How bad are Trump’s policy instincts? He’s taking tax advice from Kansas governor Sam Brownback
In the last week, Donald Trump has backed away a bit from his ridiculous ideas to retire the federal debt by selling national assets and has noted his approval of the Federal Reserve’s low interest rate policies in recent years. This may have led some to question whether or not his policy instincts are really all that bad. They are.
To see why, one needs to dig into his plan for federal taxes. The regressiveness of this plan has been well-advertised: about 40 percent of the $9.5 trillion cut would eventually go to the top 1 percent. But look beyond this bullet point and you’ll see that Trump’s plan is so convoluted that a key loophole it contains has largely escaped analysis. This loophole is a piece of tax policy so bad that, at an Urban Institute panel on tax ideas from the campaign trail, Joe Rosenberg of the Tax Policy Center deemed it the worst tax idea from the campaign. To put it even more bluntly, this loophole is so bad that even the resolutely pro-tax cut Tax Foundation doesn’t like it.
Luckily, we already have evidence of just how bad this loophole is. This is because it has already helped blow a hole in the revenue of the only entity that has adopted it: the state of Kansas.
First, some context. In a failed experiment of supply-side economics, Governor Sam Brownback of Kansas enacted steep income tax cuts in 2012, believing they would “be like a shot of adrenaline into the heart of the Kansas economy.” Unsurprisingly to anyone who has read the research in this area, this growth never materialized. Instead, from fiscal 2013 to fiscal 2014, Kansas’s growth performance ranged from average to worse-than-average, which is to say that all the tax cuts did was make individual income tax revenue fall off a cliff. Revenues plummeted from 2.11 percent of state GDP to 1.76 percent (for comparison, the states surrounding Kansas only saw their income tax revenue decrease by an average of 0.06 percent of state GDP). Faced with steep budget deficits and tax collections coming in consistently under projections, even some Kansas Republicans have lost patience. Governor Brownback, who has already raised regressive sales and excise taxes as well as cutting spending on necessary investments like education to cover deficits in previous years, refuses to reverse his regressive income tax cuts.
Exacerbating these cuts is a new and deeply strange tax loophole. As part of the cuts, Kansas also decided to reward tax avoidance by exempting “pass-through” income from the income tax. The income of a pass-through business entity is usually not taxed at the corporate level, but rather passed through to the owners who are then taxed at their individual income tax levels. By exempting this type of income even from personal income taxes, Kansas gave corporations an even larger incentive to reorganize as pass-through entities (which they already do plenty of) and gave individuals an incentive to call themselves independent contractors.
This led to—you guessed it—even more lost tax revenue for Kansas. This is because loopholes do not encourage growth, they encourage income-shifting and tax avoidance. In 2013, Kansas GDP shrank even as the number of pass-through entities grew extraordinarily. Kansas initially expected 190,000 to claim this exemption; in reality, about 330,000 claimed it in fiscal 2013. In 2014, Kansas GDP bounced back a bit, growing slightly slower than the national average. Pass-through exemptions held steady at around 330,000 in fiscal 2014. Combined with tax revenues consistently falling below projections, it is increasingly clear that this one-off growth of pass-through entities is not the result of magic supply-side growth, but rather run-of-the-mill tax avoidance.
This brings us to Donald Trump’s tax plan and the worst tax idea of the campaign trail. After Brownback’s tax cuts, the top individual state income tax is only 4.6 percent higher than what is levied on pass-through entities. This small-sounding 4.6 percent difference, along with sweeping cuts for the rich, has proved disastrous to Kansas’s public finances as individuals and corporations classify themselves as pass-through entities to dodge taxes. Trump pairs his own sweeping tax cuts for the rich with a top marginal income tax rate that is 10 percent higher than his proposed rate on pass-through entities. Rather than pay the 25 percent marginal rate, high-income tax payers will find a way to avoid it, instead paying the lower 15 percent rate on pass-through entities.
When Citizens for Tax Justice updated their estimates to account for this loophole, they found it would cost taxpayers an added $1.2 trillion and increase the tax break for those in the top quintile substantially. This means that Trump’s tax plan will cost even more money and be an even larger giveaway to high income tax payers than the headline estimates would imply. This is hardly policy pragmatism. Instead, it is just a new way to accomplish the old goal of Republican fiscal policy—minimize the taxes paid by the highest income households.