Jeb Bush And The Spirit Of 1986

This post was originally published on Forbes Sep 10, 2015

It is tough to love a tax plan that starts with two false statements. I can probably get by them, although I feel compelled to highlight them.  In his Reform And Growth Plan, we learn from Jeb Bush:

 Today, the tax code is a labyrinth littered with thousands of special-interest giveaways, subsidies and other breaks written to favor Washington insiders. At 80,000 pages, it’s a tax code only an army of tax accountants and lobbyists could love—because they’ve written it.

Accountants Don't Write The Tax Laws

I'm not going to argue about that first sentence, but I have problems with the second.  The Internal Revenue Code, which is what I think someone should mean when they talk about the "tax code" is not close to 80,000 pages long.  That popular factoid is high by more than an order of magnitude. Why it is that people think that is an interesting story. C. Eugene Emery of the Providence Journal looked into it and concluded, as have others, that the source is the length of the CCH Standard Tax Reporter and:

......that publication isn't just the tax code. "That includes the code, regs, annotations to court cases, revenue rulings, explanatory material, other things that come out of the IRS that are not regulations," said Mark Luscombe, principal analyst for the tax and accounting group at CCH. "But some politicians and media have picked that up and called it the code, which is not correct."

Much more significantly the Code may largely be written by lobbyists, but it is not written by tax accountants.  As a matter of fact most tax accountants don't even read the Code. Those that do, although they are valued somewhat, are considered a little odd and can be rather annoying to their superiors who wear better suits and know about single malt scotch and how to play golf.

Individual Changes

Putting my personal hurt feelings aside, I do find the Jeb Bush plan has some merit as it evokes memories of the Tax Reform Act of 1986, which made my career, such as it was.  The most detailed version of the plan that I have been able to find is this Backgrounder. For individuals you've got lower rates (Maximum of 28%), larger standard deductions and sharp limits on deductions other than charity with the outright elimination of the deduction for state and  local income taxes.  I think the rule of thumb might turn out to be that unless you are very charitable, you won't be itemizing, although the way the limit works is giving me a little bit of a headache

 All remaining itemized deductions, with the exception of charitable contributions, would be limited by a tax cap. The cap would limit the tax value of itemized deductions to two percent of a filer’s adjusted gross income. Since it is dependent on a progressive tax schedule, a filer in a lower bracket will be able to have more deductions as a share of their incomes. Low- and middle- income filers in the 10 percent tax bracket could deduct up to 20 percent of their income, while high-income filers in the top bracket could only deduct about 7 percent. The cap has the virtue of allowing the taxpayer to use any of these deductions but not to an excessive extent.

The AMT is eliminated which should make everybody including tax accountants happy, although the elimination of the state and local tax deduction probably would make AMT moot for a lot of the people it applies to.  The elimination of the state income tax deduction coupled with a rate reduction is political genius since it ends up being an income tax cut for high earners except for the ones that live in New York and California.  (I'm oversimplifying a bit)

The proposal eliminates the state and local tax deduction. The tax deduction favors filers in states with high tax rates. Over 90 percent of tax expenditures related to state and local taxes accrue to filers with AGIs above $100,000. The tax expenditure subsidizes high tax states, which encourages poor fiscal policy by state governments. High tax, high spending states have the right to conduct whatever fiscal policies they prefer, but citizens of lower tax states should not be required to pay for it.

The plan has a real marriage boon.

The proposal would allow the individual in a married couple with the lower earnings (wage and salary income) to file a separate simple tax return using the tax schedule for single filers. All other income, deductions, and credits would remain on the tax return of the primary earner.

Then there is the payroll tax relief for the people who need it the least as the employee's share of payroll taxes for people who have reached full retirement age is eliminated. The plan also enhances the earned income credit.

Investment Income

Besides eliminating the tax on net investment income making capital gains and dividends taxed at 20%, the Bush plan would also tax interest income at 20%.  The plan also promises to limit capital gains treatment to situations  in which there is actually capital at risk.

All non-investment income will be taxed at ordinary rates. That is, only those putting real capital at risk will be able to benefit from the lower rate on capital gains. Specifically, “carried interest” without real capital at risk will no longer receive the same tax treatment as real investment income, but instead will face a top rate of 28 percent

Fixing carried interest is one of those things where the devil really is in the details.  Of course, the stakes are a lot lower since there is not as much of a spread between ordinary income and capital gains under the Bush plan.

Estate Tax

The estate tax is eliminated along with the step-up in basis on assets for estates that would be currently taxable.

Business Changes

These are the most radical changes and it would be great to get some clarification here.  For example the plan states that businesses could "fully expense all new capital investments"

This would simplify the tax code and significantly increase incentives to invest in new machines, equipment, buildings, and other structures.

Does "new" mean new to them like when you buy a "new" used car or really new?

Then we have the elimination of business interest deductions.

Generally, businesses would no longer be able to deduct interest payments. Under the current code, debt financing receives favorable tax treatment relative to equity financing. Allowing both expensing and interest deductions would create negative tax rates on debt financed capital expenditures.

I'm wondering what devilish details lurk in that "generally", but this provision strikes me as the most radical change for small business and possibly a significant tax increase for entrepreneurs.  Tim Worstall gets into this change at some length in his piece - The Bombshell In Jeb Bush's Tax Plan, And Boy, Is It A Doozy

It will make bank loans nonviable as sources of financing for companies and businesses, mostly eradicate the leasing business and would make property development almost impossible in any economic manner. Those are all fairly large effects from a simple change to the tax code but they are indeed likely outcomes of it. Even if it doesn’t cause calamity it’s going to cause huge ructions in the economy and be incredibly destabilizing as the practices of well over a century (and, we should note, the practices followed by every other country’s tax system) are over turned.

Economists see the elimination of the interest deduction as a necessary trade-off for full expensing  of capital expenditures.  It is important to remember though  that small business currently has expensing on a lot of its capital investments through the Section 179 deduction (Although the limit on that is scheduled drop).  Small business also tends to be more reliant on bank financing, so it would seem that the two proposals taken together (expensing and interest deduction elimination) favor Wall Street over Main Street.

Switching to a "territorial" system so that corporations are only taxed on income that they earn in the United States is another area where the devilish details are of interest.  The research and experimentation credit is retained.  So will a company be able to shelter much of its current earnings with credits for  developing intellectual property, then park the IP in a foreign subsidiary and never make any money in the United States because of all those royalties that US operations have to bear?

View From The Big Apple

I spoke with Scott Ehrenpreis who heads the tax controversy group at Friedman LLP in Manhattan.  Friedman ranks 12th in the nation among accounting firms.  Scott is working on a comparison chart of the candidate tax positions similar to what the Tax Foundation has, although it is not yet ready for publication.  He thinks that Bush has the best plan so far and certainly the most detailed.  Scott agrees with me that tax accountants really don't have anything to do with writing the Tax Code - more like we have the first pass at trying to figure it out.

Scott is concerned that neither Bush nor Trump who are calling for big tax cuts have a real clear picture of how they are going to be paid for.  Scott thinks we need a major overhaul and may have to consider a national sales tax.  He think planning is premature since there are two many candidates in the field now.  I'm hoping to hear more from Scott on his thoughts on the change in interest deductibility, so stay tuned.

What To Do?

I'm giving myself the project of thinking about what would be good to do in 2016 and 2015 on the assumption that a particular candidate is elected and is able to implement his or her plan.  If you think the Bush plan will happen, you probably want to double down on deferring income and accelerating deductions, but possibly put off large capital expenditures.  If you are heavily debt financed start trying to figure out where you could get some equity.

If you have been considering a major charitable gift, don't put it off, since charitable deductions will be more valuable in 2015 and 2016 due to lower marginal rates.  If you are approaching full retirement age do whatever you can to defer compensation in anticipation of that payroll tax break.

If you are a highly leveraged entrepreneur in a high tax state you might like the Bernie Sanders plan better than the Jeb Bush plan.

The thing about the Tax Code being 80,000 pages and tax accountants writing the Code might seem petty, but, since I have taken on the project of rewatching West Wing on Netflix, I have decided to adopt a "Would Jed Bartlett make a mistake like that?" standard.  I've also decided that any candidate that promises to make Allison Janney press secretary has my vote.