Jonathan Swan of Axios reports:
The Republicans on the House Ways and Means Committee — engaged in a high-pressure, high-stakes tax policy rewrite — are currently exploring not cutting the income tax rate for people who earn $1 million or more per year.
The current top rate of 39.6 percent kicks in at $418,400, and if you make between that and a million, your rate would fall to 35 percent, while income exceeding $1 million would stay at 39.6 percent. Take that, plutocrats!
This is a bit of a surprise, for two reasons. The first is that it appears to mean the wealthy would pay higher taxes. But that’s mostly an illusion, as I’ll explain in a moment. The second reason is that while Republicans talk a lot about “simplifying the tax code,” in practice the only specific idea they usually mention is reducing the number of tax brackets. While it might sound like “simplification” if we go from the current seven brackets down to three or four, in practice it makes absolutely no difference. If you’re doing your taxes, once your income is calculated and your deductions have been removed, you look up in a table how much tax you owe, and it really doesn’t matter whether you’re finding that number in one of three columns or one of seven (or more likely, your software calculates it for you either way).
Which is why many people (especially liberals) believe that we should have more brackets, not fewer. A person earning $500,000 is rich, but she could pay less in taxes than a person earning $5 million or $50 million. The Congressional Progressive Caucus’s budget, for instance, proposes five additional tax brackets for super-high earners, topping out at 49 percent for incomes exceeding $1 billion.
We have to be clear about one thing: If Republicans change the marginal rates so that people making more than $1 million will pay what they’re paying now, it’s still a tax cut for them. That’s because of how marginal rates work. If you make, say, $1.118 million, right now you pay 39.6 percent on all your income over $418,400, or $700,000 of what you made. But under this plan, you’d be paying 39.6 percent only on the amount exceeding $1 million. In that case, just $118,000 of your $1.118 million would be subject to the higher rate. Presto: tax cut.
But anything less than a big tax cut for the wealthiest of the wealthy fills Republicans with dread.
“The highest income earners are most sensitive to high marginal tax rates, and thus not lowering their rate is a missed opportunity to encourage additional work, saving and investment by a nontrivial segment of Americans,” Adam Michel of the Heritage Foundation told me by email.
I’m of the opinion that people making more than $1 million aren’t exactly being discouraged from working and investing under the current rates, but Michel made another interesting argument to me: “The higher top wage rate also increases the distance to the pass-through rate and thus increases the incentive to artificially recharacterize income to lower tax liabilities.”
What’s interesting about that? It’s very similar to what I was told by Josh Bivens of the Economic Policy Institute, a liberal think tank. When I asked Bivens about the idea of leaving the tax rate for those making more than $1 million where it is, he said, “In a vacuum I would probably be pretty happy about it.” But in the context of the Republican plan, Bivens said, “it’s going to be mostly meaningless, because even a lot of income at the current top rate is just going to be reclassified as pass-through income to take advantage of the new loophole they’ve created.”
What is the loophole they’re both talking about? The Republicans’ proposed change to the rules on “pass-through” income is a critical part of what makes their plan such an enormous gift to the wealthy. Right now, if you’re a consultant or a dentist or a lawyer, there’s a good chance your business is organized as a “pass-through,” meaning the profits go directly to you and you pay taxes at the normal income tax rates. If you made $100,000, your marginal rate is 28 percent (for a single filer); if you made $200,000, your rate is 33 percent; if you made anything over $418,400, your rate is 39.6 percent.
What Republicans propose to do is tax all pass-through income at 25 percent, which means that the richer you are, the bigger a gift it is. Let’s say you have some kind of consulting business and you made $100,000. You’re paying a 28 percent marginal rate now, so it’s not that big of a deal if your rate goes down to 25 percent.
But let’s say you’re a corporate CEO and you made $40.4 million last year. If you change your arrangement with your company so you’re now a consultant, and instead of giving you a paycheck they write a check to your “small business” of Fat Cat Inc., you’ve just saved yourself $5.8 million in taxes.
“I think you’d see a really substantial hemorrhaging of money” if all pass-through income is taxed at 25 percent, Bivens tells me. “People would use it pretty aggressively.” We should also note that there’s a certain company called the Trump Organization that is organized as a collection of hundreds of pass-throughs, meaning that the president stands to save millions of dollars from this change (though of course we don’t know exactly how much, since he won’t release his tax returns).
The implicit argument that Michel of the Heritage Foundation makes — that if a gazillionaire’s income tax rate is 35 percent, they won’t bother turning themselves into a small business to take advantage of the new 25 percent pass-through rate, but if their income tax rate stays at 39.6 percent, then they will — isn’t particularly persuasive. But it’s important to remember that the pass-through provision is only one of the pieces of the Republican tax proposal that benefits the wealthy. You’ve also got a large cut in the corporate tax rate, most of which will flow back to wealthy investors, and the elimination of the inheritance tax (good news for Ivanka, Donny Jr., et al.), which right now is only paid by that small sliver of estates worth more than $5.5 million.
In other words, even if they leave the tax rate for millionaires where it is, they’re going to be taking care of their patrons in the top 1 percent. And don’t be surprised if once they hear from the super-rich that they’d really prefer to pay as little as possible, this proposal to keep the income tax rate where it is for those making more than $1 million gets quietly shelved.