Mnuchin's Tax Comments Sound Like Class Warfare
The idea of the Treasury Department picking winners and losers by industry is distasteful and arbitrary.
By Jared Dillian
The Bloomberg View
The Bloomberg View
September 14, 2017
The major plank of the Trump administration’s proposed tax reform has been to lower corporate rates to 15 percent or thereabouts, contingent on negotiations with Congress. It’s a fact that the U.S. has the highest corporate tax rate in the developed world at 35 percent (though the effective rate is more like 25 percent after deductions), but the reality is that most businesses aren't affected. So Trump also wants to lower tax rates on pass-through entities such as limited liability companies and partnerships, which are mostly small businesses whose profits or losses passed through to the owner’s tax return.
This is a big deal. According to the Harvard Business Review, half of all companies were formed as C corporations in 1985. The number is just 20 percent today, with the rest being pass-through entities. So if you can figure out a way to lower taxes on LLCs, S corps and partnerships, it could potentially have an enormous economic impact. Americans have had a long cultural love affair with “small business” and a collective disdain for “big business,” but usually end up favoring the latter at the expense of the former.
Then, Treasury Secretary Steven Mnuchin abruptly announced at the Delivering Alpha conference that the 15 percent rate might not apply to all pass-through entities. “If you’re an accountant firm and that’s clearly income, you’ll be taxed an income rate, you won’t be taxed at a pass-through rate,” Mnuchin said. “If you’re a business that’s creating manufacturing jobs, you’re going to get the benefit of that rate because that’s going to be passed through to help create jobs and better wages.”
There's a lot to unpack here. First, in all the preliminary discussions about tax reform, the Republicans have been touting its simplicity -- that you can fill out your taxes on a postcard and mail it in. If there is any ambiguity about what constitutes a service pass-through versus a goods pass-through, taxpayers will ruthlessly exploit it, and it will spawn a cottage industry of tax-avoidance schemes so that business owners remain eligible for the preferred pass-through rate. The Internal Revenue Service will probably spend most of its time determining which businesses deserve preferential tax treatment, and which don’t.
Also, the idea of the Treasury Department picking winners and losers with tax rates by industry is distasteful and arbitrary. A different president with a different ideology might want to incentivize clean energy and discourage coal mining -- and achieve it through taxation. Using the tax code to manipulate behavior is exactly the kind of social engineering that Republicans claim to despise. Trump happens to romanticize blue-collar manufacturing work, and wants to encourage it. He disdains lawyers, accountants and hedge funders -- they get stuck with the higher rate. Mnuchin says that hedge funds will also lose the carried-interest exemption, but not all private investment partnerships will, if they “create jobs.”
There has been a lot written about the Trump administration's misguided attempts to “bring back” manufacturing jobs. The trend toward services and away from manufacturing has been intact for decades, and the combination of tax tweaks combined with trade protectionism and a weaker dollar will only keep it on life support for a few more years. At the risk of stating the obvious, more effort should be spent on training a workforce to compete in a post-industrial society.
Also, plenty of “services” create a lot of jobs. Imagine a large dental office, with about 20 to 30 employees. A fresh-out-of-dental-school doctor has to take out a huge loan to buy an existing practice, with all the employees and the equipment, or build one from scratch. It is a big risk. He or she is no less an entrepreneur than someone who has a small manufacturing facility making throw pillows, or energy bars, or dog toys. Why encourage one type of risk-taking but discourage another? Bureau of Labor Statistics data show that service sector jobs have grown 17.5 percent since 2000, while manufacturing jobs have declined 18.4 percent.
Most reasonable people can agree that the U.S. needs to cut corporate taxes and broaden the base. And if you cut corporate taxes, you should find a way to cut taxes on small business by a corresponding amount. Mnuchin’s proposal sounds a bit like thinly veiled class warfare. Manufacturing comprises a smaller percentage of the economy than ever, so preferential tax treatment of manufacturing has limited economic impact. If job creation were really the focus of the Trump administration, it would enact an across-the-board tax cut for pass-through entities. Immediately.
The major plank of the Trump administration’s proposed tax reform has been to lower corporate rates to 15 percent or thereabouts, contingent on negotiations with Congress. It’s a fact that the U.S. has the highest corporate tax rate in the developed world at 35 percent (though the effective rate is more like 25 percent after deductions), but the reality is that most businesses aren't affected. So Trump also wants to lower tax rates on pass-through entities such as limited liability companies and partnerships, which are mostly small businesses whose profits or losses passed through to the owner’s tax return.
This is a big deal. According to the Harvard Business Review, half of all companies were formed as C corporations in 1985. The number is just 20 percent today, with the rest being pass-through entities. So if you can figure out a way to lower taxes on LLCs, S corps and partnerships, it could potentially have an enormous economic impact. Americans have had a long cultural love affair with “small business” and a collective disdain for “big business,” but usually end up favoring the latter at the expense of the former.
Then, Treasury Secretary Steven Mnuchin abruptly announced at the Delivering Alpha conference that the 15 percent rate might not apply to all pass-through entities. “If you’re an accountant firm and that’s clearly income, you’ll be taxed an income rate, you won’t be taxed at a pass-through rate,” Mnuchin said. “If you’re a business that’s creating manufacturing jobs, you’re going to get the benefit of that rate because that’s going to be passed through to help create jobs and better wages.”
There's a lot to unpack here. First, in all the preliminary discussions about tax reform, the Republicans have been touting its simplicity -- that you can fill out your taxes on a postcard and mail it in. If there is any ambiguity about what constitutes a service pass-through versus a goods pass-through, taxpayers will ruthlessly exploit it, and it will spawn a cottage industry of tax-avoidance schemes so that business owners remain eligible for the preferred pass-through rate. The Internal Revenue Service will probably spend most of its time determining which businesses deserve preferential tax treatment, and which don’t.
Also, the idea of the Treasury Department picking winners and losers with tax rates by industry is distasteful and arbitrary. A different president with a different ideology might want to incentivize clean energy and discourage coal mining -- and achieve it through taxation. Using the tax code to manipulate behavior is exactly the kind of social engineering that Republicans claim to despise. Trump happens to romanticize blue-collar manufacturing work, and wants to encourage it. He disdains lawyers, accountants and hedge funders -- they get stuck with the higher rate. Mnuchin says that hedge funds will also lose the carried-interest exemption, but not all private investment partnerships will, if they “create jobs.”
There has been a lot written about the Trump administration's misguided attempts to “bring back” manufacturing jobs. The trend toward services and away from manufacturing has been intact for decades, and the combination of tax tweaks combined with trade protectionism and a weaker dollar will only keep it on life support for a few more years. At the risk of stating the obvious, more effort should be spent on training a workforce to compete in a post-industrial society.
Also, plenty of “services” create a lot of jobs. Imagine a large dental office, with about 20 to 30 employees. A fresh-out-of-dental-school doctor has to take out a huge loan to buy an existing practice, with all the employees and the equipment, or build one from scratch. It is a big risk. He or she is no less an entrepreneur than someone who has a small manufacturing facility making throw pillows, or energy bars, or dog toys. Why encourage one type of risk-taking but discourage another? Bureau of Labor Statistics data show that service sector jobs have grown 17.5 percent since 2000, while manufacturing jobs have declined 18.4 percent.
Most reasonable people can agree that the U.S. needs to cut corporate taxes and broaden the base. And if you cut corporate taxes, you should find a way to cut taxes on small business by a corresponding amount. Mnuchin’s proposal sounds a bit like thinly veiled class warfare. Manufacturing comprises a smaller percentage of the economy than ever, so preferential tax treatment of manufacturing has limited economic impact. If job creation were really the focus of the Trump administration, it would enact an across-the-board tax cut for pass-through entities. Immediately.
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