Originally published on Forbes.com.
When it comes to new Code Section 199A (often referred to as the pass-through rules) and Professor Daniel Shaviro of NYU, don’t get him started. He had his piece Evaluating The New US Pass-through Rules published in a UK journal – The British Tax Journal – because he thought it was not representative of how temperate he normally is. Here is how it starts (You have been warned):
The pass-through rules that the US Congress enacted in 2017—permitting the owners of unincorporated businesses in favoured industries to escape tax on 20 per cent of their income—achieved a rare and unenviable trifecta, by making the tax system less efficient, less fair, and more complicated . It lacked any coherent (or even clearly articulated) underlying principle, was shoddily executed, and ought to be promptly repealed. Given the broader surrounding circumstances, the mere fact of its enactment sends out a disturbing message about disregard among high-ranking US policymakers for basic principles of competence, transparency, and fair governance.
Large Sums To Lawyers And Accountants – Is That So Bad?
It happens that I kind of agree with him to a point, but I don’t have the same emotional reaction. That may be because of an aspect of the provision that Professor Shaviro highlights later in the article.
…the 2017 Act has created a system in which it will make sense for almost everyone, earning at least several hundred thousand dollars annually and not irrevocably tied to the tax law status of being deemed an employee, to pay large sums to tax lawyers and accountants to figure out how best to structure their arrangements with an eye to minimising federal income tax liability (Emphasis added)
On Saturday, I officially retired from my last accounting job after forty years (more if you are generous and consider being a hotel night auditor an accounting job) of calling myself an accountant. Now I am either retired or a writer, depending on my mood. I am planning, however, to spend the month of December consulting on 199A with a remnant of my very first public accounting firm and may well continue from the road. So a small portion of those large sums is coming my way.
The Corker Kickback
So as you can see, I’m kind of a cynical bastard, but it is nothing compared to Professor Shaviro. He starts his article by comparing the passage of 199A to gilded age corruption . He is particularly hard of Senator Bob Corker of Tenessee who put aside his anti-deficit stand when the pass-through rules were modified so that owners of tangible property with no or negligible wage expense would also qualify for the deduction. That provision (199A(b)(2)(B)(ii)) became known as the Corker kickback.
Real Tax Reform In The Eighties
Before going into academia, Professor Shaviro was on the staff of the Joint Committee on Taxation. He worked on the Tax Reform Act of 1986. He told me that he and a few other staffers had been involved in drafting the language for Code Section 469 (the oxymoronic passive activity loss rules). The section was scored, very high, before they drafted it, so they were told to make it really tough.
TRA 1986 was designed to be revenue neutral and provisions like 469 and the repeal of the General Utilities doctrine made up for the sharp reduction in marginal rates. TRA 1986 was also bipartisan and long planned for. I could really see why somebody who was involved in that effort is really upset at TCJA’s claim to be tax reform.
What Were They Up To?
The most interesting part of the paper is where Professor Shaviro tries to divine the rationale behind 199A. When I spoke to him, he indicated that he is speculating rather than having listened to the tapes from the smoke-filled room where the plan was hatched. The theory is that the Republicans had to deliver something to their donors.
The corporate tax cut actually has some economic thinking behind it in terms of making the country more competitive. And a corporate rate substantially lower than the individual rate has a logic to it, because there is an extra layer of tax before you can spend the earnings on steak and champagne and your fifth house.
Main Street Wants It Piece
The problem is that the corporate tax cut is a more a thing for the billionaire class and Wall Street. What about mere multi-millionaires on Main Street? The theory is that the supporters of individual Republican congressmen are people of more modest means. You know. The kind of guy that owns a couple of dealerships and a few strip malls, kind of like the contemporary equivalent of Mr. Potter.
Mr. Potter wants to know where his tax cut is and he doesn’t want to share it with all those working stiffs. Mr. Potter doesn’t own C corporations, because of the Tax Reform Act of 1986.
While the impetus to demand such rules could be viewed purely in terms of economic self-interest, it also appears to the author to have closely linked psychological and ideological elements. Powerful people, who might be accustomed to getting what they want immediately , yet who are sufficiently insecure and anxious about their power in an electoral democracy to crave continual repetition (both to themselves and others) of the claim that they are the society’s “makers” (not “takers”) and “job creators”, may gravitate naturally to demanding special treatment.43 Loyalty to their own social group may also incline them to favour, for psychological as well as revenue reasons, denying their specially crafted tax benefits to others whom they do not view as part of their own group sociologically, even if those others, such as successful members of the educated professions, are both formally and substantively fellow “business owners”.
Accountants As Intellectuals?
Professor Shaviro is alluding here also to the way that people involved in health, law and accounting among other things are excluded from the benefit of 199A.
The sociological divide between the business and educated “classes” goes back more than a century in US history—as one can easily see, for example, in literature. In the Gilded Age, when the educated academic and professional classes were less developed than they are today, it often concerned cultivated old versus brash new wealth, as in the work of Henry James and Edith Wharton. Today, the divide has more to do with rival intellectual and business elites.
As I noted in my coverage of Linda Sugin’s analysis of TCJA, the flaw in the reasoning here is the notion that accountants are part of the educated “classes” and the intellectual elite. I picked up on Profesor Shaviro’s article from one of the footnotes in that piece.
Maybe It Was A Jobs Bill
I do have to say that I think the W-2 test that went into the final version did justify the notion that there was a jobs bill going on here. Of course, the Corker kickback made buying robots instead of hiring people an optional way to get the benefit, but when you run the numbers it seems like it is really real estate that is meant to benefit.
Assume that you are getting a million dollars in flow-through income. In order to get the $200,000 deduction, you need to be paying $400,000 in W-2 wages or, with no W-2 wages, have $8 million in depreciable assets. When you buy tangible personal property, it will be in your base about ten years (which I am going with to keep the math easier). So you would have to be spending $800,000 per year buying new robots or whatever.
Another Way To Look At It
And that is where I part with Professor Shaviro. I can construct a rationalization if not a rationale for 199A. It is based on my observations over the last forty years. Basically, the argument is that the job creators really are much rarer than the job seekers.
I have seen a lot of people try to strike out on their own and maker a living for themselves without having an employer. A decent percentage manage it, but very few take the next step and successfully hire other people. And there are a lot of people who would like to just show up and practice their craft or just do what they are told in exchange for a decent wage.
The successful job creators are pretty rare and a lot of them are very tax-sensitive. So 199A has created a strong incentive to create your own job. If you do, you can be making pretty good money (over $300,000 with a low earning spouse)and getting the 20% benefit regardless of what you do and whether you employ anybody. If you are making really good money, though, you have a strong incentive to have W-2 employees, as opposed to a bunch of gigsters.
The professions where the partnership form is common and most of the business owners are actually people just practicing the craft exclude the big earners from the benefit.
It may well be that most of the benefit is going to the children and grandchildren of yesterday’s jobs creators – the new gentry. The original version of the tax bill in the House was custom designed for the new gentry. What ultimately passed benefitted a much broader class of people whose income is not from W-2 employment or simple investment – the job creators, their progeny and working stiffs who make their own jobs.
So maybe 199A is not so bad, even though it seems likely that it might not have been thought through that well. After all, it is better to be lucky than good.