Monday, July 11, 2016

Story of the Week: Auditing the Presidential Candidates’ Tax Proposals

Part one of a two-part series. By noted Austrian Christopher P. Casey, CFA ®, managing director at WindRock Wealth Management, in Naperville, IL, USA.

Economic intervention by government derives from monetary, regulatory and fiscal (taxation and spending) policies. While all three possess great potential for mischief and misery in bulk, fiscal policy stands alone as a subject in political races. Taxation, in particular, evokes strong emotional responses from voters who instinctively chant “soak the rich” or plead for tax relief.

History, however, does not support knee jerk reactions about presidential tax policies. The labels of Republican and Democrat bear little correlation with increases or decreases in tax rates and code complexity: for every Reagan there is a Kennedy, and for every Bush (pick either) there is a Roosevelt. Presidents, not parties, ultimately guide tax policy.

By what criteria should tax policies be judged? Overall magnitude, simplicity and fairness should be the bright lines. With this in mind, and while unrealistically ignoring any difficulties in passing tax legislation through Congress, what would a sober assessment of Republican Donald Trump, Democrat Hillary Clinton, and Libertarian Gary Johnson tax platforms conclude?

Unsurprisingly, due to his business background, Trump’s platform pushes for dramatically lower tax rates for both individuals and businesses across the board. Ordinary individual (head of household) income tax rates would be capped at 25 percent (from the current 39.6 percent) with other tax brackets equaling 0 percent, 10 percent and 20 percent.

These brackets would also be expanded substantially:

  • Those earning up to $37,500 would pay no income tax;
  • Individuals earning up to $75,000 would pay 10 percent (the current bracket ends at only $13,250); and
  • Anyone earning less than $225,000 would pay no more than 20 percent in ordinary income tax.

Businesses would likewise enjoy massive tax reductions as rates would drop from 35 percent to 15 percent. Equally impressive, the magnitude of tax rate reduction would be matched by tax code simplification. For individuals, numerous exemptions and complexities (e.g., life insurance interest, Alternative Minimum Tax, etc.) would be eliminated while the number of tax brackets would drop from seven to four.

Also, the estate tax and all of its required filings would be eliminated.

Not all of Trump’s proposals are positive since, presumably in a misguided attempt at “fairness,” pass-through businesses (e.g., S corporations and partnerships) would be taxed at 15 percent (which may be beneficial in certain situations but does introduce double taxation when dividends/distributions are made), and carried interest taxes for individuals would be at ordinary income tax rates instead of at capital gains tax rates.

Overall, however, Trump’s tax plan would be a significant boon to the economy as a whole and to every household individually.

Clinton’s tax platform, though, proposes significant tax rate increases and voluminous additions to the tax code. To wit:

  • A new individual tax bracket of 43.6 percent would be added for those earning $5.0 million and above;
  • Long-term capital gains tax rates would increase to between 27.8 percent and 47.4 percent;
  • The estate tax rate would revert to 2009’s 45 percent (from 40 percent) with the exemption lowered to $3.5 million (from today’s $5.45 million); and
  • Tax-free or tax-deferred retirement accounts would be limited in total value.

Given the current state of U.S. government insolvency, many may object that the Clinton tax plan would raise revenue and lower debt levels. However, the static models utilized to project tax revenue additions from tax rate increases fail to account for the lower economic activity (the ultimate source of tax revenue) attributable to these same taxes.

And even if the Clinton plan did increase tax revenues, history has demonstrated that increased tax revenues possess little correlation with decreased debt, but significant correlation with increased spending. While Americans may have been spared from “Feeling the Bern,” they may end up burned nonetheless.

The Johnson tax platform deserves a separate column, for it is not one of magnitude, but rather of nature, and thus requires additional discussion in next month’s column.

However, platforms, like promises, are frequently broken, ignored or rendered unfeasible in the world of politics, so while the contrast between each candidates’ tax proposals may appear dramatic, the ultimate tax profile of American households and businesses may change very little in the years ahead.

Look for part two from Mr. Casey in an upcoming post. He can be reached via email at chris.casey@windrockwealth.com.

http://www.austrianinvestmentreport.com/

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