Trump’s Unilateral Tax Cut Proposal for the Rich is a Political Gift to Democrats

Posted in: Tax and Economics

Amidst the now-typical blizzard of Trump-related fresh controversies this week was an announcement by the Treasury Secretary that his department might give another tax cut to wealthy investors. This idea is at best economically naïve and legally indefensible. Mostly, however, it is politically suicidal.

The story broke in a New York Times article on July 30: “Trump Administration Mulls a Unilateral Tax Cut for the Rich.” Before getting into a discussion of Trump’s proposal, however, I should note that the reporters who wrote that article, Alan Rappeport and Jim Tankersley, did a masterful job of covering all of the relevant issues. Given how frequently I have criticized articles in The Times and The Washington Post, especially articles about tax policy (see, for example, my comments in this Dorf on Law column last year), I am happy to give the credit that is due in this case.

Indeed, most of the media coverage of this mini-travesty has been remarkably spot-on. Perhaps that is because Treasury’s idea is transparently bad in every way, but in any case, this is a moment in which it is enjoyable to see nearly everyone stop pretending that tax ideas are too complicated to talk about coherently and that everything must be given the both-sides-are-equally-wrong treatment.

The bottom line is that this regressive tax cut will almost certainly never happen. Here, I will explain what the idea is, why it is going nowhere, and why it will likely be so damaging to Republicans politically nonetheless.

Trump Fixes Small Problems When They Affect Him and His Rich Friends

The United States has been experiencing very low levels of price inflation for decades. For those of us who are old enough to remember President Richard Nixon’s wage-and-price controls and, shortly thereafter (but unrelated to those controls) the “stagflation” caused by oil price spikes at two points in the 1970s, a world with very mild inflation is a pleasant reality that we did not expect when we were growing up.

Actually, inflation can be too low, which has been true for the past few years, with monetary policymakers at the Federal Reserve persistently failing to reach even their target level of a two percent annual rate of inflation. (Even that target level, in fact, is arguably too low, for economic reasons not relevant to the subject here.)

Back when inflation was relatively high, it was very important for people to reorganize their lives to anticipate and counteract inflation. Retailers openly encouraged people to “buy now, before prices rise.” Unions demanded larger and more frequent cost-of-living adjustments. And at the federal level, Congress in 1981 (ironically, just as the era of high inflation was ending) decided that it could no longer count on its own ability to adjust the tax code frequently enough to counteract the inadvertent injustices that inflation could create.

That 1981 bill famously adjusted tax brackets each year to prevent “bracket creep,” that is, to make sure that people will pay progressively higher tax rates only when they receive higher inflation-adjusted incomes, not merely because they receive higher nominal incomes that merely keep pace with (or even fall behind) inflation. Again, Congress had been adjusting brackets on an ad hoc basis for years, but it finally decided in Ronald Reagan’s first major legislation to make the process automatic, with the IRS issuing new brackets every year based on a legislated formula.

Even though Congress explicitly indexed tax brackets, however, it very prominently did not index the entire tax system. There are all kinds of provisions in the tax code that include specific dollar amounts that are not adjusted for inflation. For example, businesses can deduct no more than twenty-five dollars’ worth of any gift, and that number has remained unchanged for decades. Similarly, a complicated provision in the section dealing with alimony requires taxpayers to plug $15,000 into an equation, with that number also not being indexed to inflation.

In fact, the Treasury Department issues a document every year that updates all of the numbers that Congress has explicitly required to be adjusted for inflation. Every provision that is not included in that annual list is not adjusted for inflation.

One of those un-indexed provisions is the measure of the cost of an investment that is subtracted from the sale price of the investment to determine a “capital gain.” That is, if a person buys a piece of land for $10,000 and sells it for $30,000, the law says that the taxpayer must pay tax on $20,000 of income, which is the difference between the $30,000 sale proceeds and the $10,000 initial cost.

What about inflation? Congress has never said that the “cost” provision (in Section 1012 of the Internal Revenue Code) is to be adjusted for inflation, thus Treasury has never done so. Is that fair? In one respect, it obviously is not; but that is only a small part of the story.

Even with low inflation, holding an investment for a number of years can result in an increasingly incorrect computation of gain. Even if inflation runs at only two percent per year, for example, a $10,000 purchase price ten years ago would be the equivalent of about $12,200 (due to compounding) today. Therefore, the inflation-adjusted gain upon a sale for $30,000 would be $17,800, not $20,000.

So as a matter of simple economics, Section 1012 mismeasures the cost of an investment, and that means that the taxpayer pays taxes on a number that is somewhat larger than it should be. Is that a big enough problem that it needs to be fixed? Congress has not thought so, including the tax-cut-frenzied Congress that passed its unpopular mess of a regressive tax bill this past December.

More to the point, the failure to index the cost of investments when computing capital gains is more than offset by the highly preferential rate that Congress has set for taxing those gains. The richest taxpayers now pay a 37 percent rate on their salaries but only a 23.8 percent rate on their capital gains.

In addition, capital gains taxes are only paid when a taxpayer sells the item (if ever), which means that even if an investment is making a person $2,000 richer per year for ten years, she does not have to pay taxes until she chooses to sell it. Because of what is known as the “time value of money,” this amounts to an interest-free loan to wealthy taxpayers.

So the small-bore unfairness of failing to index the cost of investments is more than made up for by much bigger giveaways to wealthy investors.

And we are definitely talking about truly wealthy investors. As the Times article points out, “more than 97 percent of the benefits of indexing capital gains for inflation would go to the top 10 percent of income earners in America. Nearly two-thirds of the benefits would go to the super wealthy—the top 0.1 percent of American income earners.”

How can that be? The answer is that most non-rich people own either no investments or their investments are otherwise tax-protected (such as retirement accounts), so Trump’s Treasury plan would clearly and almost exclusively benefit people like Trump himself and the very few people who can rearrange their finances so that they receive income in the form of capital gains rather than salaries.

Might this possibly trickle down, with the benefits of this $100 billion tax cut (over the next ten years) somehow showing up in workers’ paychecks? Not a chance. Even the economic models that implausibly suggest that cutting tax rates on the rich and businesses will have trickle-down benefits do not predict any positive impact of Treasury’s plan. This is a pure giveaway to the rich.

The Legal Terrain: No Good Argument for Presidential Unilateralism

What about the peculiar idea that, rather than proposing to have Congress amend Section 1012, Trump’s people are simply planning to do so through executive fiat? The irony is rich, as Jonathan Chait pointed out in a column earlier this week:

Do you remember the years and years of hysterical right-wing denunciations of unilateral executive action by the Obama administration? It’s possible, just possible, that they did not represent a principled belief about the limits of executive statutory interpretation.

Beyond the hypocrisy, however, the reality is that some executive actions are constitutionally permissible while others are not. Even if Republicans were consistently wrong in saying that Barack Obama was a tyrant who governed by decree, it is possible that this particular Treasury proposal would be within the president’s power. In fact, however, it is not.

The closest analogy to this situation is the so-called “carried-interest loophole,” which liberals have been trying to get Congress to close for years. That loophole, in fact, is precisely one of those maneuvers by which some wealthy taxpayers are allowed to incorrectly recharacterize their regular income as capital gains income, thus taking advantage of the lower capital gains tax rates that Republicans created for them.

As it happens, there has been a lively debate about whether that loophole could have been closed by executive action, which was a possibility when Obama was still president. I was among those who said that executive action would have been justified in that case, mostly because the carried-interest loophole had been created by administrative action in the first place. That is most definitely not what is happening here.

Two tax law professors, Daniel Hemel and David Kamin, wrote a fantastic paper earlier this year in response to early rumblings that Treasury might try to index Section 1012 unilaterally. Although the first President Bush’s administration had concluded that no such unilateral action is possible, conservatives now argue that an obscure 2002 Supreme Court opinion opened up the possibility of executive unilateralism.

As Hemel and Kamin showed, however, that precedent does nothing to advance the cause of Trump’s potential power grab. The Court did, indeed, interpret a different statute to allow an agency to define the word “cost” in a way that is inconsistent with Section 1012, but that conclusion was based entirely on the context of that other (non-tax) statute.

By contrast, the entire legislative history of Section 1012 makes clear that when Congress used the word “cost” it meant the cost in dollars at the time an investment was purchased. As I noted above, Congress frequently tinkers with the tax code, and it very deliberately passed inflation-adjusting provisions during the Reagan era (and it also adjusted the estate tax for inflation starting in 2013), yet it has never revisited Section 1012—even though, as Hemel and Kamin also point out, Congress has enacted a number of other ways in which the computation of a capital gain can be adjusted after the fact.

In short, if ever there were a situation in which an executive agency is foreclosed from disturbing a longstanding interpretation of a congressionally defined term, this is it. Therefore, news reports that say that any action by Treasury “might” be met with a lawsuit are understated in the extreme. Short of getting this case before a shameless Trump-appointed judge who is willing to place loyalty to Trump over adherence to the law (in a circuit with enough lawless judges to affirm such a ruling), this proposed regulation is dead on arrival.

The Politics Are So Bad for Republicans That This Is All Inexplicable

Even if the executive branch cannot unilaterally rewrite the legislation, Congress obviously can do so. Why not just have both houses of a Republican-dominated Congress pass this as stand-alone legislation? The short answer is that no one thinks that such legislation could pass, which is why Trump’s people are talking about this desperate workaround.

Part of the reason that such legislation would go nowhere is that it would require 60 votes in the Senate, and there is no way that nine Democrats would vote for this proposal. But when has that stopped Republicans before? They certainly could be trying to propose such a bill specifically to force Democrats to vote against it and thus be blamed by voters at the polls.

The problem, from the Republicans’ standpoint, is that Democrats would be applauded, not vilified, for killing this idea. Voters, even many Republican voters, would see this for what it is: a naked money grab by plutocrats who bankroll the Republican Party. Even some Republicans in the House and Senate might vote against it to prevent themselves from being attacked in upcoming elections.

And this is why it is so bizarre that Trump’s people would even float this trial balloon. Without even having a vote in Congress, the Republicans now own this extremely unpopular idea, and Democrats can spend the next 95 days until the midterms reminding voters that the Republicans are ultimately looking out for the super-rich. This would be but one talking point among many, and it fits nearly perfectly into the established narrative about Republicans’ solicitude for the moneyed class.

And even if some Republican tried to explain that the idea is merely to “fix” a problem caused by inflation, Democrats can respond that there are plenty of ways in which inflation harms people, most obviously including the effect that inflation has on the minimum wage, which has lost almost 20 percent of its buying power since it was last increased in 2009, yet Republicans have steadfastly refused to adjust the minimum wage for inflation. Why, Democrats should ask, are the Republicans only concerned about fixing inflation’s effects on the people who can afford to buy and sell investments for fun and profit?

In short, the Trump administration has handed Democrats a generous political gift. For those strategists who are worrying that the Democrats are too tempted to emphasize opposition to Trump himself (a concern that I do not share, but no matter), this is a perfect issue, because it reminds people of everything they suspected about Republicans’ priorities all along.

When the Republicans passed their hugely regressive tax bill last year, it was extremely unpopular. Republicans were sure that that would change, but the law has only become less popular over time, so much so that Republican candidates are affirmatively running away from talking about their own tax cut. Now, Trump’s people have given Republicans another political stinker to try to explain away. Democrats should say “thanks ever so much” and beat them over their heads with it.

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