Episode: 194
Originally Aired: May 17, 2017
Topic: Economist Laurence Kotlikoff Grades the Trump and Ryan Tax Plan – and How You Can Take Advantage of Predictable Events
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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TOPICS COVERED:
- Introduction of Economics Professor Laurence Kotlikoff of Boston University
- Both Trump and Ryan Personal-Income Tax Plans Would Be Regressive
- High Marginal Tax Rate on Business Drives Away Investment, Employers
- Value-Added Tax Should Be Balanced by Wage Subsidy
- Eliminating Ceiling on FICA Tax Would Offset Tax Cut Revenue Losses
- House Plan’s Corporate-Tax Reforms Could Spur Economic Growth
- Trump Plan Is Only a Single Page and Unclear on Many Details
- House Tax Plan Grade Is B+ to A-; Trump Plan Is B- to C
- Politicians Lack Basic Understanding of Tax Mathematics
- Pass-Through Provisions in Trump Plan Would Encourage Cheating
- Deficit Has to Be Addressed for Tax Plan to Stimulate Economy
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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
1. Introduction of Economics Professor Laurence Kotlikoff of Boston University
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg, along with CPA and attorney Jim Lange. This week, our guest is renowned economist Laurence Kotlikoff. Professor Kotlikoff is a renowned professor of economics at Boston University. He served as a consultant to the World Bank, the IMF and several Fortune 500 companies, and, in 2015, he was named by the Economist magazine as one of the world’s 25 most influential economists. Dr. Kotlikoff is also the author or co-author of 17 books, including his latest, Get What’s Yours: The Revised Secrets to Maxing Out Your Social Security, which was a Number 1 Amazon best-seller. Our primary focus over the next hour will be the future of tax reform. Both President Trump and the House have their own tax plans, and Larry will help us understand the nuts and bolts of each plan, how they’re similar and different. He and Jim will also talk about what assumptions are safe for you to make and how you can act to maximize your investments in anticipation of these proposed changes. With that, let’s say hello to Jim Lange and Larry Kotlikoff.
Jim Lange: Well, welcome back, Larry. I always enjoy having you on the show. You have given us tremendous value in your analysis of Social Security, you have spoken about some of the political issues, particularly as it regards to the economy, and you’ve also talked about the importance of running the numbers, and I understand that you have some new software that we want to talk about for that. But the thing that really caught my interest is that you were just in the Wall Street Journal, I believe, on May 17th, and you had an op-ed, and you were talking about both the Trump tax plan and the House tax plan. Could you give our audience kind of the essence, if you will, of that article that appeared in The Wall Street Journal?
2. Both Trump and Ryan Personal-Income Tax Plans Would Be Regressive
Larry Kotlikoff: Sure, Jim. It’s great to be back with you. So, we have this major tax decision in front of us. There are two competing Republican plans. There’s the House Better Way plan that was developed about a year ago by the House Ways and Means Committee, the Republicans on that committee, and then we have the president’s plan. Now, both plans are pretty regressive when it comes to our personal-income taxation. Both plans cut the top rate. The House plan goes from like 39.6 percent down to 33 percent. The Trump plan goes down to 35 percent. They get rid of other things, like the alternative minimum tax. So there are some things that are regressive. There’s a few things that are progressive on the personal side in both proposals, but taken by itself, the personal-income tax side is going to be a money loser. It’s going to be regressive.
But then if you look at the business-tax reform, it’s actually a reform that economists like myself and other public-finance economists have been pushing for a long time, and it’s almost identical to a plan that Alan Auerbach, who’s a long-time colleague of mine, he’s a Berkeley Professor of Economics, he designed a tax reform on the business side back in 2010, and it’s actually a very progressive element and a much better business-taxation system than we now have. So if you combine the two parts of, let’s say, the House Better Way Plan, the business-side reform and the personal-side reform, the business-side reform is progressive and will help bring in some more revenue; the personal side is regressive and loses money. The two together, if the economy responds as some of my simulation studies suggest, could actually be revenue neutral or even make a little bit of money, and basically maintain progressivity where it is now. So what I wrote in the Journal is that the Better Way House plan is more progressive than people think and it will generate more revenue than people think, and the essence of the reason why the business part is progressive is that it’s taking us from having a very high marginal corporate-income tax — it’s been estimated that we have the highest, or pretty much the highest, of any developed country.
3. High Marginal Tax Rate on Business Drives Away Investment, Employers
So what we’ve been doing in recent years, with our very high marginal tax on investing in the U.S., is driving investment out of the U.S., driving companies out of the U.S., and when companies and their investment dollars leave the U.S., they leave the workers behind. So when you really look deeply at the corporate-income tax that we now have, you could come to the conclusion, which I do, which I hold, that the corporate-income tax is really a hidden tax on workers. It has this very high marginal tax on investing here, but it actually doesn’t collect a lot of money because of the loopholes that there are. So it collects half of the amount of money you’d expect, and so if you got rid of it entirely, you’d be getting rid of a tax that really is hurting workers, not the rich. The rich are just taking the money abroad and escaping the corporate tax, and I know Democrats may not think that, but they’re not economists, and this really is an economic issue, not a political issue.
So you’re starting with a tax on wages, and then you’re going under the House Better Way Plan to the combination of … essentially, what they’re proposing is a value-added tax plus the subsidies to wages. So if you look at exactly what’s getting taxed, it looks like a standard European style of value-added tax. It’s collected a little bit differently than they do in Europe, but ultimately, it’s a value-added tax and a subsidy to wages. Now, the key thing here is the value-added tax is really taxing consumption because if you look at exactly what a value-added tax is going after, it’s really an indirect way to tax consumption.
Jim Lange: We would think of that as a sales tax.
4. Value-Added Tax Should Be Balanced by Wage Subsidy
Larry Kotlikoff: Yeah, it’s like a sales tax, but it’s just done in a different way. So the language is different, but fundamentally, it’s like a sales tax. Now, suppose you have, like, a sales tax or consumption tax, and you know that workers are going to have to pay that out of their wages when they go to buy things, and that people with wealth are going to have to pay the sales tax when they spend their wealth. So a consumption tax is really taxing wages and wealth. But this particular business proposal, tax-reform proposal, is not just a value-added tax; it’s a value-added tax plus a wage subsidy at the same rate as the tax rate on consumption. So that wage subsidy is compensating the workers for having to pay taxes on consumption. So you’re going from this current situation, which is a tax on wages, to something that taxes consumption but insulates the workers from it, and then the only people that are really going to get hurt from that value-added tax are people that spend by consumption based on their wealth. So you’ve, in effect, gone from a tax on wages under the current corporate-income tax to a very subtle, but nonetheless very real, tax on wealth.
So here you have the Republicans. Think how ironic this is. You’ve got these Republicans who are proposing as part of their reform to unburden the tax on workers and put a tax on wealth. I don’t think most Republicans understand this. I don’t think most members of Congress get the economics of what it is they’re proposing, but that’s what they’re proposing, and most Democrats don’t understand that they should be applauding this because if some Republican, like Senator Grassley, came out and said, “I’d like to lower taxes on workers and put a wealth tax in place,” Nancy Pelosi would be overjoyed. If they do the same thing with different words, Nancy Pelosi’s going to call it regressive. That’s what she’s doing.
So what we need to do, Jim, is to have this tax bill passed. It has to be passed, but written up in two different languages; one maybe being in English for the Republicans and in Spanish for the Democrats, and when you translate the Spanish version, it would describe it as a reduction in wage tax, elimination of a wage tax and a tax on wealth, and then the Republicans would be happy. They’d get their bill passed. The Democrats would get their bill passed. They can claim to all their supporters that they just passed a wealth tax. And the economy will pick up because we’ll go from having one of the highest, if not the highest, taxes on investing in our country to the lowest, to actually a tax at the federal level of zero. Now, there’s still state corporate taxes, which are significant, but we’ve simulated this in a very large-scale model. I mentioned this in the Wall Street Journal article. I’ve been working with a team of economists in Russia and my grad students here and some other economists for several years now to make a very elaborate global model, and when you simulate U.S. corporate-tax reform in the model, you get a big impact. A lot of capital comes in, wages go up by about 8 percent, the GDP goes up by about 8 percent. So this is actually, potentially, a really good proposal, and it’s not coming from just right-wing Republicans. The business part of this proposal was really designed by a nonpartisan, apolitical, top-notch public-finance economist named Alan Auerbach, who I’ve written with since grad school. We were in grad school together, so we’ve written books together and all kinds of articles. We’re working together right now, and I mentioned him in The Wall Street Journal article because we have a study on my website, which is www.kotlikoff.net, which is a joint study we just released last week, which assesses this House Better Way Plan.
The Trump plan we’re not so keen on for a couple of reasons. In the House plan, there’s something called the border-adjustment tax, and that’s a very important component of that proposal to make sure that all of consumption is taxed that Americans do, and we have a true consumption tax, and all these other European countries that have value-added taxes have this border-tax adjustment. So it hasn’t destroyed their economy. We’re not talking about putting a tax on imports. It kind of has that initial appearance, but the exchange rates … this gets a little complicated, but exchange rates adjust so that there’s no real bias towards exports or away from imports. It’s just a wash on that score. So there’s no change in the relative cost of imports versus exports to American consumers. So Walmart, which has come out in opposition to this border-adjustment tax, they don’t understand the economics, same thing for the Koch brothers, or they’re playing a deeper game, which is they want to have this border-tax adjustment part of the plan eliminated, and then what you end up with is a tax on consumption, a value-added tax , a wage subsidy, and then, get this, Jim, you end up with a third component if you don’t do the border-tax adjustment, which is a subsidy to net imports. So think about Walmart. Walmart is importing a lot of stuff, right?
Jim Lange: Sure.
5. Eliminating Ceiling on FICA Tax Would Offset Tax Cut Revenue Losses
Larry Kotlikoff: They would love to see a subsidy to imports. It would help their business. So we want to do it the right way, and we can’t leave it up to the politicians to describe this, or the press. The press has been misdescribing the House bill for, especially The New York Times in article after article, they’ve been saying that this border adjustment represents a tax on imports. It doesn’t really. It’s just part of when you tax consumption, you have to tax all consumption, including goods that people buy from abroad and consume. That’s part of consumption. So it’s not really a tax on imports. It’s not changing our desire to buy American versus foreign goods when you look through carefully at the proposal. So I think the House plan is something we should adopt.
I also said in the op-ed piece that we should, just to make sure that this thing doesn’t lose revenue and that it absolutely is progressive as the current system, we should get rid of, at the same time, the ceiling on the FICA tax, and that would produce about $300 billion more in revenue, and our country is really desperately broke, so we need more revenue, and the reason we have so many bridges and other infrastructure that are crumbling is because we’re broke. The reason we can’t fund the National Science Foundation to the tune that we did in the past, or we can’t have as much defense spending as we have had in the past, is because we are broke. We have been spending decades engaged in take as you go, taking money from young people, giving it to old people who spend it in a variety of transfer programs, Medicare, Medicaid, Social Security, and they’ve consumed more.
The young people have been left with these bills, and right now, we have all of these off-the-book liabilities to my generation, I’m in the Baby Boom generation, and all my Social Security benefits, for example, are not on the books. All the Medicare benefits I’ll get in the future; not on the books. If I ever need Medicaid, it’s not on the books, and this stuff just swamps the official debt and it’s not going to go away just by keeping it off the books. So what we have is a kind of an Enron situation where the government has been hiding the liabilities off the books for decades now, both parties, and our true debt is about $200 trillion right now. It’s not $20 trillion.
If you look at the way economists measure a country’s fiscal position, they look at all the spending that is scheduled to happen in the future under current law, and then they look at all the taxes, then they take the present-value difference. So they value in the present all that future spending, and that spending includes servicing official debts, so we’re talking about every single dollar going out and every single dollar coming in. The net fiscal gap in the U.S. is about $206 trillion right now, and our official debt’s $20 trillion. So the true debt number is 10 times larger than the one that’s being reported, and that’s because Congress does not want to come clean with the public, and, I think, frankly, the public doesn’t want to hear the truth because I think that we’re collectively engaged in an effort to expropriate our children, and our parents did that to us, and now we’re doing it to our kids, and our kids are hoping to do it to their kids, and that’s the way of Argentina. That’s a path downhill, and our country has been sliding downhill in terms of economic progress for decades.
Jim Lange: And that probably also applies at the state and local level, when you have enormous unrecorded debts like pension liabilities that are understated, and infrastructure.
Larry Kotlikoff: Absolutely. It’s the same take as your Ponzi scheme game, and you’re hearing from somebody who’s not partisan. I’m not a Democrat or a Republican. I actually ran as a write-in candidate in this last election. I didn’t get any traction because the press was too interested in Donald Trump’s verbal bowel movements every day. So we’re stuck with him as opposed to discussing real policy. So I was running against both candidates, so I think your listeners should know that I’m somebody who thinks that politicians are not our friends. I think they’re basically lower life-forms.
Jim Lange: Well, this isn’t the first time you’ve run. You’ve always said that you need an adult who understands economics in the White House, and one of the reasons I really wanted to have you on is because here’s this bright, objective, really superstar economist who is saying something really good about the Republican plan, and I’m going to question a few of your assumptions there.
Larry Kotlikoff: Sure, go ahead.
Jim Lange: Well, one of the assumptions that I do have to question, and maybe what you’re going to say is the corporate plan is going to overcompensate for the personal plan, but you said that there is … and this, by the way, is exactly the opposite of, we had, what was his name? Roberton Williams?
Larry Kotlikoff: Bob Williams Jr. I went to school with his dad and I know Roberton very well.
Jim Lange: All right, so we had him on the show, and he said that the tax cuts were almost certainly going to increase the deficit substantially, and then he cited, you know, when Reagan cut the taxes and when Bush cut taxes that the deficit went way up, and he thinks it’s going to be no different. He was estimating, I think it was around $10 trillion for the Trump plan and maybe $7 trillion for the House plan, and he said, “Well, yes, maybe the increase in economic output will maybe save a trillion,” but you’re saying, “Hey, wait, no. Even though there’s going to be massively less taxes, that the stimulant to the economy’s going to be so great that it’s going to be revenue-neutral or even a plus.” So that’s going to be the assumption that I’m going to question because I don’t think there’s a historical precedent for that, is there?
Larry Kotlikoff: Well, in general, the supply-side miracles that Republicans have been talking about are unfeasible.
Jim Lange: Trickle down.
6. House Plan’s Corporate-Tax Reforms Could Spur Economic Growth
Larry Kotlikoff: Yeah, trickle down. They’re not feasible. For example, if you cut personal income taxes, just do that, there’s no way that they’re going to actually pay for themselves. You’re just going to run into a bigger deficit. In the future, you’re going to have to raise taxes. The economy, in the long run, will be worse off. Our model shows that as clear as day. But the House plan doesn’t just have that going on. It has this change in the structure of business taxation, which can actually pay for itself and stimulate the economy and produce a lot more revenue to offset the losses on the personal side so that you end up with about a … you know, my estimate with Alan is that we would lose about $212 trillion each year, which is close to the Tax Policy Center’s estimate, without incorporating any dynamic feedback. But when you incorporate that, you end up with about $38 billion per year in positive revenues on net.
Now, I don’t know what method they’re using to estimate the feedback effects on the economy, but I have this 17 Regent Global model that’s probably the most detailed computer simulation model of the world economy that exists anywhere on the planet, and this team of economists that I’ve been directing has been working on this for about four years now, and when you run that model, you see a pretty strong impact. I mean, just think about it. All the major U.S. companies have a lot of activities going on abroad: Ford, Apple, you name it. They’re producing a lot overseas, and some of them are moving headquarters overseas. You know, part of that is because the labor’s so cheap, part of it is the ability to communicate with the internet, part of it is, well, you know, you can do business right over the Mexican border, and so you’re very close to your sources of production.
But part of it is also the tax system. Part of it is the fact that our effective marginal tax rate, according to Jack Mintz, who’s a public-finance economist in Canada, highly respected, been working on these calculations of international comparisons of marginal effective corporate-tax rates for decades now. He just came out with a study that said that our current rate is around 34.6 percent, essentially the highest of any developed country. If we do what the House plan suggests, it would drop it down to about 16.4 percent, in that range, 16.6 percent. So it would produce a dramatic reduction and a much bigger incentive to invest in the U.S., and I think that’s a real thing. I don’t think that that should be ignored, and that should, according to our simulation model, produce about an 8 percent increase in GDP and wages, and that will generate enough revenue to offset the losses of revenue from the personal income-side cuts. So you’re talking to somebody who thinks that supply side economics can work in this circumstance, but not in every circumstance. There’s just a very few set of circumstances where supply side economics actually makes any sense, and this is one of them.
So this is why Alan proposed his reform. This is why we’ve written papers together about moving towards consumption taxation, away from income taxation. This is why President Bush’s tax reform panel proposed something that’s very similar to the House business-tax plan. It’s because economists think that this can work, and I think what the Tax Policy Center is doing, they look at just your current year taxes versus your current income. So Warren Buffett could have very little current income because he hasn’t realized any capital gains. He could look super-poor in their analysis, and somebody who’s earning $50,000 a year could look like he’s paying a very high share of his current income in taxes, and the whole thing can look very regressive.
But if you look at it from a different analysis, if you look at it the way economics says to look at it, which is don’t compare an 80-year-old with a 20-year-old because the 80-year-old has already paid all their taxes, or most of their taxes, over their lifetime. The 20-year-old’s got all their taxes in the future. So take 40-year-olds. Look at what they’re going to pay over the rest of their life and what they’re going to get over the rest of their life, look at their net present value of taxes and look at their remaining lifetime average tax rate to understand progressivity, and that’s what we’re doing. So I think that we’ve got a much more sophisticated, economically sensible way of looking at progressivity, and it really comes down to the inequality in remaining lifetime spending, and we have a pretty progressive fiscal system when you look at it this way. There’s still a lot of inequality, but over a five-month period we studied this tax bill, and we looked at all the aspects of the tax reform, both the personal and the business, and it looks like it’s as progressive as the current system when you do the analysis the right way. So I think the TPC, the Tax Policy Center, as much as I respect those guys, have just terrible progressivity analysis. They don’t get it at all, that issue, and I don’t think they’re getting the feedback effects correctly, and this doesn’t make me a Republican just because I’m saying this.
Jim Lange: I did want to mention that even though we’re talking about what is generally known as “macro,” that is, large economic issues, Larry is a genius at what I would call “micro” and has two resources, both relatively new, that I think would be very important for many of our listeners and people who are interested in having some control over their finances. The first one, which is probably the best book out there on Social Security, is Get What’s Yours: The Revised Secrets of Maxing Out Your Social Security, by Larry Kotlikoff. Larry would prefer that you buy it at a local bookstore if that is available. If not, Amazon or Barnes & Noble would have it, and he also is a serious number cruncher and has certainly done that at the macro level, but he also has developed software at the micro level. I have looked at some of his previous software, which I think the world of, and just had a client come in who just loved it, but the most recent version is called www.maxifiplanner.com. And we will get to that later on.
But we had just talked about the House version of the proposed tax reform, which Larry seemed to give a pretty good grade. So, Larry, can I actually assume that you’ve actually read and really studied this version? Is that correct?
7. Trump Plan Is Only a Single Page and Unclear on Many Details
Larry Kotlikoff: Yeah, I have. The House plan is pretty detailed. There’s a bunch of issues about the transition that aren’t clarified. The Trump plan is about one page long and is very unclear on many important details. One of the things I don’t like about the Trump plan is the pass-through entities, like self-employed people and Subchapter S corporations, limited-liability companies, they get taxed at 15 percent. So, like myself, I’m working for Boston University, I’m an employee, I could quit, BU could hire me back, I could take all the income that BU pays me as consulting income and get taxed on it at 15 percent rather than the top rate that Trump is proposing, which is 35 percent. So he’s got a proposal that invites massive tax evasion and just the elimination of progressivity because everybody who’s above a 15 percent tax bracket will have an incentive to play the game I just mentioned.
So I think that’s why, right on the face of it, it’s not an intelligent design, and then they’re not doing the border-tax adjustment, which is, I think, critical to really make sure that you tax all consumption, whether you import goods from abroad or buy goods domestically. If you consume them, you should be subject to the tax. That’s the whole idea of this value-added tax. So, Trump loses points on those two counts, and I think also the thing would not generate as much in revenue, primarily because of the tax-avoidance potential. So, I like the House plan. I think that President Trump, as we’ve seen, shoots from the hip, and from one day to the next, he’s got a different idea about what to do, but what we do know from that behavior is that he doesn’t really know what to do. He’s not an expert. He doesn’t have great economists around him. He got this idea from Steve Moore, who considers himself an economist, but he’s really a journalist and a political operator. So I know where the Trump plan came from, and it’s not a really good place from the perspective of academics.
Let me just point out one quick thing, Jim, which is this book I wrote, Get What’s Yours: The Revised Secrets to Maxing Out Your Social Security, has two co-authors: Paul Solman, who’s the PBS News Hour economics correspondent, and Phil Moeller, who’s a long-time personal finance columnist, and it did become a New York Times Number 1 best-seller for a couple weeks and a Top 10 best-seller for about a half a year, so it’s done well, and it will help you navigate Social Security, which is incredibly difficult. And Maxifiplanner is a tool to not just help you with Social Security, but with retirement-account decisions, annuitization decisions, find safe ways to get your living standard up. It’s like robo-optimizing your living standard. It’s not like robo-investing you, it’s robo-money making you, figuring out a way to make money from getting more benefits and paying fewer taxes over the rest of your life.
Jim Lange: So, let’s get back to the Trump plan for a minute, if we could, and I just wanted to clarify the pass-through. So, for example, let’s say, for discussion’s sake, that I am in the top tax rate as a self-employed individual, or that I have an LLC and I am taxed on the income that my company makes, which is actually accurate. So, what would happen under the Trump plan, and let’s assume right now I’m in the top tax bracket, what would happen then in the Trump plan is I would be taxed at 15 percent, and let’s say that I had a secretary who was making, say, $60,000, and let’s say her husband was making $60,000. They would actually be in a higher tax bracket than I would be under the Trump plan.
So let me ask you this: so you’re a professor and you’re still teaching, and let’s say, for discussion’s sake, that you decided, as an interesting project, that you would give your students the job of writing a tax-reform plan, and let’s say that somebody handed in, let’s take the two extremes: one, they handed in the Trump version, and two, they handed in the House version. And let’s just say that while you didn’t have very, very specific goals, one of the things that you mentioned in the assignment was you didn’t want to blow up the deficit, you wanted to stimulate the economy, you wanted to have some fairness factor, perhaps both within the country and even outside that. How would you grade the House plan? How would you grade Trump’s plan?
8. House Tax Plan Gets B+ to A-; Trump Plan Gets B- to C
Larry Kotlikoff: Well, if the House plan were modified a bit to get rid of the ceiling on the FICA tax, I’d give it an A. The way it is, I would give it somewhere between a B+ and an A- because it’s so risky whether we’re going to get the economic feedback that these stylized simulation models suggest. But I would give it a shot. I would go for the House plan. If I were a member of Congress, if it was versus keeping the current system versus the Trump plan, I would vote for it. The Trump plan, I would give, at this point, a B- to a C because I think it’s too risky. I think it’s going to cost too much money. I think the potential for evasion, you know, your secretary you just mentioned and her husband can both become consultants back to their employers and also get taxed at 15 percent. So, it’s an invitation for everybody above the 15 percent bracket to disguise all their income as business income, and we have a massive loss of revenue and also the end of progressivity. So it’s really a stupid, stupid plan.
You know, this president is supposed to be as smart as it gets, that’s what his reflection in the mirror every morning tells him, but this is one of the dumbest proposals I’ve yet seen, just on the face of it. Now, maybe they’ve got something that they know about that they haven’t told us that would restrict this kind of evasion problem or tax-avoidance gaming. But it’s incumbent upon anybody who, they had a long time to think about what to do and they put out this half-baked thing over a few hours. That’s the way this guy operates, from the hip, and it’s getting him into terrible hot water. He’s, like, unhinged. But I could go on at length.
Jim Lange: Well, I’m actually surprised that you gave him a B- or a C. I was expecting a D or even an F.
Larry Kotlikoff: Well, you know, if it’s as bad as it could be, it would be a D. I’m thinking that somebody grown up, if it got into the Senate or the House, that they would put some restriction on that kind of game playing where I could sell my services back to BU, that that would be restricted. So, I think it would probably end up more like a B-, but if it got passed exactly the way it’s on paper, it would be an F.
Jim Lange: So let me ask you another question. When you were explaining the House plan … now, I like to follow these things and I am a CPA and an attorney and I was following, I think, most everything that you said. How many people do you think in the House really get it? And again, either the Republicans or the Democrats because, from my understanding, the Democrats are thinking that this is the most regressive tax proposal they’ve ever heard…
9. Politicians Lack Basic Understanding of Tax Mathematics
Larry Kotlikoff: What I’d like to do is lock the entire Congress into a room where I have a big whiteboard and/or blackboard and show them the economics, show them the national accounting, show them why this proposal (the House Better Way plan) actually is a tax on consumption and a wage subsidy. It won’t take more than about 15 minutes. It would require eighth grade … it’s just addition and subtraction. I think they could handle that. And then you start the conversation from a position of knowledge.
Right now, we have Arkansas senators being pressured by Walmart to oppose publicly the border-adjustment tax, but you can see in that national income accounting with some addition and subtraction that you need the border adjustment to actually fully tax all of consumption, and if you don’t have it, you’re effectively taxing all of consumption but, in addition, subsidizing net imports. You’re taxing exports and subsidizing imports, which is exactly the opposite of what Trump campaigned on. So this is beyond Alice in Wonderland.
This is why I say, you know, if we can write the bill in two languages, we could get the Democrats to go for it and the Republicans to go for it because neither side really understands what it is that they’re talking about, and when it comes to banking reform that they’re considering and health-care reform, they don’t have solid economic thinking underlying what they’re doing. I think the House Better Way plan, somebody pretty smart got in there and put that together. I don’t think it was Paul Ryan or the current chairman of the House Ways and Means, but somebody on the staff who really knows about taxes or some consultant did a good job, and when the Republicans do a good job, somebody should say, “Hey, good job! Let’s go for it.” In this context, Nancy Pelosi should look at it and say, “Yeah, we can live with this, but why don’t you get rid of the ceiling? We’ll really help you.” So, to do a major tax reform, we need bipartisan support, and the same thing with health-care reform, and I see, so far, this very divisive administration, a very divisive Republican Congress, they treat the Democrats like they’re a bigger enemy than the Russians. It’s not the way to run the government. It’s a prescription for deadlock and for nothing to get accomplished. Meanwhile, we’ve got the stock market booming because we’ve got irrational traders who think that just because Trump says this is going to happen, it’s going to happen. It’s just not reality.
Jim Lange: Well, that’s actually a whole other issue, trying to predict the ups and downs of the market. But let me continue on this track because I think it is important. Let’s even assume, for discussion’s sake, that you are right, that the Better Way really is a better way, and if it was passed as written in whole, maybe in Spanish for the Democrats to go for it maybe in a different language for Republicans to go for it. What I fear is, and the way you have analyzed it, you’re actually analyzing all the parts. What I fear is maybe during a committee conference or at some point, that there are changes that will, let’s say, keep some of the things that might be attractive to Republicans, for example, lowering tax rates, eliminating the alternative minimum tax, eliminating the estate tax, things that they want to do, but, for example, not doing some of the things like the import adjustment that you’re saying that is critical to the whole plan. Do you fear some bastardization of the plan, if you will?
10. Pass-Through Provisions in Trump Plan Would Encourage Cheating
Larry Kotlikoff: Yeah, I think Trump is really bastardizing a very good plan. That’s basically what he’s doing. He’s going too far on dropping the pass-through tax rate and the business-tax rate. From where it currently is at 35 percent, he wants to drop it to 15 percent and make the personal tax 35 percent. Well, there’s a big difference between paying taxes at 35 percent versus 15 percent. That’s a huge incentive to try and transform yourself into a small business and just pay at 15 percent. And then, he is getting rid of, not including the border-adjustment tax, which is critical to make sure you’re taxing all of consumption, no matter where the goods come from, and if you don’t have that, you’re effectively subsidizing imports and taxing exports. This is exactly the opposite of what he campaigned on.
I’m not in favor of taxing imports and subsidizing. I’m not in favor of putting on tariffs at all. I think his notions about trade are just delusional and that NAFTA’s been a great thing for us. We should be signing with TPP. We should be doing a deal with European Union on free trade. We should be pushing for free trade with everybody we can. So, he’s just out to lunch, and he’s got an economic advisor named Peter Navarro. No economist would recognize him as a true economist given the kinds of things he said, like the Germans are manipulating their currency. They don’t even have their own currency. They’re using the Euro. So, I think I’m digressing here, but yes, Trump is undermining the Better Way plan, and there’s a good chance that it will get screwed up by the Senate right now.
I think the Senate is going to possibly save the health-care reform because the House so badly screwed that up. They passed a terrible bill that’s cruel and mean and nasty and it’s going to put 24 million people out of … will make their insurance coverage just the worst possible thing to pass. I think the Senate will come up with something better, and maybe health-care reform doesn’t happen at all because the House won’t go for what the Senate comes up with, but that’ll be that. And then we’ll have Obamacare being undermined by Trump and a lot of people out of luck when it comes to health insurance. So, that’s that. Then we’ve got this other very important policy, which is tax reform, and, again, Trump is taking us down the wrong path.
Jim Lange: Let me ask you this, and this might not be a fair question, but I’ll ask it anyway. So, this is my limited analysis, not having great economic education or abilities. My analysis is something is going to pass, and that it is going to lower the tax rates, and that even if the Better Way … let’s even say you’re right and the Better Way will actually reduce the deficit instead of increasing it. But my thinking is, all the things that are in it right now are not going to survive. Some of the regressive things like eliminating the estate tax, eliminating AMT and lowering the tax rates will survive. The deficit will go up again, and then either a different administration will then raise taxes. So, I was kind of looking at this as a Roth IRA conversion opportunity, particularly if they do lower taxes. Do you actually think that that’s reasonable, or do you think that, hey, no, taxes are going to be lowered and that’s going to be the way it is for the next 25, 30 years?
11. Deficit Has to Be Addressed for Tax Plan to Stimulate Economy
Larry Kotlikoff: Well, I know, Jim, you’re probably the world’s expert on Roth conversions, and absolutely, if the tax rates come down, this would be the time to consider seriously a Roth conversion, because if they come down now, there’s a good chance they’re going to go back up in the future, unless everything’s done right so that we actually do get the economic stimulus that we’re simulating. But if they just start cutting taxes and kind of ignore the impact on the deficit, it is true that there’s going to be a rationale for capital to come into the country, investment to come in, because the tax rate on investing in the U.S. would be lower.
But on the other hand, a lot of the investment money would be buying up this additional government debt that’s printed. So not all of the investment will go into building new factories, new equipment or new residential structures. A lot of it will go into buying up government debt, which then has to be paid back by future generations. So deficit finance in the context of actually trying to stimulate your economy can be a very negative thing. It can undermine the stimulus, and that’s all part of our model. If we run our model, which is producing this 8 percent wage increase and 8 percent increase in GDP, with a big deficit as part of the package, you don’t get that kind of a stimulus. You might get a 3 percent increase in wages and GDP, but not 8 percent. So the model is kind of the bread-and-butter economics model. It doesn’t have any black magic.
You know, if you think about taking any really well-conceived model and putting in place a 100 percent wage tax, for example, what would happen? Well, in such a model, people wouldn’t work, the tax wouldn’t collect any revenue, and cutting the tax from 100 percent, let’s say, down to 75 percent or 50 percent, that would lead people to work and produce some revenue. So that’s an example where you can have a supply-side miracle, if you like, which is cutting taxes and actually stimulating the economy and have the tax cut pay for itself, because you’d actually get some revenue in, whereas you were getting nothing in before. And that’s part of what can happen here under the House Better Way plan, because the corporate-tax rate is so high, the marginal rate is so high but the average rate is so low that if you get rid of the thing entirely, you can actually get more investment in the country, and that can help stimulate the economy and raise wages, and then you get more personal income-tax revenue as a result, and that will help pay for itself. So, as I said, there’s not that many ways that we can be more efficient, but we do have this option right now, given how screwed up our tax system is, that we can actually achieve an efficiency gain that’s significant.
Jim Lange: Well, I’m afraid we are out of time. We didn’t spend as much time talking about Social Security as I would have liked, but, let’s say, the quick takeaway for people is to buy the book, which I completely recommend, which is called Get What’s Yours: The Revised Secrets of Maxing Out Your Social Security, and then, for the quantitative types, we run numbers extensively in our office on a personalized basis, but perhaps for the do-it-yourselfer, www.maxifiplanner.com is Larry’s newest software, and he has done some great service. He also has a package for divorce. The conclusion, by the way, is you probably can’t afford to get divorced, but Larry, it has been a pleasure as always to have you on, and I want to thank you for really informing our audience about both the House and the Trump tax plan.
Larry Kotlikoff: My pleasure, Jim, and let’s do this again soon. Thank you so much.
Jim Lange: I’d like that.
Dan Weinberg: All right, and we are up against the clock, so I will simply thank Jim and our guest, Larry Kotlikoff, and stay tuned listeners for some more information about how you can get in touch with Jim Lange. For now, I’m Dan Weinberg. Thanks so much for listening. We’ll see you next time for another edition of The Lange Money Hour, Where Smart Money Talks.
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