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The Myth of Beneficial High Tax Rates

May 5, 2021|

The inequality narrative driving tax policy this year is built on three shaky foundations: (1) that the rich have captured all the economic gains in recent years, (2) that Americans support very high tax rates, and (3) that America thrived under much higher tax rates than are being considered today.  S-Corp addressed the first two fallacies (here and here).  A recent Senate Finance Committee hearing on how to make the tax code fair provides a good example of why the third leg is just as unstable.

The hearing featured Abigail Disney, who is part of the group Patriotic Millionaires and supports higher taxes on income and wealth.  She is also the granddaughter of Disney cofounder Roy Disney and inherited a sizable fortune.  According to Ms. Disney:

Corporate taxes are at an all-time low, and shameless corporate tax avoidance at an all-time high. Trillions of dollars are currently being stashed overseas in tax havens by fortune 500 companies in ways both quasi legal and potentially criminal. All of this value accrues once again to managers and to shareholders like me.

Ms. Disney provided similar testimony a few weeks ago before the Senate Budget Committee, where she made clear that, even as he built his empire, her grandfather took a very modest salary from the company:

In 1965, the average CEO made 21 times the salary of the typical employee at the company, whereas today their pay averages around 320 times. Studies of corporate efficiency, however, have not revealed anything close to a 320 times advance in efficiency, profitability, or research and development. CEOs, in other words, aren’t 320 times better than they were in the 1970’s. 

So Roy Disney amassed a huge fortune despite high tax rates and paying himself only a modest salary?  Something is missing here.  Those who understand the history of taxation in the U.S. know the answer to the riddle.  As Vox posted a couple years ago:

In the 1960s and 1970s, companies usually reinvested their profits rather than giving raises to executives — the high tax rates meant those salaries would be largely taxed away. Reinvesting the money ultimately benefited shareholders in the company by increasing the company’s value, and benefiting shareholders means benefiting rich people. Owning corporate shares was much rarer for middle-class people in the ‘60s and ‘70s before the rise of 401(k)s and IRAs.

Roy wasn’t paying himself a modest salary out of solidarity with his workers; he was doing it as a tax avoidance scheme.  One of the challenges in comparing CEO compensation today to prior decades is the differing tax treatment.  What’s seen as an era of more reasonable CEO pay can just as easily be explained as an effort to minimize tax bills.

As you can see from the table, taxpayers in the 1950s had a choice of paying top marginal rates of 91 percent on their wage and salary income, 52 percent on their corporate income, or 25 percent on their capital gains income.  With those choices, you’d be crazy to take your income as wages and salary.

The challenge was to shift the income someplace where it would get more favorable tax treatment.  In this case, Roy and his brother Walt were building their successful empire, which meant they had a ready-made C corporation to shelter their income and build wealth.

The trick was to reinvest earnings and increase leverage to reduce the corporate income subject to tax.  By reinvesting profits and borrowing to finance expansions, even profitable businesses could have little or no taxable income at the end of the year.  As Phillip Magness observed:

The mid-century tax system only functioned because policy makers in that era intentionally used a complex system of exemptions, deductions, incentives, loopholes, employment-related benefits, and legal shelters for certain income sources to reduce effective tax rates well below the statutory rates.

In other words, the tax code in 1950s and 60s combined extremely high rates that nobody paid with a very narrow, loophole-ridden tax base.  It’s the opposite of good tax policy, and certainly nothing to emulate today.  You can see the combined effects of these policies in the effective rates – the taxes that were actually paid – from those decades.

Shifting income from salaries to corporate profits and capital gains may have allowed wealthy taxpayers to keep more of their income, but it came at a cost.  It was highly inefficient and resulted in decisions being made for the sake of the tax code rather than the business.

The 1986 Tax Reform Act changed all this.  It lowered rates and eliminated many of the loopholes and other provisions used by the wealthy to avoid taxes and to amass their fortunes.  As S-Corp Advisor Tom Nichols told the Ways & Means Committee years ago:

In this regard, the bipartisan Tax Reform Act of 1986 stands out as an excellent template for Tax Reform. It expanded the tax base by eliminating numerous preferences and privileges for specific taxpayer groups, thereby creating room to dramatically decrease the tax rates for C corporations, pass through businesses and individuals alike.  This approach allowed many, if not most, owners and managers to get out of the tax planning business and immerse themselves in the operations of their real businesses instead.

Now, motivated by questionable economic studies and a desire to punish success, the Biden Administration wants us to return to the pre-1986 days where corporate tax shelters dominated the economic landscape.  It won’t help address real economic disparities, it won’t be good for family businesses, and it won’t be good for America.

Talking Taxes in a Truck Episode 9 – Tax Foundation President Scott Hodge

April 28, 2021|

Scott Hodge, President of the Tax Foundation, joins to discuss details of the Biden administration’s latest tax proposal, the economic effects of policies being considered (spoiler alert: they’re not good), and his recent appearances before the Senate Finance and Budget committees. Scott also shares his predictions on the Washington Nationals’ prospects this year, and debates Brian on motorsports.

Our latest “Talking Taxes in a Truck” podcast was recorded on April 28, 2021, and runs 21 minutes long.

 

Are the Pollsters Wrong on Taxes?

April 26, 2021|

Politico recently ran a story about the soul-searching taking place in the polling community, whose 2020 projections predicted a landslide victory for Joe Biden and an significant expansion of the Democratic majority in the House.

“Twenty-twenty was an ‘Oh, s—‘ moment for all of us,” said one pollster involved in the effort, who was granted anonymity to discuss the process candidly. “And I think that we all kinda quickly came to the point that we need to set our egos aside. We need to get this right.”

That’s about where the answers end. The collaboration’s first public statement acknowledges that their industry “saw major errors and failed to live up to our own expectations.” But the memo also underscores the limits of the polling autopsy, noting that “no consensus on a solution has emerged.”

Meanwhile, as Axios observed, the Biden Administration is relying on polling to promote its massive, $3 trillion tax package.

The top pollster for Joe Biden’s presidential campaign is advising the White House to do something that often makes Democrats nervous: Talk loudly and proudly about raising taxes on the rich.

John Anzalone tells Axios his extensive polling and research has found that few issues receive broader support than raising taxes on corporations and people earning more than $400,000 a year.

In other words, the very pollsters who assured us that Democrats would run up the score in November are now advising Biden to push hard on tax hikes. They admit they don’t really have an answer for how they got 2020 so wrong, but that isn’t slowing their roll in 2021.

Is it possible they are, once again, misjudging Americans’ views, this time on taxes?  We think so.

The reality is that Americans consistently oppose high tax rates, regardless of who’s paying them. Back in 2019, the Winston Group asked voters: “For each of the following, what is the maximum rate at which you think they should be taxed?”

Categories included the wealthy, family businesses, and public corporations, and the average responses were all consistently low, topping out at 31 percent for the wealthy and coming in as low as 17 percent for small and family-owned businesses.

The irony here is that wealthy Americans already pay more than 31 percent of their income to the federal government.  This table from the Joint Committee on taxation shows the effective marginal tax rates – the average tax paid on new income — paid by different income classes.  According to the JCT, top income earners pay an EMTR of 42 percent, or about eleven percentage points higher than the maximum Americans think they should pay.

 

 

The results gap between John Anzalone’s “extensive polling and research” and the Winston Group’s survey ultimately boils down to the fact that most Americans are unaware of real tax burdens — what Americans think is fair verses what they think businesses and individuals actually pay.

That’s no surprise as most press coverage tends to focus on tax havens, loopholes, and tax cheats rather than taxes paid, but it does present the business community with a unique challenge. In the fight over tax policy, one priority needs to be educating the American people on who pays what.

For the Biden Administration, their challenge is to view those rosy tax hike poll numbers with a little more skepticism. They are brought to you by the same folks who blew the 2020 elections, after all.

 

SALT Parity Promises Billions in Main Street Relief

April 23, 2021|

More good news on the SALT Parity front.  New York has become the 10th state to adopt our reform legislation while a similar bill is sitting on the desk of the Georgia Governor awaiting his signature, which would make 11.

Those states join Connecticut, Wisconsin, Oklahoma, Louisiana, Rhode Island, New Jersey, Maryland, Alabama, and Arkansas in passing SALT Parity, while a dozen others are actively considering similar bills. Illinois is new to this list, following yesterday’s unanimous vote in favor of S.B. 2531 in the state Senate.  The map below shows the current status of SALT Parity legislation.

 

 

So of the 41 states that tax pass-through businesses at the owner level, more than half have either adopted our SALT Parity reform or are actively considering it.

This is a big deal to the S corporations and partnerships in those states.  The disparate SALT treatment they experience puts them at a significant disadvantage compared to their C corporation competitors and compared to entities operating in states with no income tax, like Texas and Florida.

Billions are at stake.  The Michigan Department of Taxation, where a SALT Parity bill is moving, estimates the legislation would save Michigan S corporations and partnerships $190 million per year.  Using IRS data and the fiscal notes published by other state revenue agencies, we roughly estimate that more than three million S corporations and partnerships would benefit from $5.9 billion in annual relief.

Even for smaller firms, those savings can amount to several thousands of dollars each year.  That’s a significant amount, particularly as those affected by the cap are often the same businesses that have been hardest hit by the pandemic.

Our SALT Parity map tracks the progress of states across the country in moving SALT Parity legislation.  If your state is in green on this map, congrats.  If your state is in blue, that means there’s no legislation under consideration.  If you want to change that, give us a call.  Your state’s inaction is literally leaving money on the table and costing your Main Street employers millions.

A Little Reality on the Tax Gap

April 20, 2021|

IRS Commissioner Charles Rettig made news last week when he endorsed a new tax gap estimate from, among others, French economist Gabriel Zucman.  We reviewed the Zucman paper here and found it typically wanting – questionable assumptions and methodologies leading to improbable conclusions.

That didn’t stop Rettig from endorsing the estimate, however.  Well, he sort of endorsed it.  Here’s what he actually said, according to Bloomberg:

Internal Revenue Service Commissioner Chuck Rettig told a Senate panel Tuesday that previous tallies of the tax gap — which came to a cumulative amount of about $441 billion for the three years through 2013 — didn’t include some tax evasion-techniques that weren’t on their radar at the time.

New estimates include the use of cryptocurrency, he said. Offshore tax evasion, illegal income that goes undetected by the IRS and underreporting from pass-through businesses also contribute to a larger than previously known tax gap, Rettig said.  “I think it would not be outlandish to believe that the actual tax gap could approach and possibly exceed $1 trillion per year,” Rettig told the Senate Finance Committee. [Emphasis added]

Any statement that includes the phrases “would not be outlandish to believe” and “could approach and possibly exceed” is hardly definitive, especially coming from the organization that’s spent more time studying the issue than anybody.  Howard Gleckman of the Tax Policy Center said it sounded “like a man just trying to get his budget increased.”  It sounded to us like a man uncomfortable with the talking points put in front of him.

This kinda-sorta statement didn’t slow the press any, who pounced with typical enthusiasm.  The New York Times won the Most Ridiculous Headline award, claiming: “Tax cheats cost the U.S. $1 trillion per year, I.R.S chief says.”   Members of Congress quickly followed suit.  As Law360 reported:

Several key Democrats said the rough estimate by the Internal Revenue Service commissioner, Chuck Rettig, of a current annual tax gap of $1 trillion would bolster support for more IRS funding and enforcement measures targeting businesses and wealthy taxpayers. That estimate, which Rettig gave in a Senate hearing on Tuesday, is up from the official estimate of $441 billion annually from 2011 to 2013, before factoring in late payments and enforcement work.

Given all this, our question is:  Is there any hope for a dose of reality in the tax policy debate this year?

The answer is yes.  One person did step up.  Former National Taxpayer Advocate Nina Olson – who spent nearly two decades looking over shoulders at the IRS – offered a refreshingly skeptical view:

Speaking on an Urban-Brookings Tax Policy Center webinar April 15, Olson said her reaction to Rettig’s announcement was “Where did that number come from?”

Olson, who headed the Taxpayer Advocate Service from 2000 to 2019, faulted the IRS commissioner’s sourcing, methods, and assumptions in calculating a $1 trillion tax gap.  Rettig’s inclusion of underreported taxes on cryptocurrency transactions, as well as research the IRS contributed to finding up to $175 billion in offshore entity underreporting, “still doesn’t add up to $1 trillion,” Olson said.

Host Howard Gleckman then asked Olson how big of a problem the tax gap really is:

Equating the entire tax gap to “tax evasion” is just so disingenuous. And it’s also wrong; it’s incorrect. Evasion has a technical meaning under the law, and generally it requires mens rea, a criminal intent. So much of it is error, or inadvertent…there are a bunch of different types of noncompliance. And if you say [it’s all tax evasion] – and that’s what the Washington Post called it, that’s what the New York Times called it – then that creates distrust among the taxpayers of the tax agencies. [They’re asking], “why am I paying if you’re letting all these people off the hook?”

Finally, Olson reminded webinar viewers that the tax gap is relatively small – just 16 percent of taxes owed.  For perspective, that’s one of the best collection rates in the world, which poses its own challenge as every additional dollar collected at the margin is “harder to get.”

The tax gap has always been the Holy Grail of congressional pay-fors.  It doesn’t require new taxes, just better enforcement of existing rules.  But like the Grail, it’s proven to be an elusive quarry.  As Olsen points out, a large percentage of the tax gap is the result of taxpayers who are broke and simply unable to pay what they owe.  No amount of IRS funding will collect that money.

To summarize: economists with a history of questionable work and an aggressive political agenda write a working paper, the IRS commissioner references it in the weakest possible terms, and now we’re ready to legislate.  The tax gap is an important challenge and it deserves an honest discussion.  You’re not going to find that discussion in anything associated with the Zucman paper.

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