A Not So Simple Tax Question

TaxMagnificationMy Comments: I try to not post anything with political implications. And while this post looks like one, there are larger issues with implications for Republicans, for Democrats, and Libertarians.

I’ve argued for years that the current chasm between the ‘haves’ and the ‘have nots’ in this country must be bridged. This article from the Financial Times speaks to an issue with the Tax Code that contributes to the visceral dislike of so many voters for politics as usual, and the favors that Congress promotes, that contribute to the growing disconnect between the electorate and those presumably in charge.

By Gillian Tett, The Financial Times, May 26, 2016

Donald Trump loves to disregard political rules. Now he is trying to break yet another: although it has long been customary for American presidential candidates to release their tax returns, Mr Trump is refusing to comply.

He says this is because these are being audited by the Internal Revenue Service; critics say he has something to hide (experts agree that being audited does not preclude someone from releasing the returns). Either way, the row is becoming poisonous — not least because polls suggest that two-thirds of Americans think he should release those returns.

As the mudslinging intensifies, it is not just the issue of Mr Trump’s tax returns that should make American voters angry. The bigger scandal is the way the corporate tax code treats those who own or develop real estate, and construction groups in a wider sense.

For if it were to emerge that — as his critics suspect — Mr Trump has paid little (or no) tax in recent years, the dismal truth is that he is not alone. On the contrary, there are so many loopholes that an audit of most property groups would show rock-bottom tax rates. Or, as one powerful real estate titan recently observed to me (in private): “If you are a developer who is paying tax, you have to be pretty dumb.”

Normally, these loopholes do not attract much attention. Corporate tax is fiendishly complex and many large property companies are privately held. The type of scrutiny that publicly listed companies face in relation to tax has rarely troubled big construction groups.

The row about Mr Trump’s returns has served the public interest by casting a spotlight on some of the practices. Some of these are quite colourful: a property classified as “agricultural” or “environmentally protected” can often escape certain federal and municipal taxes. It recently emerged that Mr Trump got a $39.1m tax deduction on a New Jersey golf course in 2005 because he donated the land for “conservation easement” — and installed some goats to claim it as farmland too.

The most important loopholes cannot be easily photographed. Developers can depreciate the value of their properties to reduce their tax liabilities, or appraise values in opaque ways. Another recent revelation is that Mr Trump claims for tax purposes that one of his golf courses in Ossining is worth a mere $1.35m — while local realtors have suggested a figure of $50m is more appropriate.

If real estate groups organise themselves into partnerships, they can write off mortgage interest payments against tax. They can also use the “1031 clause” in the property code, which stipulates that such partnerships can defer tax on a real estate sale if they “swap” their holding for another piece of property.

President Barack Obama tried but failed to curb the use of the clause. Even if a developer still faces a tax liability, they can almost always arrange their affairs to ensure that the gains are taxed as capital gains, not income. For top earners, this cuts the tax rate from 39.8 per cent to 23.8 per cent.

Such loopholes are not unique to the world of property, or America. But decades of lobbying has made the US real estate pattern particularly extreme. While it is unclear how much revenue is being lost as a result, some hint of the pattern can be seen by looking at some number crunching recently performed by colleagues on FT Alphaville.

Using data from the Bureau of Economic Analysis, they calculate that between 2011 and 2014 residential real estate was the single most profitable American business sector, ahead of non-residential and construction. If you look at the amount of tax paid, the construction sector was third from bottom, while the non-residential and residential sectors sat well below their profit rankings too. That means that real estate is producing profits, much of which are escaping the tax net.

From a policy perspective, this looks bizarre — and wrong. There may have once been good reasons why governments felt the need to support the real estate industry: to encourage urban development, or offset the impact of high interest rates, say. But today, rates are rock bottom, and property developers are some of the wealthiest people in the country.

So perhaps it is time for Mr Trump’s critics to widen their attack. Yes, it is interesting to speculate about how little tax Mr Trump has paid; and yes he has probably been more “creative” than most. But the really interesting question is what Mr Trump — or Hillary Clinton — would do in office. Will either of them actually abolish those real estate loopholes? Or just crack down on more visible targets such as hedge funds, banks or technology companies? No prizes for guessing the answers. And therein lies another outrage.