending Trump goes something like this: Shouldn’t the tax code allow people to deduct losses just as they are required to include gains? The net operating loss provision was added to the tax code to reflect the possibility that a business could receive money in one year but pay expenses in a different year. Why let the different number on the calendar determine tax fates?

Even if—and again, this is still only an if—Trump’s situation was nothing more than that kind of timing issue, then Trump’s tax fairness argument does not do what he needs it to do. He needs to say that the tax system is fair to everyone and that he only relied on the tax benefits that happen to benefit him. Unfortunately for Trump (and especially unfortunately for the rest of us), the provisions on which he supposedly relied do not benefit everyone.

Nuanced Perfection or Rough Justice: Why Are There So Many Special Provisions for People Like Trump?

No tax code can cover every nuance of human and commercial activity, and if we tried to make the tax code sensitive to every possible situation, the Internal Revenue Code would be even longer and more complicated than it already is.

Take, for example, the tax treatment of a gift. In economic terms, a person who receives a gift is richer, which means that she has received income. Whether my employer pays me $10,000 or “gives” me $10,000, I am equally better off. Without a special provision, a tax on income would necessarily be also a tax on gifts.

Congress long ago decided that it did not like that idea, partly for practical reasons and partly as a matter of simply being human. Do we really want to ask everyone to include in taxable income the amount of money that they receive from Grandma and Grandpa on their birthdays? Trying to require people to do so would be prohibitively expensive as well as rightfully ridiculed.

Congress decided, therefore, that gifts should be excluded from the income tax. It then noted, however, that a lucky few people every year receive extraordinarily large gifts that no longer look much like a five-dollar bill tucked inside a Hallmark card. Thus was born the gift tax, which is imposed only on the largest gifts.

But even before getting to the gift tax, we have to know what counts as a gift that will be excluded from the income tax computation. Allowing people to say the magic word “gift” would be begging for rampant abuse. No one would earn a salary ever again, and bank accounts would not pay interest. Employers and banks would suddenly announce that everything is a gift.

That means that carefully crafted rules are necessary to prevent opportunistic behavior. Otherwise, applying Pence’s logic, anyone who did not take advantage of that gaping loophole would be a fool.

But if everyone can legally reduce their income taxes to zero, then you would need to come up with a different source of revenues for the government. Even Republicans have many government programs that they support. If the income tax code were so badly written and enforced that it raised no revenue, then we would simply have to impose a bigger estate tax, or a large national sales tax, or a poll tax, or something else.

The problem is that, when Congress has turned its attention to limiting opportunistic behavior in the tax code, it has been highly inconsistent in the way that it treats different categories of taxpayers. Homeowners who lose money on the sale of a home are not allowed to use the equivalent of an NOL, or even a current-year deduction. People with medical expenses are only allowed to deduct the excess beyond ten percent of their adjusted gross incomes, not the entire amount of their hospital bills.

Why the inconsistency? When Congress, and by extension the Treasury Department and the Internal Revenue Service, has to deal with a problem that comes in all shapes and sizes, not everyone can receive individualized justice. The result is what amounts to tolerable levels of injustice, or what is commonly called rough justice.

There are surely, for example, people who receive what in some Platonic sense truly are gifts, but they are not able to prove that the person who gave them money or property had the “detached and disinterested generosity” that the Supreme Court has ruled is required to exclude something from income as a gift.

If Congress really cared, it could write much more detailed code provisions, and it could further tell Treasury’s tax lawyers to write more detailed regulations—and, most importantly, it could fund the IRS sufficiently to allow it to administer the newly more-complicated tax code. Congress has chosen not to do so.

The most innocent version of Trump’s situation is that he happens to be in a business on which Congress has lavished a great deal of attention and for which Congress is willing to give every benefit of the doubt in every tax computation. This is why real estate is the least-taxed category of business in the country.

A less innocent (but still not criminal) version of Trump’s situation is that, when Congress decided to be excruciatingly careful not to ever allow rough justice to be too rough on the real estate industry, lobbyists were able to get Congress to provide illegitimate hidden subsidies from which only people similarly situated to Trump could benefit.

And this is why the political frenzy around Trump is so important. He cannot simply say that he did not violate the law. Even if that turned out to be true, people are rightly asking whether the law should be changed. A president ought to have a defensible argument on that kind of question.

The Tax Justice Debate and the Return of the Romney Gaffe

Trump is unable or unwilling to explain whether he thinks the tax code’s nuances should continue to be available in so many varieties to the wealthy, to businesses, and especially to the real estate industry. He cannot say that everyone should get the benefit of the doubt in every case, because even he admits that the government needs to collect revenues. He must, therefore, say whether he wants to continue to give special benefits to those who are already doing quite well.

Trump’s campaign has offered a moving target on tax policy (as on so many other issues). Through all of its vague iterations, however, what we have seen consistently is that Trump would lavish tax cuts on the richest Americans, especially owners of businesses. The middle class and poor would get crumbs, and there are even groups within the middle class who would do worse—because Trump’s advisors are willing to let justice be rough for those people, even though those people have done nothing wrong but would fall on the wrong side of some arbitrary lines.

As many people have recently pointed out, Trump has not even hinted that he would support changes to the special rules that apply to the real estate sector. For him to act as if he is somehow an innocent bystander is utterly disingenuous.

In fact, however, the problem is much more basic than that. The Trump approach to taxes is to say that the lucky people to whom Congress has been catering for decades will receive even more special and favorable treatment. And the heck with everyone else.

As I noted earlier, this means that Trump’s tax policy conundrum is all too familiar to Republicans. They talk about how complicated the tax code is, or how high taxes are, but when it comes to taking action, attention is always paid to those at the high end. This makes the tax code more complicated and less fair.

The most common defense from Republicans is to say that rich people really do not have it so good. For example, an Associated Press article on the Trump tax controversy cited a conservative economist who pointed out that the top one percent of earners pays 38 percent of all federal income taxes.

The implication is that, whatever Trump might have gotten away with, the rich are already paying more than enough. It is, in short, a variation on Mitt Romney’s infamous “47 percent” gaffe, in which the claim is that nearly half the country is getting a free ride from Democrats’ giveaways, leaving the rich to carry the burden.

But this is a classic misdirection play. Both the 38 percent number cited in the AP article and Romney’s 47 percent only include federal income taxes, not the entire tax system. Other taxes, especially state and local taxes—which Trump’s defenders have assured us that he pays, even if he is not paying federal income taxes—are notoriously regressive.

More importantly, the top one percent of earners earns much, much more than one percent of all income. Even if we were willing to settle for a non-progressive tax system, we would expect that higher-income people would pay more in taxes than everyone else. If the top one percent earned 60 percent of all income and only paid 38 percent of all taxes, that would be quite different from a situation where it earned 10 percent of all income.

In fact, as this chart shows, the overall tax system in the United States in 2016 is barely progressive at all. The top one percent receives 21.6 percent of all income and pays 23.6 percent of all taxes. This is hardly Sweden, and many of the highest-income people—which Trump claims to be—pay significantly less than the average.

Trump and the Republicans, therefore, continue to be stuck when it comes to winning the political debate on taxes. They want to say that “job creators” need these special tax breaks, when the evidence shows overwhelmingly that trickle-down economics (and certainly tax breaks for the real estate sector) does not increase economic growth.

Losing that argument, Republicans then change the subject, using misleading statistics to claim that it is only fair to reduce the supposedly onerous tax burden on rich people. But that is not true, either.

Having Donald Trump at the top of their ticket, therefore, should make it especially difficult for Republicans to continue to say these things with a straight face. But they have had a lot of practice, so I suspect that they are up to the task. No one else should be fooled.