By Robin Wallace
The tax plan President Trump released last Wednesday appears to have delivered on his promise to dramatically reduce taxes on individuals and businesses and simplify the tax code. As the media and economic experts have noted since the plan’s release, however, it may have created a loophole so big that only the unluckiest taxpayers could be stuck paying any income tax at all.
There is no disagreement that the plan would significantly cut individual taxes for most taxpayers – disproportionally benefiting the slimmest percentage of the wealthiest Americans. The ramifications for those farther down the economic food chain could be either positive or devastating, depending on a wide range of both known and unknown variables that remain alarmingly unclear. However, a provision to drastically cut taxes for small businesses could offer 99-percenters a way to inoculate themselves against tax liability with the same muscle as Fortune 500 companies.
In addition to slashing tax rates and condensing them into just three brackets – 10 percent, 25 percent and 35 percent – the president’s plan reduces the corporate tax to 15 percent. He extends the corporate tax rate not just to small businesses, but also to very small businesses – sole proprietorships, LLCs and S corporations – types of businesses known as “pass through” businesses because their earnings essentially pass through the corporation to the owner as a salary.
The argument for low corporate taxes has always been that big companies use tax savings to expand and create jobs, thus helping to grow the economy and the tax base. However, many small business owners – those with few, if any, employees – report their earnings as personal income and pay the much higher income tax rate. This has long been a sore point among small business owners.
The extension of the corporate tax rate to very small businesses opens the door for the self-employed and independent contractors – freelancers, writers, nannies, tutors, personal trainers, just about anybody who works – to incorporate as an LLC or S corporation and pay the business tax instead of the income tax. It’s an attractive option for such workers because among the three tax brackets, the 15 percent rate would likely be lower than someone’s likely income tax rate.
This may seem like good news that allows the little guy to level the playing field with the big boys – do you recall the dust-up when Mitt Romney’s tax returns revealed his competitive dancing horses were considered a small business? Except that only a small fraction of small businesses contribute to meaningful economic growth or create jobs, while most employ only their owner. There is no offset for the loss in revenue.
Nobody likes this idea. While Democrats have flagged this loophole, Republicans have promised that they can write rules to prevent these abuses. The real concern here is not that a freelance writer might score a tax break. The fear is that high-income individuals – doctors, lawyers, professional athletes, financial advisers – will skirt paying income taxes on their large incomes by incorporating as small businesses.
The media has been quick to winnow out this loophole due to another danger: Traditional workers may decide it is in their best interest to negotiate an independent contractor status with their employer. It may save the employees money at tax time, but there is another reason that companies have already been moving their workforces toward this model.
Independent contractors don’t get health insurance, sick or maternity leave, vacation pay, or any other benefits. They don’t get a pension or a 401k. They don’t get to join the union and, depending on circumstances, are not eligible for unemployment benefits. Employers can still mandate hours and attendance.
It’s not clear if the loophole in Trump’s plan was intentional or not. The one-page bulleted list that the administration released left economists and analysts with so much blank space to read between the lines, the best they’ve been able to do is envision a disemboweled economy that has been under a monstrous deficit. And that’s before the nation’s workforce converts en masse into independent contractors.
Economists and analysts from across the political spectrum have denounced the administration’s claims that the tax cuts will pay for themselves via spurred economic growth. They instead expect the cuts to drain revenues by more than $6 trillion over the next decade and swell the national debt by $7 trillion, numbers from the Tax Policy Center that represent a consensus among such experts.
The only way these tax cuts could be revenue-neutral is if they are paired with deep, if not draconian, spending cuts. The slim likelihood of such spending cuts can be seen in the bipartisan shredding Congress gave Trump’s budget this week. Trump’s starvation diet for the federal government was on the brink of forcing a government shutdown. The compromise Democrats and Republicans struck instead on the budget handed out plump goodie bags to most of Trump’s targets and reads like an homage to former President Obama.
