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This Big Tax Cut for ‘High Fliers’ Shows Why an Overhaul Is Hard

The lack of specifics continues to frustrate members of the House Freedom Caucus, who are negotiating support of the budget resolution in exchange for assurances on the timing of a tax bill’s release.

(Bloomberg)— President Donald Trump and Republicans love the idea of cutting taxes. But the hard part comes now as they wrangle over who will see the biggest breaks.

Trump has vowed that the middle class would be the main beneficiaries under his tax plan, but the framework’s limited details have led to estimates that top earners would reap the biggest gains. While GOP leaders say those analyses aren’t fair -- because they filled in the plan’s gaps with details from a previous Republican blueprint -- the debate has left them vulnerable to pushback from their own members, and attacks from Democrats.

The lack of specifics continues to frustrate members of the House Freedom Caucus, who are negotiating support of the budget resolution in exchange for assurances on the timing of a tax bill’s release. The House may vote as soon as this week on the Senate budget resolution -- a crucial step to passing a tax bill with only Republican votes. The Ways and Means Committee has promised to release legislation soon after.

Trump and Vice President Mike Pence joined a House Republican conference call Sunday afternoon to build momentum for the tax legislation, according to a person familiar with the matter. During the call, Trump urged House members to adopt the Senate budget this week and follow through on the tax overhaul, said the person, who asked not to be named.

When it’s unveiled, the legislation will finally reveal decisions on income tax brackets, a top fourth individual income tax rate, the child tax credit and deductions -- all essential to determining which Americans stand to gain the most.

One of the most-watched debates will be around cutting the rate for income from so-called pass-through businesses -- such as partnerships and sole proprietorships -- and whether it will be limited to firms of a certain size. Without such limits, the proposal would be a boon for the highest earners -- about 70 percent of pass-through income flows to the top 1 percent, according to the nonpartisan Brookings Institution.

The White House has struggled all year to counter charges that Republican tax proposals will primarily benefit the top 1 percent. Treasury Secretary Steven Mnuchin recently said high earners pay most of the federal income taxes, making it “very hard not to give tax cuts to the wealthy” under a broad overhaul of the code.

How U.S. Republicans Clash on Their Own Tax Plan

The tax framework sets a top pass-through rate of 25 percent -- down from 39.6 percent currently. A study by the left-leaning Center on Budget and Policy Priorities says that 80 percent of the benefit from that cut would go to millionaires -- an average of $50,000 each. It also says that 86 percent of pass-through tax filers already pay a rate of 25 percent or less and estimates that the measure would lower taxes on just 2 percent of households earning less than $100,000.

Pass-through businesses include small operations like corner stores and free-lancers, but also doctors, lawyers, consultants, hedge funds and even Trump Organization. Trump has said the goal of his tax plan is to benefit the middle class and not himself or his "rich friends." He’s also said a top rate of 25 percent for pass-throughs, along with a 20 percent corporate rate, is non-negotiable.

House Republicans are exploring ways to prevent abuse of the new pass-through rate. “Members are developing a pass-through rule with strong guardrails to ensure that the provision cannot be inappropriately used by pass-throughs of any size,” Emily Schillinger, a spokeswoman for Ways and Means Committee said in an email. She didn’t indicate what those limits might be.

The chief tax writer in the Senate, Finance Chairman Orrin Hatch, said he doesn’t support restrictions on the size of businesses that would get the cut. He said he wants all businesses classified as pass-throughs to be eligible for the new rate.

“I think if you do it to everybody you’re going to have an upswing in the economy like you never saw before,” Hatch said in an interview. “And so I’m for cutting taxes for everybody.”

‘Grand Canyon Gap’

The pass-through proposal is already drawing criticism from Senator Ron Wyden, the top Democrat on the Finance Committee. He said the pass-through rate cut contributes to a “Grand Canyon-sized gap” between the middle-class rhetoric and the reality of the Republican tax framework, and that it should be limited to small businesses and not “high fliers.” Wyden said committee members were told the issue would be fixed months ago, but it hasn’t been.

Mnuchin said in September before the framework came out that businesses such as service companies shouldn’t be able to take advantage of the 25 percent rate.

The framework refers to the need for the tax-writing committees to prevent individuals from becoming pass-throughs in the future to game the system, saying “the framework contemplates that the committees will adopt measures to prevent the recharacterization of personal income into business income to prevent wealthy individuals from avoiding the top personal tax rate.”

But it was silent on limiting which kinds of pass-throughs can enjoy the 25 percent rate.

Senator Mike Rounds of South Dakota shares Hatch’s opposition to limits, saying taxes should be “equitable” across pass-through entities, regardless of their size or wealth. “The vast majority of those, right now, are small to medium size businesses,” he said in an interview. “That’s where the vast majority of the dollars come from.”

Adjustments Needed

The pass-through issue illustrates the political challenges and complex math facing Republicans as they try to prevent their tax cuts from exploding the debt. A 25 percent tax rate on pass-through entities would add $770 billion to the deficit over a decade, according to the nonpartisan Tax Policy Center, which estimated that $130 billion of that total would come from tax avoidance by individuals.

The pass-through rate is a sticking point for Senator Claire McCaskill of Missouri, a Democrat facing re-election who the White House is wooing on taxes. She told top Trump officials last week that an unrestricted 25 percent rate would be a windfall to millionaires, and said it would “absolutely” break Trump’s promises not to help the rich in his tax plan.

“There needs to be adjustment to that,” McCaskill said, describing it as just one of many questions she has about the Republican framework. When she asked Mnuchin about what kind of safeguards would be in place for pass-throughs, he responded: We’re going to have to take a look at that, McCaskill said.

Two other Republicans on the Senate Finance Committee -- Tim Scott of South Carolina and Pat Toomey of Pennsylvania -- wouldn’t say whether the 25 percent rate should be limited to certain existing pass-through businesses. They said the bill hasn’t been drafted.

Small Businesses

Senator Susan Collins of Maine, a closely watched GOP vote on taxes, kept her powder dry when asked if there should be limits on the 25 percent rate. “I’m going to wait till the tax bill is out before judging the various provisions,” she said. “I do think it’s important that tax relief be given to hard working families and to small businesses, as well as to larger corporations in an attempt to get them to do their investments here in this country.”

Republicans are keeping their options open. Before passing their budget vehicle to begin the tax debate last week, they united to reject a Democratic amendment to prevent tax breaks for the top 1 percent of earners. North Dakota Democrat Heidi Heitkamp joined them, fretting that the measure was overly broad.

“I don’t know why it’s such a big problem. They think that the rich are going to benefit?” Hatch said, referring to the lower pass-through rate. “Well, the rich are going to always benefit. The question is: What works?”

--With assistance from Billy House and Justin Sink.To contact the reporter on this story: Sahil Kapur in Washington at skapur39@bloomberg.net To contact the editors responsible for this story: Alexis Leondis at aleondis@bloomberg.net John Voskuhl

© 2017 Bloomberg L.P

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