Arkady
President
Republicans like to talk about simplifying the tax code — holding out a vision of most people filing their taxes on a postcard. They do not, of course, actually care about that. They work for the rich donors, and the donor class has their taxes done by professionals. They see tax complexity is a good thing, because it’s in that thicket of special rules and exceptions that they manage to lower their rates far below what a back-of-a postcard calculation would have told you they’d pay. But, the promise of simpler tax filings matters to the rubes, and the Republicans need the rubes to vote for them, so they pretend they’re working towards that goal.
The truth is that they nearly always push for rules that will inevitably add complexity. Much of the complexity in the code is driven by the way different forms of income get different treatment. Rules that treat forms of income differently — or similar types of economic transactions differently — give people an incentive to recharacterize their income or transactions in a way that lets them use the lower tax rate. Then that drives the creation of new rules to prevent abuse of the old rules. That’s how the rules grow so dramatically.
Here’s a simple example from one of my own clients. I had a client who wanted maintenance done on some very expensive assets. All that was needed was to pay a service provider to come in and do the work. But my client instead wanted a Byzantine contract where instead, he sold the assets to the service provider, who then did the work, and sold them back. This was a lot more complex, legally, because of the transfers in ownership, which required options, etc., to make sure the client could require them to be sold. Why go through that? Well, if it’s a sale and purchase, it gets better tax treatment (capex) than if it’s just maintenance (opex). It’s the exact same real-world transaction either way, but the client was willing to pay a lot of money to have it look different on paper. And that involved plenty of legal research, because the IRS polices that trick. They want to make sure it’s a genuine sale, not a disguised maintenance contract, and so there are a bunch of additional rules about what constitutes a genuine sale. Then businesses find ways to comply with those rules while still disguising maintenance as a sale, and so additional rules are made to prevent that. And so on.
The current tax bill increases the number of ways that similar economic transactions get different treatment, and thus it will accelerate that process. Paul Krugman pointed out one example. Because the Republicans despise people who work for a living, they want business owners to pay lower taxes than employees. But, that creates an incentive for people to create businesses that are basically just selling their professional services. So, the code builds in a lot of complexity to try to prevent that — so that, for example, an economist working for a company can’t instead form a one-man economic consulting firm pass-through that sells his services to the company, and thereby lower his taxes. So, the rules prevent certain professions from doing that, including economists. But, in theory, the economist could sell novelty t-shirts, and thereby characterize himself as a t-shirt company that does some economic consulting on the side.... and the t-shirt company would be eligible for the superior tax treatment. So, more rules are needed to prevent that — for example, a rule requiring that more than 50% of the revenues come from the qualifying activity. But clever people can game those rules — for example, create a bunch of nested subsidiaries, where at each level 51% of revenues come from a qualifying entity, but at the bottom of the structure is a very small t-shirt operation that gets great tax treatment for a very large economic consulting firm. So, more rules are needed to prevent that. And so on.
There are ways to fight complexity, but they involve removing such special treatment. Stop treating business owners as superior to mere workers, for tax treatment. Stop treating unearned income (interest, dividends, capital gains, gifts, and inheritance) as better than earned income. The more you can reduce the incentive to recharacterize economic transactions for tax reasons, the fewer rules you need to prevent such behavior. If, for example, a CEO doesn’t have a tax reason to care whether his compensation shows up as salary or as a capital gain on a stock option or discounted company stock, then you don’t need a lot of rules to prevent salary from being recharacterize as one of those other things.,
The truth is that they nearly always push for rules that will inevitably add complexity. Much of the complexity in the code is driven by the way different forms of income get different treatment. Rules that treat forms of income differently — or similar types of economic transactions differently — give people an incentive to recharacterize their income or transactions in a way that lets them use the lower tax rate. Then that drives the creation of new rules to prevent abuse of the old rules. That’s how the rules grow so dramatically.
Here’s a simple example from one of my own clients. I had a client who wanted maintenance done on some very expensive assets. All that was needed was to pay a service provider to come in and do the work. But my client instead wanted a Byzantine contract where instead, he sold the assets to the service provider, who then did the work, and sold them back. This was a lot more complex, legally, because of the transfers in ownership, which required options, etc., to make sure the client could require them to be sold. Why go through that? Well, if it’s a sale and purchase, it gets better tax treatment (capex) than if it’s just maintenance (opex). It’s the exact same real-world transaction either way, but the client was willing to pay a lot of money to have it look different on paper. And that involved plenty of legal research, because the IRS polices that trick. They want to make sure it’s a genuine sale, not a disguised maintenance contract, and so there are a bunch of additional rules about what constitutes a genuine sale. Then businesses find ways to comply with those rules while still disguising maintenance as a sale, and so additional rules are made to prevent that. And so on.
The current tax bill increases the number of ways that similar economic transactions get different treatment, and thus it will accelerate that process. Paul Krugman pointed out one example. Because the Republicans despise people who work for a living, they want business owners to pay lower taxes than employees. But, that creates an incentive for people to create businesses that are basically just selling their professional services. So, the code builds in a lot of complexity to try to prevent that — so that, for example, an economist working for a company can’t instead form a one-man economic consulting firm pass-through that sells his services to the company, and thereby lower his taxes. So, the rules prevent certain professions from doing that, including economists. But, in theory, the economist could sell novelty t-shirts, and thereby characterize himself as a t-shirt company that does some economic consulting on the side.... and the t-shirt company would be eligible for the superior tax treatment. So, more rules are needed to prevent that — for example, a rule requiring that more than 50% of the revenues come from the qualifying activity. But clever people can game those rules — for example, create a bunch of nested subsidiaries, where at each level 51% of revenues come from a qualifying entity, but at the bottom of the structure is a very small t-shirt operation that gets great tax treatment for a very large economic consulting firm. So, more rules are needed to prevent that. And so on.
There are ways to fight complexity, but they involve removing such special treatment. Stop treating business owners as superior to mere workers, for tax treatment. Stop treating unearned income (interest, dividends, capital gains, gifts, and inheritance) as better than earned income. The more you can reduce the incentive to recharacterize economic transactions for tax reasons, the fewer rules you need to prevent such behavior. If, for example, a CEO doesn’t have a tax reason to care whether his compensation shows up as salary or as a capital gain on a stock option or discounted company stock, then you don’t need a lot of rules to prevent salary from being recharacterize as one of those other things.,
