Senate Tax Debacle: Certain Pass-Through Entities Face Marginal Tax Rates Over 100% Under Current Bill

As the House and Senate continue to try to reconcile their two versions of a tax plan, the taxing structure for pass-through entities (s-corps, LLC"s, etc.) continues to be somewhat controversial, if not completely nonsensical. As we pointed out last week, the Senate bill somewhat randomly chose to exclude pass-through entities organized as family trusts from tax cuts which would ultimately leave them on the hook for much larger tax bills due to the elimination of other deductions. It"s unclear whether this bizarre exclusion was just an oversight or an intentional political hit on an easy target that no one in Washington DC would dare defend publicly: rich families organized as trusts.

Now, a new note from the Tax Policy Center lays out some scenarios whereby the marginal tax rate for high-income pass-through entities could soar to over 100%.  Of course, while two rational people can debate the impact of a ~40% tax rate on a person"s desire to work, we"re almost certain that a taxing structure that takes more than 100% of your marginal income will be a slight disincentive.  Here"s an example of how it works from the Wall Street Journal:

Consider, for example, a married, self-employed New Jersey lawyer with three children and earnings of about $615,000. Getting $100 more in business income would force the lawyer to pay $105.45 in federal and state taxes, according to calculations by the conservative-leaning Tax Foundation. That is more than double the marginal tax rate that household faces today.

 

If the New Jersey lawyer’s stay-at-home spouse wanted a job, the first $100 of the spouse’s wages would require $107.79 in taxes. And the tax rates for similarly situated residents of California and New York City would be even higher, the Tax Foundation found. Analyses by the Tax Policy Center, which is run by a former Obama administration official, find similar results, with federal marginal rates as high as 85%, and those don’t include items such as state taxes, self-employment taxes or the phase-out of child tax credits.

As Joseph Rosenberg of the Tax Policy Center notes, the penalty is greatest for high-income pass-through entities in highly taxed states. 

Consider the example of a married couple whose entire income is “specified service” income generated by a pass-through entity and who claims the standard deduction. At an income of $524,000, the couple could take an $87,000 deduction (17.4% of the couple’s taxable income “without regard” to the deduction) that would reduce their taxes by $30,450 (since they are in the 35% tax bracket), but the deduction is entirely phased out at an income of $624,000. On average, that amounts to more than a 30% surtax on top of the 35% statutory tax rate over that range of income.

 

The actual phase-out is much more complicated, as the bill’s text released Monday night makes clear, because the deduction continues to apply even as its benefit is phased out. (If that sounds convoluted, it’s because it is.) The couple’s marginal income tax rate would jump to 61.375% at $528,541 of income. And it would rise to 73% until their income reaches $624,000 and the deduction is fully phased-out, at which point their marginal tax rate would return to the 35 percent ordinary income tax rate. (Note that these calculations do not include the additional 3.8 percent in self-employment payroll tax or the net investment income tax).

Here is how the overall tax rate schedule for pass-through income would look:

“This is a big concern,” said Scott Greenberg, a Tax Foundation analyst. “It would be unfortunate if Congress passed a tax bill that had the effect of making additional work and additional income not worthwhile for any subgroup of households.”

Of course, in the end, this type of taxing structure just raises the returns on "gaming" the tax system in every way possible.  “I would expect a huge tax-gaming response once people fully understand how it works,” said Mr. Gamage, a former Treasury Department official, who said business owners have an easier time engaging in such tax avoidance than salaried employees do. “The payoff for gaming is huge, within the set of people who both face these rates and have flexible enough business structures.”

Not surprisingly, lawmakers are looking at changes to prevent this debacle from happening as they attempt to reconcile Senate and House versions of the tax bill this week. The formal House-Senate conference committee will meet on Wednesday, and GOP lawmakers have said they may unveil an agreement by week’s end...though they seem to consistently miss their own self-imposed deadlines.

But you shouldn"t worry about these issues too much as a spokeswoman for the Senate Finance Committee assured the Journal that as "with any major reform, there will always be unusual hypotheticals delivering anomalous results...The goal of Congress’s tax overhaul has been to lower taxes on the American people and by and large, according to a variety of analyses, we’re achieving that."

Putin Asks: "Is America Now A Banana Republic"

Moments ago, Russian president started speaking at the final session of the Valdai International Discussion Club’s 13th annual meeting in Sochi. More than 130 experts and political analysts from Russia and other countries are taking part in this year’s three-day meeting, titled ‘The Future in Progress: Shaping the World of Tomorrow’.

While Putin"s speech can be seen below, he has already had a handful of soundbites, most notably the following he just said in response to accusations that Russia could influence the US election:

"Hysteria has been whipped up in the United States about the influence of Russia over the U.S. presidential election," said Putin, calling it a ruse to cover up for the fact that the U.S. political elite had nothing to say about serious issues such as the country"s national debt or gun control.

"It"s much simpler to distract people with so-called Russian hackers, spies, and agents of influence. Does anyone really think that Russia could influence the American people"s choice in any way? The number of mythical, dreamt-up problems include the hysteria - I can"t think of another word - that has broken out in the United States about the influence of Russia on the current elections for the US president."

He ended that phrase as follows: "What, is America a banana republic?!"

Putin mocks claim that Russia is trying to influence the US elections: "What, is America now a banana republic? America is a great power."

— Steve Rosenberg (@BBCSteveR) October 27, 2016

And then, to emphasize his trolling, added the following: "correct me if I am wrong."

He also said that "Russia has no intention of attacking anyone, it is ridiculous, foolish and unthinkable. I read your analytical materials prepared not only by those present but also by analysts in the US and Europe. However, it is just unthinkable, silly and unrealistic. In Europe alone, the combined population of NATO countries stands at 300 million, in the US the total population is, probably, 600 million, while in Russia - 146 million. It is just funny to talk about this."

According to the Russian president, contradictions stemming from redistribution of political power are growing.

"Regrettably, next to nothing has changed for the better in the past months. To be frank, nothing has changed. Contradictions stemming from redistribution of economic power and political influence are only growing," Putin said.

Hence, according to the Russian leader, the burden of mutual mistrust is limiting possibilities to stand to real challenges and real threats facing the world community. "As a matter of fact, the entire globalization project has turned to be in a crisis and voices in Europe are speaking (and we know and hear it well) about the failure of the policy of mulicultiralism," Putin said, adding that this situation is a consequence of a wrong, hasty and somewhat arrogant choice made by Europe’s political elites some twenty-five years ago.

"Back then, at the turn of the 1980s and 1990s, there was a chance not only to spur globalization processes but to give them a qualitatively new, harmonious and sustainable character," the Russian leader said.

He drew attention to the fact that the countries that claimed to be the winners in the Cold War began to reshape the global political and economic order in their own interests.

These states, in his words, embarked on a path of "globalization and security for themselves only, but not for all." But not all agreed on that.
Some could not resist that any longer whereas others were not yet ready, so, no wonder the system of international relations has been feverish and the global economy is failing to recover from the crisis, Putin added.

On globalization

The Russian president stressed globalization should be for all but not only for the select few.

"Obviously, the global community must focus on really topical problems facing the entire humankind, the solution of which will make the world a safer and more stable place and the system of international relations equal and fair," Putin said.

He said such an approach will make it possible to "make the globalization for the select few turn into globalization for all."

"I am confident that it is possible to overcome any challenges and threats only together," Putin stressed.

On Global Propaganda

The president said he regrets that Moscow does not possess such global propaganda techniques as Washington does.

"I would like to have such a propaganda machine in Russia. But, unfortunately, I don’t. We have no such global media as CNN, BBC and some others. We have no such opportunities so far," Putin said at a session of the Valdai Discussion Club.

On the world economy

The president expects the trend towards regionalization of the world economy will continue. It is absolutely evident that economic cooperation must be mutually advantageous and be based on general universal principles, so that each state could become a full-fledged participant in the global economic life," Putin said. 

"In the mid-term prospect, the tendency towards regionalization of the global economy will apparently continue, but regional trade agreements should complement, develop, and not substitute universal norms and rules," the president said.

The global economy is unable to get out of the current systemic crisis and the political and economic principles continue to be reshuffled, Putin stressed.

"The system of international relations remains feverish. The global economy is unable to get out of the systemic crisis. The principles and rules in politics and the economy continue to be reshuffled. Quite often dogmas that until recently had been regarded as fundamentally true are turned inside out," Putin said.

These days, he said, whenever the powers that be find some standards or rules beneficial, they force everybody else to obey them. However, if at a certain point the very same standards begin to pose obstructions, they are at once sent into the dustbin as outdated and new rules are established.

As an example of that strategy Putin mentioned the missile and bombing strikes against Belgrade and Iraq, then against Libya and Afghanistan. The operation began without a corresponding resolution by the UN Security Council. Some superpowers, the Russian leader said, in their attempts to change the strategic balance of force in their favor have torn down the international legal regime that prohibited the deployment of new missile defense systems. They have created and armed international terrorist groups, whose cruelty is now pushing millions of migrants out of the unsafe areas.

Whole countries are being plunged into chaos. The principles of free trade are trampled on and sanctions are used to exert political pressures.

"We can see the freedom of trade being sacrificed and so-called sanctions being used for exerting political pressures. In bypass of the World Trade Organizations attempts are being made to form closed economic alliances living by harsh rules and putting up firm barriers alliances where dome

On NATO

He said that NATO has outlived its usefullness as a structure and on the topic of the escalating proxy war in Syria, Putin had a simple comment: "Our agreements with the US on Syria did not work out."

And some more headlines from his pragmatic remarks:

• RUSSIA"S PUTIN SAYS RUSSIAN MILITARY THREAT BEING EXAGGERATED TO JUSTIFY MILITARY SPENDING


• RUSSIA"S PUTIN SAYS CYBER ATTACKS OR OTHER TYPES OF INTERFERENCE INTO OTHER COUNTRIES" AFFAIRS UNACCEPTABLE


• RUSSIA"S PUTIN SAYS DONALD TRUMP BEHAVES EXTRAVAGANTLY , BUT IT IS FOR A REASON

Follow Putin"s speech live below.

David Rosenberg Calls For A Multi-Trillion, "Helicopter Money" Stimulus Package

With the inherent weakness in US GDP and the rising probability of a recession (two weeks ago Bank of America modeled that the next recession would likely start roughly one year from now), Gluskin Sheff"s David Rosenberg thinks that with monetary options exhausted it will take a fiscal boost in the trillions of dollars to kickstart the economy. These issues were discussed in an extended interview with Real Vision TV, where the chief economist and strategist at Gluskin Sheff proposed some radical policies to engineer the growth needed in nominal income. 

His ideas, some of which can be seen here in a clip of the interview, include helicopter money attached to a $2 trillion perpetual bond, massive infrastructure spending and measures to tackle the $1 trillion student debt load that has seriously hamstrung the economy.

Here are some of the interview highlights:

Doing the Same Thing Over Again and Expecting a Different Outcome

Whether the US will in fact experience the technical definition of a recession is a matter of fervent debate, with the odds something like 20%-30%, according to Rosenberg (60% according to Deutsche Bank), but with growth averaging around 1%, there is no doubt the economy is weak.

“There are some people saying a recession is here right now,” Rosenberg says, “I don"t think that we meet those conditions yet. But people say, well, look. Twelve months in a row of negative year on year industrial production, that"s never happened outside recession, check. We"ve had now going into six quarters of profit contraction, year over year. That"s only happened in the context of a recession, check. I mean, all that is true, but so much of this has been related to the oil shock that we had.”

Rosenberg’s problem with monetary policy, now in its 7th year of unorthodox experimentation, is that it has become a weak antidote to structural problems in the economy (even if it is still quite potent at boosting financial asets). Fiscal policy on the other hand, if constructed right, could be the answer due to its very powerful multiplier impact. “I can"t say that I know for sure, but it"s the old Einstein adage about the definition of insanity,” Rosenberg said. “And we"re finding that we"re really-- if we"re not hitting the wall on monetary policy, we"re certainly seeing classic economics 101 of the law of diminishing returns.”

In terms of infrastructure spending, he said that one lesson from recent history and the Great Recession is that you"ve got to have the credibility to convince people that this is going to be permanent and not temporary, in terms of the impact on the economy. “So it can"t be transitory. It"s got to be very big. With interest rates as low as they are, there"s certainly the capacity. I mean, you"ve got a lot of governments around the world issuing 50 or 100-year bonds. So this is a once in a lifetime opportunity to borrow money.”

A Couple of Trillion Dollars of Helicopter Money

While companies have been taking advantage of these conditions to borrow money, the funds have not been invested in the real economy. Share buybacks have become more popular, while personal savings rates have increased amid the economic uncertainty. This all boils down to a big case for government spending, with monetary policy joining forces with fiscal policy in the form of helicopter money.

“What you do with helicopter money is you finance it off the central bank"s balance sheet because we"re talking doing something very dramatic to reflate the economy,” Rosenberg said. “It"s not a few hundred billion dollars. It"s a couple of trillion...I know I"ll get accused of bailing out the sinners, but, my lord, we"ve already done that. I mean, nobody went to jail.”

One of the things holding the economy back is the $1 trillion student debt load, which he said has left 35% of males aged 18 to 34 living with mom and dad, not getting jobs and not becoming first time home buyers. Employment growth for the 65s and over is 7%, meanwhile, as the aging boomers have to work longer because they didn’t save enough for retirement. 

“Helicopter money is QE plus where, say, the treasury issues a perpetual-- call it, like, a century bond, a $2 trillion bond on the Fed"s balance sheet. And so when that bond matures, it"s, like, we"re all dead in the long run at that point. And then the Treasury can use that money to stimulate growth. "

The beauty of this idea, according to Rosenberg is that you don’t have to go through Congress, with such difficulty in achieving corporate or personal tax reform.  “It would lead to a permanent increase in the monetary base. Inflation expectations would go up, which means that real interest rates would go negative. And the theory is that that would provide a bigger thrust towards getting what we all want, which is sustainable and accelerating nominal income growth.“

Real Risk of Fed Mistakes or Trump Trade War

Sustainable and accelerating nominal GDP is certainly what’s required while the risk persists that we could be shocked into recession, or the Fed could make a mistake in raising interest rates too aggressively.

“That"s what happened in December of last year. They raised rates 25 basis points, but the overall financial tightening, in terms of what it meant for the dollar or in credit spreads and the stock market, it was really, like, 75 basis points of tightening. And the next thing you know, the economy slows to stall speed."

Another concern for investors is the prospect of a Trump presidency, bringing with it the potential start of a trade war. That could provide the sort of exogenous shock to cause the economy to go into recession, Rosenberg stated, noting that historically all the recessions in the post war period have been created by the Fed.

“The problem is that when you have the economy running on average 1% growth, or 1% plus, which is not a big cushion. And so, you know, it"s a complicated question to try and handicap a recession on us right now. There"s a lot of people out there that are convinced that a recession is coming.”

To watch the full interview with David Rosenberg, visit Real Vision TV.  You can access this and many more interviews with a free trial. 

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Oh, if Rosenberg"s idea gets traction - and execution -  which it will eventually, as we have said since our first days in 2009, buy lots and lots of gold.