Republicans Exact Their Revenge Through a Tax Bill

Start with the mea culpa: I doubted that the Republican tax bill would cross the finish line.

I was not such a chump as to take seriously the professed deficit concerns of GOP lawmakers like Senator Bob Corker. What I did anticipate, though, was that the few remaining blue-state House and Senate Republicans would balk at the targeting of their constituents. The Republican tax bill lands like a hammer on upper-income professionals in blue states. Highly compensated attorneys, doctors, accountants, and financial-service professionals will lose tens of thousands of dollars in deductions for their heavy state and local taxes and costly coastal mortgages, without getting much in return. Individuals earning between $200,000 and $500,000 will see most of that income increase from a marginal rate of 33 percent to 35 percent. (Individuals earning more than $500,000, by contrast, will see their marginal rate drop from 39.6 percent to 37 percent.

The bill is also littered with provisions almost designed to goad professionals. I asked Philip Hackney of Louisiana State University, formerly in the IRS’s general counsel’s office, to detail a few.

Offered a better job across the country? If your new employer tells you, “Don’t worry—we’ll cover your moving costs,” those payments will now add to your taxable income.

If your house floods or burns in a routine accident, not a national emergency? That loss is no longer deductible, either.

There’s even what looks like a special revenge tax upon the National Football League: Pro athletes may no longer deduct their agents’ commissions from their salaries.

(The deduction for major medical expenses was, however, reinstated by the Senate after a surge of protest. It was even made more generous for the tax plan’s first two years, returning to the 2017 level in 2020.)

Yet my expectation of blue-state GOP dissent was wrong. The Republican caucus cohered. The GOP has likely traded away the last of its seats in New York, New Jersey, Northern Virginia, and California. What did it get in return?

At the core of the bill is an important and needed reform: a reduction in the corporate income tax to something like the developed-world norm of 21 percent from the current 35 percent, which had been among the highest rates in the world.

Such a reform, properly executed, would have cost the Treasury surprisingly little in forgone revenues. While the U.S. taxes corporations at a high rate, the corporate code is so perforated with exemptions that U.S. tax collections from its corporate income tax fall far below the developed-world norm: 2.5 percent of gross domestic product in the U.S. vs. 3.5 percent for the developed world as a whole. Moving from a high-rate, narrow-base corporate tax code to a lower-rate, broader-base code would have rationalized economic decision-making and actually topped up federal revenues.

Two decisions blocked that happy outcome. The first was a decision against broadening the corporate tax base very widely. The second—even more fateful—was to insert an amazing new tax refuge into the tax system: a super-low tax rate for pass-through businesses.

Most American businesses do not pay the corporate income tax. They pay through the individual tax system. So long as the corporate rate and the individual rate more or less tracked each other, this fact did not muck things up too much.

But once the decision was made to lower the corporate rate so substantially, those other businesses faced a heavy tax penalty. What to do? The congressional GOP’s answer: Let them pay at a new radically lower “pass through” rate.

The implications of the pass-through decision are staggering. Not only is it massively disruptive of federal revenues, but it wildly distorts decision-making throughout the private economy. Adam Looney at the Brookings Institution computes:

If a plumber makes $60,000 a year as wages paid by an employer, he or she will pay 60 percent more in income taxes than if that plumber had been a sole proprietor or self-employed and takes advantage of the pass-through rate.

As of 2014, there were already 30 million pass-through businesses in the United States.  Under the new incentives, there will instantly appear many millions more. To deal with the ensuing revenue loss, Congress had to squeeze somebody. Upper-income blue-state residents got the chop.

But wait! What if those upper-income blue-state residents organize themselves as pass-through businesses? Won’t they get the last laugh on their red-state plutocratic persecutors? Not so fast. Congress thought of that. Section 1202(e)(3)(A) of the Internal Revenue Code lists the fields forbidden to take advantage of the new pass-through rate: health, law, accounting, actuarial science, performing arts, business consulting, athletics, brokerage services, financial services, or any other trade or business whose principal asset is the reputation or skill of the business owner.

The list tracks almost perfectly with the professions with which the Republican Party has most difficulty. (Good news, engineers and architects: You were originally on the prohibited list, but somebody’s effective lobbying got you omitted at the last minute.)

If the idea behind tax reform is to eliminate favoritism from the tax code, then the tax law of 2017 is anti-reform: an aggressive loading of the costs of the state upon disfavored persons, groups, and regions. It leaves behind an unstable legacy, both economic and political. Economically, the system invites gaming. Politically, it accelerates the exodus of college-educated professionals out of the Republican Party. It will tint the blue states ever bluer, up and down the income scale.

States like California and New York desperately need a competitive Republican Party—especially at the state level—to challenge the lazy and often corrupt practices of local Democratic machines. This new tax law will have the opposite effect, wrecking whatever little remains of GOP strength in the states that motor American innovation and growth. It threatens to push New Jersey, Colorado, and Virginia into single-party blue rule as well, by painfully demonstrating that the party of Trump is not only obnoxious to their values but implacably hostile to their welfare.

Perhaps the surge of economic growth promised by the bill’s proponents will salve hurts, change minds, and protect blue-state Republicans. If not, America’s already bitterly polarized two-party system may soon be evolving further and faster into two single-party systems, each bent upon pillaging the other.