Originally Aired: April 19, 2017
Topic: The Tax Policy Center’s Expert Roberton Williams Joins Jim Lange to Discuss President Trump’s Tax Policies
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Introduction of Roberton Williams of the Tax Policy Center
- Tax Reform for Corporations Is Easier Than for Individuals
- Individual Tax Rates Likely to Drop, With Fewer Deductions
- Trump Plan Would Tax Business Income as Individual Income
- All Three GOP Tax Plans Would Greatly Boost Deficit Over 10 Years
- Consumption Tax Is One Way to Offset Revenue Drop
- Democrats in Senate Could Filibuster Permanent Tax Cuts
- Lower Tax Rates Would Make Roth Conversions Attractive
- Spending Cuts Would Require Reductions in Entitlement Benefits
- Consumption Tax Is Regressive, Favoring the Wealthy
- Loss of Revenue, Question of Fairness Over Estate-Tax Repeal
- House, Trump Differ on Taxing Capital Gains
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 Roberton Williams of the Tax Policy Center
Dan Weinberg: And welcome to The Lange Money Hour. I’m Dan Weinberg along with CPA and attorney Jim Lange. Late last summer, as the presidential campaign entered its home stretch, Roberton Williams of the Tax Policy Center joined us to talk about Hillary Clinton and Donald Trump’s tax policy proposals. With President Trump now in office, we welcome him back to The Lange Money Hour this week to talk about what’s happened since his last appearance when it comes to taxes. Roberton Williams is the Sol Price Fellow at the Urban-Brookings Tax Policy Center at the Urban Institute, where he focuses on communicating the Tax Policy Center’s broad range of work. Twice given the Urban Institute President’s Award for Communication, Bob has spearheaded the Tax Policy Briefing Book, overseen development of interactive tax returns and four Tax Policy Center tax calculators, and written the popular whiteboard video “Debunking Myths About Who Pays No Federal Income Tax.” Before joining Urban, Bob worked in the Congressional Budget Office from 1984 through 2006. Over the next hour, Bob and Jim will talk about what we could see in the months and years ahead in terms of tax policy and how it might be the same or different from what Donald Trump promised on the campaign trail and what that all might mean to you as investors and Americans. So, with that, let’s say hello to Jim Lange and Roberton Williams.
Jim Lange: Welcome, Bob!
Roberton Williams: Thank you.
Jim Lange: You did a great job last time, and it is important for our listeners to know that you truly are a bipartisan commentator. You’re not here to try to talk us into anything. You’re not promoting a liberal or a conservative viewpoint. You’re saying, “Hey, this is what is going on,” and I actually thought that you did a remarkably good job of being objective and letting people know, let’s say, what might be coming, because, of course, we’re predicting the future, but not trying to promote one viewpoint or another. So I sure appreciate that.
Roberton Williams: Well, let me modify things one bit. Rather than being bipartisan, we consider ourselves nonpartisan.
Jim Lange: OK, that’s even better.
Roberton Williams: We don’t take any position one way or the other, and that’s important in this current economic and political climate.
Jim Lange: OK, that’s even better. I like that, nonpartisan. So, right now, here we are. We have, for whatever reason, and for whoever you want to blame, we did not have a major health-care reform, which was, let’s say, the president’s first priority, and we have been hearing, both during the campaign and recently, “Well, we’re interested in tax reform. We’re interested in infrastructure.” On the other hand, he came out of the bat, you know, with a, let’s say, legislative failure. What can we expect in terms of tax reform, when it’s going to come, what it’s going to look like? So, I’ll kind of leave a little bit of an open-ended question, and then I’ll probably be more specific after I hear some of your answers.
2. Tax Reform for Corporations Is Easier Than for Individuals
Roberton Williams: That’s really the $64,000 question. What will the timing be on another health bill, or a tax-reform bill, and what form will the tax bill take when it appears? Right now, following the collapse of the health plan, the administration is somewhat in disarray about how to proceed. Some talk is of trying to resurrect the health plan and get it done first. That’s important from a legislative perspective because repealing the Affordable Care Act gets rid of some tax revenues that otherwise would have to be taken into account when they do tax reform. So it’s a question on the budget side: Can we get rid of the revenue collection ahead of doing a tax bill, or does it have to be part of that? That said, the likelihood of getting a health plan agreement among Republicans seems fairly slim. There doesn’t seem to be any plan that will attract a majority of Republicans, or enough Republicans, to overcome the Democratic opposition, which will be united. So we’re likely instead to see focus on a tax bill. The question is: What will that tax bill look like? And there are two major possibilities: one is we have a single major tax reform that combines individual-tax reform with corporate-tax reform.
The alternative is splitting those in two pieces, doing corporate-tax reform first, where there’s probably more agreement on how to do it, and then turning to individual income-tax changes. On the corporate side, the main arguments are we have too high a tax rate and we have too many loopholes within the corporate-tax system. We should clean out the loopholes, lower the rates and bring ourselves more in line with the rest of the world. The top United States corporate tax rate now is 35 percent. That’s higher than any other developed country in the world. When we first cut the top rate to 35 percent in 1986, our rate was lower than most other developed countries. In the intervening years, other countries have lowered their rates and we’re now at the top of the heap. That doesn’t mean that corporations pay 35 percent of their income in taxes. That’s the statutory rate, the rate on the last dollar of income, but because of all of the tax breaks and losses that are carried forward and so forth, many corporations pay fairly low taxes or no taxes at all. In fact, a study by the governmental accounting office a few years ago showed that nearly two-thirds of corporations paid no federal corporate income tax in the previous year, mostly because they’ve had losses that offset any positive income. In any case, the typical tax rate actually paid by corporations in more like 15 percent to 20 percent, not the 35 percent statutory rate that many face.
3. Individual Tax Rates Likely to Drop, With Fewer Deductions
More important to most individuals is what’s going to happen to the individual income, the tax returns that we all filed this past week. There’s general agreement among Republicans that tax rates are too high and we need to bring them down. Currently, the top tax rate is 39.6 percent, plus a few add-ons, it can bring it up into the mid-40s. The idea among Republicans is to bring the statutory rate down to 33 percent. Both the House Republican tax plan under speaker Ryan and the president’s proposal during the campaign called for a top rate of 33 percent. Both the House Republicans and the president have proposed reducing our current individual income-tax rate structure from seven rates, ranging from 10 percent to 39.6 percent today, down to just three rates, 12 percent, 25 percent and 33 percent. Those reductions in rates require some increase in taxable income in order to avoid losing much revenue, and the way both plans would go about that would be changing the deductions and exemptions people can get, and getting rid of some special preferences built into the code.
The preferences that they would get rid of haven’t been spelled out in detail. There’s certainly a lot of room between here and legislation to itemize those. But what they have said is, “Let’s raise the standard deduction. In the case of the president, raise it to $15,000 for individuals and $30,000 for couples. In the case of the Republican plan, raise it to $25,000 for individuals and $50,000 for couples. Both of those would mean that many, many fewer people would itemize their deductions than they do today. Right now, about 30 percent of taxpayers itemize. By our estimate, the president’s plan would reduce that number to only about 12 percent of people itemizing, and the Republican House plan would reduce it to about 5 percent. Much, much larger standard deduction means there’s no good reason to itemize all those costs of state and local taxes, contributions that you’ve made, mortgage-interest payments.
The other thing that both plans would do would be get rid of individual and personal exemptions, the $4,000 that we can reduce our taxable income for each member of your family. On balance, the higher standard deduction and elimination of the exemptions means that most people’s taxes would go down, and combined with lower rates, most people’s taxes would go down substantially, although the tax cuts are much, much larger for wealthy people than for individuals.
4. Trump Plan Would Tax Business Income as Individual Income
There are a couple of other pieces that are important. On the president’s side, he would lower the corporate tax rate to 15 percent and allow individuals to report business income on their individual tax returns; that is, people who are in partnerships or sole proprietorships. Reporting business income as pass-through entities on their own tax returns would be allowed to use corporate tax rates and pay a rate no higher than 15 percent. That’s certainly a lot better than the 33 percent top tax rate that he’d proposed for ordinary income, and might well mean that a lot of people currently who are employees would try to recharacterize their income as business income. I know I, for one, would immediately go to the Tax Policy Center and say, “Rather than being an employee, I’d like you to make me a contractor. I’d like to be a contractor and have my own little business called ‘Roberton Williams, Inc.,’ not incorporated, and have you pay me that way. That way, I can call myself a business and face a maximum tax rate of 15 percent.” Whether the IRS and Congress could figure ways to stop people from doing that is a good question, but if they don’t, there’s a potential for huge revenue loss to people turning themselves into businesses instead of employees.
Jim Lange: So, you’ve mentioned a couple things where we have a …
Roberton Williams: I mentioned a whole bunch of things!
Jim Lange: Yeah, so we have a much higher standard deduction that will be partially offset by the loss of exemptions. Business income will be taxed much lower, and even individuals such as myself with a business, who would, say, normally report income at the top tax bracket, would get the benefit of paying it at 15 percent. So that sounds great.
Roberton Williams: To everything except the federal treasury.
Jim Lange: All right, well, that’s what I’m getting to, and you said, “Well, it doesn’t look like health care’s going to pass,” so we’re not going to see substantial savings on health care. How are we going to pay for all of these tax cuts, and how realistic … I mean, to me, I can’t even imagine that Congress would say, “OK, businesses, you can now pay at 15 percent, and the Roberton Williams LLC that now files as Subchapter S makes a deal with his employer that he’s now a little business.” I have a hard time picturing that passing. On the other hand, I’ve been very wrong before in my predictions.
5. All Three GOP Tax Plans Would Greatly Boost Deficit Over 10 Years
Roberton Williams: I think you’re absolutely right. I think the likelihood of it happening is very low. Right now, in Washington, there’s no single Republican tax plan. There are really three tax plans that are potentially going to appear before Congress. One that’s fairly well fleshed out and has been reported on is the House GOP tax plan put together by Paul Ryan, the speaker of the House, and by Kevin Brady, the chair of the Ways and Means Committee. Their plan would cut rates, get rid of a lot of loopholes built into the tax system right now, and, by our estimate, lose about $3 trillion of revenue over the next 10 years. They argue that we don’t have their plan defined quite correctly, that they wouldn’t lose nearly that much money and that they would make up the revenue loss in more-rapid economic growth.
Jim Lange: But as a nonpartisan institute, you guys have done some studies and you think that they’re going to lose $3 trillion. So no matter what those guys say, on a nonpartisan basis, you’re saying “No, we’re going to lose $3 trillion.”
Roberton Williams: By our estimate, the House GOP tax plan would lose about $3 trillion of revenue over 10 years. They argue that it would be smaller than that because we don’t have the details of their plan right, and economic growth would make up much of the revenue loss. When we do a macro-economic analysis or a dynamic analysis of their plan, we find that they might make up a little bit of the loss over the first 10 years, but because they’re borrowing so much money and competing with private firms for investment funds, the economy might actually grow less quickly and the revenue effects might be actually worse.
The president has a different plan. In fact, he has a number of different plans. He proposed one in late 2015 that we analyzed as losing about $10 trillion of revenue over 10 years. He revised that during the course of the campaign to bring it somewhat in line with the House Republican plan, matching their rates and getting rid of some of the more extreme aspects of his plan, but we still found that that would lose about $7 trillion over 10 years, and while his economic advisors suggest that there will be other aspects of his economic program that will make up for that loss, and economic growth will make up a lot of the revenue loss, we again find that, if you do a dynamic analysis, that the plan will lose more money over time as a result of slower economic growth than would otherwise occur, because the deficits incurred by the government would require borrowing … it would draw money out of the private sector and slow economic growth.
The third potential plan is from the Senate Finance Committee under Senator Hatch. That plan is currently being formulated, but there’s no public version of it available yet. We don’t really know what the details will look like. But the bottom line is, we’ve got three different plans being put together. One is fairly well-defined in the House representatives, one is less well-defined but under construction in the White House, and one is not very well known at all, but being put together in the Senate. Which of those will be the initial instrument used to start the tax reform is a good question. The president thinks it should be his plan. Speaker Ryan thinks the House Republican plan makes sense. By the Constitution, all tax laws have to start in the House of Representatives, so Speaker Ryan has a leg up on the president. But we know from experience and history that it’s going to take an accommodation among all three actors —Senator Hatch, chair of the Finance Committee, Kevin Brady is chair of the Ways and Means Committee, and President Trump — the three of them working together, to come up with some compromise plan that will be pushed through. The big problem is, there’s a lot of disagreement on what the plan’s going to look like, and the three plans could look very, very different. Until there is some agreement, we’re not going to see much happening at all on the legislative front, and it could be well into the summer, fall or even next year before a plan materializes in a form that the Congress will actually consider.
Jim Lange: All right, so let’s do a quick summary of where we are, or, at least, my summary of where we stand. There are three potential plans, two of them are not clearly defined, and one we don’t know much about at all, but it sounds like what we’re talking about is reduced rates, particularly for those at the top, higher standard deductions, lower exemptions, and less loopholes, if you will, and all the plans that you have talked about, on a nonpartisan basis that you have analyzed, will lose a lot of tax revenue for the country that will not be made up, or maybe a little bit made up by, let’s say, additional growth, but you are afraid that the amount going out means the less has to borrow. So, basically, it sounds like everything you’re talking about sounds like lower taxes if something passes, and ultimately, that it might be a little spurt for the economy, but we’re going to have to borrow money and that’s going to be a problem. Is that a fair summary?
Roberton Williams: That’s a pretty fair summary. There are a couple of additional pieces that I haven’t gotten to yet that are interesting.
Jim Lange: OK.
Roberton Williams: One, from your perspective that I think would be fairly important, the House Republicans talked about doing away with taxation on investment income. They’d no longer tax capital gains or dividends.
Jim Lange: Now, can you picture that happening, or is that just like a pipe dream?
Roberton Williams: No, I cannot picture that happening.
Jim Lange: OK.
6. Consumption Tax Is One Way to Offset Revenue Drop
Roberton Williams: But essentially, what that would do would move us towards a consumption tax. By not taxing investment income, you’re focusing on other income people have, and that essentially translates ultimately into a tax on what people actually spend money on. And then, you get to the whole border adjustment, and the question of how do you deal with imports and exports and boost economic growth at home, on which there’s very little agreement in Congress but a lot of discussion.
Jim Lange: Yeah, and I happen to be a free trader, so I understand that there’s some abuses going on, but that kind of thing scares me. But anyway, forgetting my personal viewpoints. And by the way, let me translate one thing to our listeners. When you say consumption tax, maybe a bunch of people know what it is, but ultimately, we’re talking about a sales tax. So in Pennsylvania, for example, we are used to a, depending on what county you live in, like a 6 percent or 7 percent sales tax in certain areas, and now, what you are saying is one possibility is that there will be a federal … well, you’re using the word “consumption.” I’ll just use “sales tax” because it’s more common, that that would be another possibility.
Roberton Williams: Effectively, that’s what it would turn out to be. It would not be directly a sales tax, it would not look like it’s a sales tax applied to goods, but it would in fact … the burden of the tax would fall on people who buy the goods and services. It would effectively act the same way as a sales tax does in terms of raising the cost of what people buy.
Jim Lange: OK.
Roberton Williams: And it would have just as much visibility as the excise taxes we have today. Every time you buy a gallon of gas or go buy a bottle of beer, you’re paying a tax to the federal government, but you don’t see the tax because it’s built into the price of the gallon of gas or the beer you’re buying. The same thing would be true with these taxes. They’d be built into higher prices for goods that people wouldn’t see. One of the things that worries a lot of politicians is that if you don’t see a tax, you’re not really going to be unhappy about having it, and for people who don’t like taxes in general, that’s not a good thing. They want people to be very aware of the taxes, and a hidden tax is not considered politically the right thing.
Jim Lange: All right, well, is something likely to pass, even if it takes a year? I mean, it sounds like we’re not going anywhere with health care. That’s what you kind of said. Is it possible that there just won’t be any agreement and they won’t do anything?
7. Democrats in Senate Could Filibuster Permanent Tax Cuts
Roberton Williams: I don’t think there’s any question that Congress will have a tough time passing any tax act. There are a couple reasons for this. One is the Democrats in the Senate have enough members to be able to stop any permanent tax change by filibustering, and the Senate requires 60 votes to stop a filibuster. The Democrats have 48 members, counting the two independents who generally vote with them. So that’s enough to stop any permanent bill. What that means is the Republicans have to use the same legislative maneuver that was used in 2001 to get George W. Bush’s tax cuts through, which is called budget reconciliation. This is using the budget as a way to pass a bill, and that only requires a majority vote. The problem with that is something called the Byrd rule.
Jim Lange: Which means you have to pay for it, right?
Roberton Williams: The Byrd rule says specifically, if there is any budgetary effect beyond 10 years, any member can call a port of order and stop the debate on the issue. So, what happened in 2001 is the tax proposals were all scheduled to expire entirely after 10 years. That way, there could be no budgetary effect after 10 years. And the thought of the Republicans at the time was, “Sometime in that period, we’ll be able to make these tax cuts permanent, so why not do it now while we can through the budget reconciliation process?” Well, that didn’t quite happen. It happened for most people. In the end of 2012, or the wee hours of New Year’s Day 2013, Congress passed a bill that made most of the Bush tax cuts permanent, but not for high income people. People at the top of the income distribution saw their Bush tax cuts disappear on New Year’s Day in 2013. It’s almost certain that a tax bill today would have to use the same approach, use budget reconciliation because the Republicans just don’t have enough members in the Senate to be able to stop a filibuster by the Democrats.
The big question is, even with that, can Republicans get the 50 votes that they need to get a budget reconciliation passed? There’s enough disagreement among Republicans today about what the tax bill should look like that getting 50 of them together to agree on something could be difficult. The same problem that they were having with the health-care bill in the House, they could find in the Senate with any tax bill because it only takes three Republicans joining the Democrats to stop … even a budget resolution requires simple majority.
So will we see that? It depends a lot on what the tax bills look like as they develop over the next year. It could come together in a few months if there’s a lot of agreement among the Republicans. It could take a lot longer. Right now, it looks like nothing’s going to happen until sometime late in the summer. It could again push out well into the fall or even next year. So we don’t really know what that’s going to be. We don’t know how the Republicans might come together as a group, or if they’ll come together at all, and until they do, we won’t have any good idea of what the tax plan will look like.
Jim Lange: All right, so I’m going to try to be a little bit practical for what our listeners can take from this, and one of the things that they’re going to do, and tell me if what I have heard so far is incorrect. We are uncertain when we’re going to have a tax bill. We’re uncertain to what it’s going to look like, but the way it seems that it’s going to look like is it is going to cut certainly the top rates, maybe have fewer tax rates, but the highest income taxpayers will certainly get a break, and maybe even the middle class will also get a break, and you don’t know when it’s going to pass. You said summer, fall, maybe next year. Let’s assume something passes, OK?
Now, I have been very much on top of the issue of what I call the death of the stretch IRA, which is the ability to defer income taxes on an inherited IRA, and the Senate Finance Committee voted 26 to 0 to basically kill that. They included a $450,000 per person exclusion, but it is something that would certainly be a quick hit, that is, a quick income-stream generator to Washington that could potentially offset some of the reduced tax rate. So, I am of the opinion, and since, historically, when the Senate Finance Committee votes 26 to 0, usually that will come, and it usually doesn’t come as a standalone bill, it usually will come as part of a larger tax bill. So the way I am thinking is, OK, I think this thing is going to come, but it’s not going to come until there’s going to be a larger tax bill. You’re saying, “Hey, we’re not sure what it’s going to look like, and we’re not sure when it’s going to come,” but the way I’m going to take that is, well, the proposed law will probably come, and there will be reduced tax rates. So, to me, I don’t know if the reduced tax rates are going to be sustainable, and I’m wondering. “Gee, is this an opportunity,” or when they do pass whatever they’re going to pass, is this going to be a good opportunity to make Roth IRA conversions on the theory that the lower tax rates will not be sustainable, you do a Roth IRA conversion at the lower rates, and then, ultimately, either when Trump is out of office or when the deficit looks like it’s going out of control and tax rates are raised again, you will have, in effect, created tax-free income at a lower rate. Is something like that viable, that, yes, we don’t know when it’s going to pass, maybe nothing will pass, but something will probably pass at some point, and it’ll lower the rates. If that does happen, could you foresee in the future, either under a different or even the same administration, them going back and raising the rates?
8. Lower Tax Rates Would Make Roth Conversions Attractive
Roberton Williams: I think you’re certainly right that it’s unlikely the stretch IRA provision will pass on its own. Typically, when a large tax bill is coming through, they’re going to save those kinds of things, particularly if there’s popularity for them — 26 to 0 sounds like a popular option — to save that as a sweetener to draw more people to support the larger tax bill. So saving it for part of the tax reform makes sense. Lower rates will certainly make it attractive to convert to a Roth plan, and people should probably think about doing so fairly quickly because, as you suggest, tax rates are likely to go up in the future. The Congressional Budget Office has projected that deficits, even absent a tax cut, will go up very, very rapidly over the next decade or so as more and more Baby Boomers retire and start drawing Social Security and Medicare benefits. The federal deficit could be large enough that our federal debt exceeds by far 100 percent of GDP, just dwarfing the highest level of the past, which occurred at the end of World War II. So it’d be a pressure to get more revenues and cut government spending. Getting more revenues means higher taxes, and that will make conversions much, much less attractive going forward, plus it makes the traditional IRAs much less attractive because when you draw money out of them, you’ll be paying at higher rates. So, I think you’re absolutely right. If they do cut tax rates and tax reform, take advantage of it while they’re available because they may not last very long.
Jim Lange: Well, the other thing is, just historically, let’s say one of the popular conservative ideas has been to cut taxes and cut spending, but nobody has been successful in cutting spending, including President Bush, who, let’s say, was successful in cutting taxes but wasn’t successful in cutting spending, and I am fearing, well, maybe the same thing is going to happen again, and I’m not the kind of guy who’s necessarily worried about the United States, although I certainly am, but I’m more the kind of guy, OK, this is a likely series of events. What should you do about it? So, interestingly, I’m talking about, OK, we think that this death of the stretch IRA is coming in future years. What should you be doing now about it? And I’ve written a book on it. I’m doing workshops on it, and by the way, I’m literally filling the room. We’re turning people away. Actually, three in a row, we’ve turned people away because we just filled the room. But the idea that something is coming, and rather than worrying about the United States, I’m probably more worried about what our individual listeners, who are just trying to get by and have a secure retirement and pass on what is left in the most efficient way they can do. So things like, yes, we’re likely to have a tax act. By my thinking, it’s likely to include the death of the stretch IRA, we’re likely to have a tax decrease, but that will, at some point, be followed by a tax increase. Well, that is very helpful information on long-term strategies, and I don’t know if this is a pipe dream for me and it’s just the way I think logically, or whether you, on a nonpartisan basis, say, “Hey, that’s a reasonable potential set of events. We don’t know when, we don’t know the details, but that sounds like a reasonable idea.”
9. Spending Cuts Would Require Reductions in Entitlement Benefits
Roberton Williams: I think there a few things we can be fairly certain about, Jim. One is that we’re going to need more revenues going forward than are projected to be collected by the government. The spending will go up. The only way to control spending is to control entitlement programs, which means cutting back on Social Security and Medicare benefits and reducing the size of Medicaid. Those are the big drivers of the federal budget. About two-thirds of federal spending is in entitlement programs. Only about a third of it is from discretionary programs, programs over which the Congress has annual control through appropriations. About half of that is for the military, and every indication is that the current administration, with Congress’ blessing, will ask for more money for the military. That means you’re down to about one-sixth of the budget, the non-military discretionary spending that’s available for cutting, and that, by itself, is not enough to pay for the increased deficits. That is, if you cut every dollar of non-defense discretionary spending, you still wouldn’t balance the budget out in the future. So, we need to do something, and the most likely something is raising taxes again.
It’s very difficult to cut the entitlement programs because they benefit lots and lots of people. Social Security is among the most popular things the United States does. Medicare is close behind. People may not like Medicaid, but that’s very important for keeping lower-income people healthy and giving them health services. So, going forward, there will be a need for more revenue. The easiest way to get more revenue is to raise tax rates and go after individuals and that’s likely to happen, as you suggest. No guarantees. Predicting the future is very difficult, and I have a very cloudy crystal ball, but I think you’re absolutely right in projecting future tax increases, particularly if we make major tax cuts now that would reduce revenues today and in the near future.
Jim Lange: All right, well, by the way, I think this, to me, I think is very, very helpful for probably all listeners, but particularly for upper-income folks to know, “Hey, we might get a break. Maybe be a little bit conservative about Roth IRA conversions right now, but be prepared to jump on them when the rates do go down because that’s not going to be a permanent state of affairs. Get your Roth IRA conversion in while it’s down, and then enjoy the tax-free growth after the tax goes up.” And the only way, to me, you’re really going to be hurt by that is if they, let’s say, Steve Forbes-type analysis where you’re cutting the income tax or even eliminating it, and you’re replacing it with a consumption tax, or a sales tax, and it sounds like that might be another way to go, which is to increase revenue by having a consumption or sales tax. But even if that happened, I would have a hard time imagining that they’re going to kill the income tax.
10. Consumption Tax Is Regressive, Favoring the Wealthy
Roberton Williams: I think it’s difficult to predict how that will come about, the shift from an income tax to a consumption tax. I wouldn’t be surprised if it happens somewhere out in the future. I don’t think it’s likely to happen in the near future, simply because consumption taxes are what we refer to as regressive, a higher burden on lower- and middle-income households than on the wealthy, because low-income households spend virtually all their income, middle-income households similarly. High-income households are the ones that put money away all the time, and therefore, their spending is relatively low compared to their incomes, and they will end up paying less of their income in consumption taxes than would other people, lower- and middle-income people. So there’s a big political issue in terms of shifting consumption tax in terms of who bears the burden of the tax, who actually pays the tax. It would fall much more heavily on low- and middle-income households than the current income tax does, and it’s hard to make it progressive.
Jim Lange: Wouldn’t it be more likely that instead of switching from income to consumption or sales tax, that the consumption or sales tax would be in addition to the income tax?
Roberton Williams: Yes, that’s true in a lot of countries, a combination of an income tax and a sales tax. If you have an income tax combined with a value-added tax, as many European countries do — in fact, we are the only developed country that does not have a value-added tax, which is essentially a sales tax or consumption tax. The combination of the two makes it possible to have a more progressive, or less regressive, system. The actual way that most of those countries maintain progressivity is not through the revenue side but through the spending side by providing a lot more social services that disproportionately benefit low- and middle-income households, and therefore, you’re taking money from them but you’re getting back a lot more than they’re paying. So the overall government system of taking revenues in and providing social services means low- and middle-income households are better off at the expense of higher-income households.
Jim Lange: So Bob, you’ve given us some great information, but ultimately, in 10 minutes, the show’s going to be over, and some people might have additional questions. They might want to have additional resources, and it would be wonderful for our listeners to have a nonpartisan source of information. Could you tell us a little bit about what your organization does and what the contact information is and how best listeners could potentially take advantage of this information?
Roberton Williams: The Tax Policy Center was created to provide a source of unbiased information about the tax system, how it works, how it might be changed and how it might be improved. You can go to our website at www.taxpolicycenter.org, and you’ll find a range of resources available.
What might be most interesting during this time of tax legislation or potential tax legislation, there’s a new feature that we’ve just brought out that explains a lot of features of the tax system and how they affect people and how they might change or might be changed by Congress in legislation now. To find that, go to our website, click on “Features” and you’ll find something about looking at tax-policy changes. There are individual articles on things like how taxes affect the distribution of income, how tax rates work, how different tax pieces work, and you might find that very informative. In general, we have lots and lots of papers and estimates of what would happen, as well as tax statistics. You can find out tax history, what tax rates have been over time, revenues from different sources and so forth. Just browse around our website and see what you can find.
Jim Lange: All right, and can you tell our listeners the website one more time?
Roberton Williams: The website is www.taxpolicycenter.org.
Jim Lange: All right, and, of course, my suggestion to your organization that your president or whoever’s in charge would veto, is the “Crystal Ball” section, which says what you think is going to happen, which is, frankly, what I’ve been trying to get out of you today, and you’ve been very politic in saying, “Well, this is what might happen.”
But anyway, the last area that I think bears a good use of our time is that my profession, that is, the estate-planning attorney’s profession, is still, to this day, very, very concerned with estate or transfer taxes. So, I know it used to be, like, a $60,000 exclusion. When I was really practicing in earnest, it was a $600,000 exclusion. Now, we have a $5.4 million exclusion with portability, that means a married couple can transfer $10.8 million at their deaths to whoever their heirs are, but presumably children and grandchildren. What is going on with the exclusion, either from a gift-tax standpoint or an estate-tax plan, with some of the proposals that you have seen?
11. Loss of Revenue, Question of Fairness Over Estate-Tax Repeal
Roberton Williams: Every Republican candidate for president in the last election, including of course Donald Trump, proposed eliminating, repealing in its entirety, the estate tax. The details differed across the plans. The proposal by the president was one of getting rid of the tax but also getting rid of step-up in basis, so that you would end up actually having to pay tax on the unrealized capital gains in an estate upon the death of the owner. That means that you would no longer make sense to hold your capital gains until death in hopes of their disappearing to the step-up in basis, although there would be an exemption to eliminate that for lower valued estates, and I think the proposal was to use the same as the current exemption for the estate tax, $5.4 million for individuals and double that for couples. So only the larger estates with capital gains would be affected by the tax going forward, and only as a capital-gains tax, not as an estate tax, would do away with generation-skipping taxes, they would do away with the gift taxes as well, and the biggest problem with this is it then opens up opportunities to turn ordinary income into capital gains that then see very little taxation or much lower taxation upon death. So we’d have to see whether that goes anywhere. It would change the number of people affected by the estate tax, obviously, reducing it to zero of people actually seeing an estate tax. There would be no estate tax, per say. That’s not much of a reduction. Right now, only about two-tenths of 1 percent of deaths results in a taxable estate. That’s just a few thousand estates every year, as opposed to the 7½ percent of estates that were subject to tax back in the mid-1970s when the exclusion was only $60,000. That was the lowest it ever was in real terms since we’ve had the estate tax back in the early 20th century.
Jim Lange: And how realistic is this that you think that they will pass this, or do you think that they’ll just bump up the exclusion even higher?
Roberton Williams: The real issue with regards to the estate tax is the revenue loss and fairness. Those are the two issues that’ll be raised. The revenue loss is only $25 or $30 billion a year. That’s real money, serious money, but it’s not very large in the scheme of a $4 trillion budget. Less than 1 percent of the budget is coming from that source. So, the revenue part is not a major issue, although certainly it’s more than just a rounding error.
The bigger question is the fairness one. Should people be allowed to pass on very, very large estates to their heirs without any taxation whatsoever? And there it becomes a philosophical question. Should there be some balancing of things across generations, and what are the effects of that on economic behavior? Do people behave differently because of the estate tax? Would they be more likely to invest and grow businesses if there was not an estate tax? Would they be more likely to spend money? What do they do? And we don’t really know because different models give different results.
Jim Lange: All right. The other thing that you mentioned, you talked about that if that happened, there would be an elimination of the step-up in basis. The good news for most of our listeners who don’t have $10 million or more is that it wouldn’t presumably have an impact for them. What are the potential changes to the capital-gains rates? Are we going to have a graduated capital-gains rate? I’ve heard that was one possibility. Are we going to have an elimination? Are we going to not have any changes? Do you have a crystal ball on what’s going to happen with capital gains?
12. House, Trump Differ on Taxing Capital Gains
Roberton Williams: There are differences between what’s been proposed by President Trump and what’s been proposed by the House Republicans. The president would not change the capital-gains tax rates. He’d leave them at the current zero, 15 percent and 20 percent, depending on your income. He would get rid of the net-investment income tax associated with the Affordable Care Act, the 3.8 percent Medicare tax tacked on to investment income for high-income people, so that would reduce capital-gains taxes for those individuals. That’s part of the health plan. The House Republican plan is quite different. Instead of having a different rate for capital gains and qualified dividends for ordinary income, they would instead say you can exclude 50 percent of the income from those sources, and then they’re taxed at regular income rates. So, if you’re in the 33 percent tax bracket, you only tax half of your gain. Effectively, that makes the tax rate half of 33 percent, or 16 ½ percent. People in the 25 percent bracket would pay at 12 ½ percent. People in the 15 percent bracket would pay just 7 ½ percent. The 12 percent bracket, that’s the bottom bracket, would pay just 6 percent. So, there would be graduated rates under the House Republican plan, each rate being half that of the ordinary rates being proposed.
Jim Lange: And again, as a tax planner, the way I would be thinking is, OK, let’s say that I have some highly appreciated assets. Let’s say I have less than $10 million, so I would get step-up in basis relief. But if this plan, or some variation of this plan, does pass, then maybe what I should do is take advantage of it, cash in some of my highly appreciated assets, and then, when the rates go back up again, I will have, in effect, gotten rid of some of my embedded capital gains.
Roberton Williams: It certainly makes sense if you think tax rates are going to be low for a short period of time to take advantage of those lower rates in anticipation of avoiding them when rates go up in the future.
Dan Weinberg: And thanks so much to both Jim and Roberton Williams for that great discussion of where the government might be headed in terms of tax policy. And listeners, if you’d like to meet with Jim Lange in person, give the Lange Financial Group a call at (412) 521-2732 to see if you qualify for a free initial consultation, or connect with Jim’s office through his website at www.paytaxeslater.com. Special thanks to our producer, Amy Vallella, and, for now, I’m Dan Weinberg. For Jim Lange, thanks for listening and we’ll see you next time for another edition of The Lange Money Hour, Where Smart Money Talks.