The unanswered questions in Trump’s tax plan

Donald Trump has sought to re-energise the prospects for tax cuts and demonstrate progress in his first 100 days of office by unveiling a broad set of goals and principles for tax reform.

But while the president’s plan on Wednesday laid out ambitious targets for cuts to personal and corporate tax, it left reams of policy questions unanswered. Among the biggest holes: how the tax cuts would be paid for. Outside estimates suggested the measures could reduce revenue by trillions of dollars over 10 years.

Here are some of the key measures and unaddressed questions.

Corporate tax changes

As Mr Trump promised during the election, the plan pledges to cut the rate of corporate tax to 15 per cent from 35 per cent at present. It also ensured that small businesses with different legal structures would share the benefits of that low rate. However, there was no clarity on how this reduction would be funded or on the details of how so-called pass-through entities that comprise the majority of businesses would be handled.

Whereas House Speaker Paul Ryan has been advocating a 20 per cent corporate tax rate partially funded by an import tax that raises upwards of $1tn, the White House has refused to embrace that plan. Steven Mnuchin, Treasury secretary, has suggested higher growth will fund the corporate tax reduction, but this would not pass muster with Congressional budget watchdogs, whose views are procedurally important. 

Repatriation of foreign earnings

The White House promised a one-off tax levy on overseas earnings to encourage companies to bring them home. US companies have an estimated $1.2tn stranded in offshore cash piles, money they do not want to bring home because it would be taxed at 35 per cent under current law.

Attempts to access this sum through other means have spurred numerous tax avoidance ruses, including the inversion deals US businesses have used to move their headquarters overseas. Mr Trump, during the campaign, condemned those moves. But knowing the likely effect of his one-off levy requires knowing the rate — and the White House has not put a number on it.

Mr Trump’s campaign tax plan said 10 per cent. House Republicans have taken a more nuanced approach: an 8.75 per cent rate on cash and a 3.5 per cent rate on earnings already invested in assets such as factories. Setting the rate too low would alienate Democrats opposed to any corporate giveaways. Setting it too high would upset pro-business Republicans who do not want to see companies punished. 

Winners and losers on individual tax

Mr Trump’s team would reduce the number of individual income tax brackets from seven to three, lowering the top rate from 39.6 per cent to 35 per cent. Among the other key proposals are a boost to the standard deduction that reduces people’s taxable income, doubling the carve-out to the first $24,000 of a couple’s earnings.

Many other deductions are eliminated, but key deductions for mortgage interest and charitable contributions would remain. Among the other measures are the repeal of the estate tax and alternative minimum tax, which are unpopular with wealthy taxpayers, and the scrapping of an Obamacare-related investment income tax.

The change to the standard deduction would help ordinary families, but very wealthy families would benefit from the plan as well — in particular from the scrapping of the AMT, the investment income surtax, and the estate tax. The richest 10 per cent of taxpayers pay 90 per cent of estate taxes, according to the Tax Policy Center. 

Effect on hedge funds and private equity

Mr Mnuchin insisted the president would hold true to a campaign pledge to scrap a tax break on “carried interest”, which is worth billions of dollars to hedge fund and private equity managers. But the administration’s plans contained a separate potential win for the Wall Street crowd that would more than offset the pain.

Carried interest refers to investment profits on which managers of private equity and hedge funds currently pay less than most people, because they are taxed at a low capital gains rate rather than the income tax rate of a regular salary. Losing that benefit would matter little, however, if individual managers were able to classify themselves as businesses to take advantage of the promised new 15 per cent tax rate for small companies.

Mr Mnuchin said he was alert to the risks of wealthy individuals trying to put their assets into companies and would seek to prevent any abuse, but he has not said how.

Impact on the deficit

Given the thin detail in the proposals, Republicans were on Wednesday cautioning against attempts to cost the package as if it were a traditional tax plan. Nevertheless, attempts to do so suggest it would be immensely costly if not offset by revenue-raising measures (or stellar growth). 

The Committee for a Responsible Federal Budget estimated that over a 10-year period the proposals would lead to a loss of anywhere from $3tn to $7tn, depending on how the details pan out. Among the most costly proposals is the corporate tax cut, which loses $2.2tn, the reduction in the tax rate on pass-through entities (that is, businesses that pass earnings to their owners as individuals), the doubling of the standard deduction and the changes to the rates of individual income tax.

The plan’s defenders would argue this ignores the so-called dynamic effect of easing taxes — namely higher growth, which generates revenue.

However, the dynamic revenue score that matters most is the one produced by the Joint Committee on Taxation, a congressional watchdog that will run the numbers on whatever emerges from Congress. This uses highly conservative assumptions that will not show a big revenue fillip from higher growth. 

Prospects in Congress

The administration’s brief tax document was cooked up in short order after Mr Trump ordered his team to energise tax reform by putting forward a road map. One of the key questions now is how the proposals mesh with an existing plan from Mr Ryan, which aims to be revenue-neutral. 

Mr Ryan put a positive gloss on the proposals on Wednesday, saying the package was “along exactly the same lines that we want to go”, while Mr Mnuchin said the administration was on the same page as Republican leaders. 

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However, there are important points of division. For example, Mr Mnuchin has not ruled out a temporary tax-cutting package that increases the deficit — something many lawmakers would see as a resounding second-best compared with permanent, revenue-neutral reform.

Nor has Mr Trump embraced the critical revenue-raising cornerstone of House Republicans’ plans — namely a levy on imports known as the border-adjusted tax.

That said, nor has he definitively rejected it, leaving Republicans on the House Ways and Means Committee to continue debating the measure.

Indeed, for some lawmakers the mere fact that the president has waded so publicly into the debate has come as a welcome development. Presidential leadership is seen as essential for tax reform to happen.