Hillary's Tax Proposals Will Make Things More Complicated

This post was originally published on Forbes Oct 13, 2015

So, as it turns out, the big debate tonight is not exactly between Hillary Clinton and Bernie Sanders.  There are three other candidates. Podium order is determined by putting the front-runner Hillary Clinton in the center flanked by those closest to her in the polls - Sanders and Martin O'Malley - and the long shots- Jim Webb and Lincoln Chafee at opposite ends of the line.

That realization sent me scurrying to learn about the other three.  Although I found something to like about each of them - (Lincoln Chaffe, being from Rhode Island is practically a neighbor. Jim Webb, an Annapolis graduate, was awarded the Navy Cross.  Martin O'Mally, like me graduated from a Jesuit high school) - none of them has released any sort of tax plan that I could find.

Bernie Sanders Taking On The Billionaires

We are still waiting on the Sanders tax plan, but his campaign sent me a paper titled "Real Tax Reform Means Making The Wealthy and Large Corporations Pay their Fair Share" -no more deferring corporate profits offshore, no more inversions, lower threshold and higher rates for the estate tax, a financial transactions tax, eliminating cap on social security earnings, no more special rates for capital gains and dividends-.  I got into it here.

The other Sanders shoe I'm waiting to hear drop is marginal income tax rates. If he really wants to mix everybody up, he'll propose dropping the top marginal rate to 35% and explain to people that when he is talking about the rich, he doesn't mean a surgeon who is making $450,000 per year.

Hillary Clinton Making Life Less Simple

That leaves Hillary Clinton.  I can't find a comprehensive plan from her, but the bread crumbs she has been dropping indicate that when one comes out it will be a doozy. Something tells me that she won't be able to talk with a straight face about how long and complicated the Code is, although I bet she has people on her team who actually know how long the Code is and wouldn't exaggerate its length by a factor of 30 or so like Jeb Bush did.

I found four proposals that Hillary has floated, all of which are indicative of the view that the economy can be micromanaged with tax provisions, which is the main reason the Internal Code is longer than it needs to be.  (The Code needs to be longer than the three pages Carly Fiorina thinks are required because there is inherent complexity in taxing income and an arms race between people coming up with clever ideas and legislators making it clear those gimmicks don't work) (See Reilly's Third Law of Tax Planning)

Targeted Financial Transactions Tax

Sanders has proposed a broad financial transaction tax to finance his free college education program.  Clinton proposes a very narrowly targeted transactions tax. The tax would be on high-frequency trading and would target HFT strategies involving excessive levels of order cancellations.  John Sanders makes a case that there are already laws that address this behaviour over in the Securities and Exchange Act of 1934, which is where they belong - not in the Tax Code.

For over 80 years, our securities market regulators have had the ability to punish the behavior that Mrs. Clinton wants to address with a new tax statute. Section 9(a)(2) of the Securities Exchange Act of 1934 states that it shall be unlawful for any person to make a series of transactions in a security, manipulating the market by "creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others." This law quite clearly gives the SEC the ability to punish high-frequency traders who engage in "unfair and abusive" trading practices like spoofing.

Remember if you make it a tax, it is the Internal Revenue Service that will be enforcing it and that agency already has too many things outside its core mission of collecting revenue to deal with.

Closing The Carried Interest Loophole

Sanders takes care of the carried interest loophole by eliminating the capital gain rate.  Trump addressed it even though his 15% business rate would make it moot.  Clinton is still hanging onto it as something that needs to be addressed by legislation.  The problem is that "carried interest" flows from fundamental principles of partnership taxation making it very difficult to root out with legislation without affecting other areas of the economy besides finance.

Capital Gains Rate

Clinton's capital gain rate proposal might be the thing that drives Robert Flach, The Wandering Tax Pro, who refuses to use the expensive and unreliable software that the rest of the industry relies on into retirement.  The Tax Foundation explains the proposal this way.

Secretary Clinton’s proposal would stick to the general principles of the current system, but elongate the decline. Gains with a holding period of one to two years would also be subject to the 39.6 percent statutory rate. Gains of two to three years would be subject to a 36 percent statutory rate, and thereafter the statutory rate would decline by four percentage points per year until reaching the current long-term rate of 20 percent at six years.

It may be self-centered of me to think about the effect that this proposal has on tax preparation.  Actually if you have all the dates, the software will probably take care of it, but it will be a nightmare for somebody, like the Tax Pro, who does returns by hand and for people who do their own returns.

The point of the proposal is to get people thinking more long term.

The stated reasoning behind Secretary Clinton’s capital gains tax plan, outlined at a speech at NYU’s Stern School of Business, is to reduce incentives for what she calls “quarterly capitalism.” The idea, roughly speaking, is that businesses are too concerned with showing immediate success on their earnings reports in order to please investors, and therefore that they are unwilling to take on projects in which successes are less immediate.

As noted I hate this proposal because it will make doing returns harder.  Len Burman, on the other hand, seems to think it might not have its intended results.

 There would be no incentive to wait until the one-year anniversary under the Clinton proposal, so the share of assets held for less than a year would increase.  Moreover, the benefit from passing each of the holding period thresholds would be sharply reduced—4 percent of the gain or less compared with 19.6 percent under current law. 

 Give The Little Guy A Piece Of The Action

Clinton's worst proposal for those of us who would like to see an Internal Revenue Code with fewer bells and whistles is a temporary tax credit (two years) for companies that establish profit sharing plans.  Robert Samuelson nailed it in his analysis.

Hillary Clinton has just given us an object lesson — presumably unintended — demonstrating why our tax system is such a complex mess. The main reason is this: Politicians of both parties cannot resist the temptation to use the tax code to promote the latest political fad or to please favored constituencies. 

As a tax adviser, I can tell you this.  I would be only recommending looking at this credit for somebody who was going to do something like it anyway, which by the way is the way the research credit works in the world that I play in.  Experts go in and identify all the things the company does that can plausibly be considered research.

A lot of firms that have bonuses as part of their compensation scheme - like many accounting firms - would all of a sudden have profit sharing plans (at least for a couple of years).  Of course there will be safeguards to prevent that type of abuse- adding a few more thousand words to the Code or the regulations.

Conclusion

There is a lot more to hear about tax policy from the Democratic candidates.  I'm hoping to learn more about the three lower tier candidates.  There is nothing really surprising about any of the Sanders proposals.  The suspense is around marginal rates.  And it is really clear that a vote for Hillary Clinton is not a vote for tax simplification.

 Note

My notion that Sanders could conceivably propose scaling back the top rate a bit may be a fantasy.  The other fantasy is a Republican candidate proposing specific spending cuts and promising to look at tax cuts in his or her second term after the deficit has become a surplus .  That would be conservative.