By James Kwak
Incoming Treasury Secretary Steven Mnuchin promised a big tax cut for corporations and the “middle class,” but not for the rich. “Any tax cuts for the upper class will be offset by less deductions that pay for it,” he said on CNBC.
This is impossible.
The tax cutting mantra comes in two forms. The more extreme one claims that reducing the overall tax burden on the rich will turbocharge the economy because they will save more, increasing investment, and will also work more, starting companies and doing all those other wonderful things that rich people do. The less extreme version is that we should lower tax rates to reduce distortions in the tax code, but we can maintain the current level of taxes paid by the rich by eliminating those famous “loopholes and deductions.” Donald Trump the candidate stuck with the former: his tax proposal, as scored by the Tax Policy Center, gave 47% of its total tax cuts to the top 1%, who also enjoyed by far the largest reduction in their average tax rate.
Mnuchin’s comment implies that he favors the latter version: lowering rates but making it up by “broadening the base.” This math might work for the merely rich—say, families making $200,000–400,000 per year. Take away the mortgage interest tax deduction, the deduction for retirement plan contributions, and the exclusion for employer-provided health care—which together can easily shield $50–75,000 in income—and you could probably fund several percentage points of rate decreases. (Of course, it would be politically impossible to completely eliminate those tax breaks, but that’s another story.)
When it comes to the truly rich, however, there just aren’t enough deductions out there to eliminate. You can only deduct interest on a mortgage up to $1 million. The fanciest employer-provided family health plan isn’t worth more than $30,000 or so. The aggregate limit for employer retirement plan contributions is around $50,000. At the top end of the wealth hierarchy, where people make millions or tens of millions of dollars per year, these are rounding errors; eliminating these deductions wouldn’t even make up for a reduction in tax rates of a single percentage point.
There are some tax breaks that matter for very rich families. Only one is technically a deduction: the deduction for charitable contributions. But obviously that only affects (to a significant degree) a small number of wealthy people in any given year, and those people can work around any limits in this deduction by simply cutting back on donations. (By contrast, if you get rid of the exclusion for employer-provided health care, employees won’t respond by foregoing health care altogether.)
The biggest tax breaks for the very rich (as I’ve written about before) are the preferential tax rate for capital gains, the deferral of taxes on those gains until you sell the assets, and the step-up in basis at death (which means that, if you pass on assets to your children, no one ever pays tax on the appreciation during your lifetime). Given that Republicans have been trying to reduce capital gains tax rates for decades (with Paul Ryan occasionally saying they should be zero), we can be sure that preferential rates aren’t going away. Taxing gains in assets when accrued is also certain not to happen. Trump has in the past supported a version of eliminating step-up in basis at death, but that was along with slashing tax rates and getting rid of the estate tax, which would be a net win for the wealthy.
In short, the idea that you can reduce tax rates without reducing the tax burden at the top end of the income distribution is a fantasy on par with the idea that you can increase tax revenue by raising rates—plausible in theory but impossible given current reality. That Mnuchin is taking this line is simply evidence that the Trump administration will try to reconcile a massive tax cut for the rich with their fake-populist rhetoric for as long as possible. In the end, we know which one will win out.