I. Our Analysis of Donald Trump’s Tax Plan Reflects Uncertainty
One thing that a reader will quickly notice about our analysis of Donald Trump’s 2015 taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform proposal. I have read every word Donald Trump has spoken on business taxes during this entire campaign. I have read more or less every article published on Donald Trump’s tax plan in a major media outlet for the last 357 days. In all likelihood, I have read more about the Trump plan than anyone.
Nonetheless, not even I know how Donald Trump’s plan would tax non-corporate business.
We had hoped that the days following the initial release of the plan would clarify the nature of the policy. We regret to say that they have not. Therefore, we have chosen to release an analysis that reflects the range of our uncertainty.
II. Our Uncertainty is about Pass-Through Business
Here is the basic idea. There are two types of business in America under current law. One kind files its own taxes and pays the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate, holds earnings within the business, and then pays out money to its owners, or shareholders, through dividends or stock buybacks. Shareholders have stock in the company, and they pay individual income taxes on their dividends and capital gains. The other kind immediately distributes its money to its owners without paying any corporate income tax, and the owners pay individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. on that. We sometimes call these “pass-throughs,” because the income immediately “passes through” to the owners. This is also sometimes called “small business,” even though many pass-throughs are not small businesses at all.
Trump policy on corporate income tax rates has been clear for almost a year. Corporate income tax rates will be 15 percent. Furthermore, the campaign has clearly stated that the shareholder-level taxes on qualified dividends and capital gains will be 20 percent. What is not at all clear is how pass-through or “small” business would be taxed. The Trump campaign website, as of today, states it this way:
The Trump plan will lower the business tax rate from 35 percent to 15 percent, and eliminate the corporate alternative minimum tax. This rate is available to all businesses, both big and small, that that want to retain the profits within the business.
This is not the easiest pair of sentences to parse. If you’re a business that doesn’t want to retain profits, then what happens? If you take advantage of the 15 percent rate on your retained profits, what happens when you decide to pay those profits out to shareholders?
If you are currently a pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. , what are your options for getting a 15 percent rate? Can you simply file it that way as long as you think your profits are retained? Do you have to become a corporation to do so, via entity classification election? Or is there some third, yet-undefined form of business that the campaign is designing on the fly? For a more colorful take on the issue, Politico’s Bernie Becker asks, “Seriously, what’s the deal with the Trump plan?”
We’ve tried to acquire additional information to answer this, and our efforts have not been fruitful.
III. Modeling Campaign Proposals Requires Judgment
Most policy is unclear or uncertain in one way or another. Even a complete bill that is signed into law can have drafting errors that need to be corrected. Any tax bill is likely to have pages and pages of guidance issued by the IRS on what it means. All of this is, of course, absent from campaign proposals. In fact, campaign proposals aren’t written in legislative language at all. Obviously, there’s going to be some degree of uncertainty about what they do.
In most cases, we do what other organizations do: we take some guesses when it comes to the little details. For example, if the childcare proposals in the plan were implemented, there would be pages of text and guidance on what kinds of childcare are eligible and what kinds aren’t. We chose to make the assumption that some expenses would be ineligible, and that affected the size of the provision, and all that affected the total revenue estimate.
Tax Foundation and other organizations make these kinds of judgments all the time, and we consider it worthwhile because otherwise we’d never be able to model anything for lack of specificity.
However, this has ended up being a unique case, in which a plan that is otherwise reasonably-specific has been unclear on a single relevant issue with a huge revenue impact. If we made a wrong assumption here about the nature of the policy, it would affect the revenue estimate of the total plan by more than a trillion dollars, as the analysis shows.
Given that, we have, in this case, decided not to make any assumption on the candidate’s behalf. We take these judgment calls seriously to provide the best information possible to our readers, and we hope that you consider our approach on these judgment calls to be principled.
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