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Did You Catch the Huge Loophole in the GOP Tax Plan? The Rich Sure Did.

November 3, 2017, 6:40 PM UTC

In September, shortly after the GOP released the initial framework for its so-called middle-class tax plan, multiple independent analyses revealed that millionaires would reap the greatest benefit, both as a share of the entire tax cut and as a percentage of their income.

The public narrative quickly shifted to the tax plan being a giveaway to the wealthy, and opinion polling revealed the plan was unpopular. So when House leaders unveiled formal legislation on Thursday, they made sure to highlight a provision that maintains a top rate of 39.6% for those reporting income of $1 million or more.

It’s a clever talking point that may temporarily provide political cover, but it is not a game-changer. The nation’s most affluent families tend to earn their money in different ways than the rest of us, and the House bill either creates or retains special loopholes for those types of income that dramatically water down the effect of the 39.6% rate. This is not breaking news. Tax writers are fully aware of this.

Under current law, the top tax rate on most investment income (capital gains and dividends) tops out at just 23.8%—far below the 39.6% rate applied to salaries and wages. This preference for income earned from investments over ordinary wages is the reason Warren Buffett, as he says, pays a lower tax rate than his secretary. The House tax plan leaves this loophole in place. As long as this loophole remains untouched, it will make little difference to wealthy investors whether the top ordinary income tax rate is 35%, 39.6%, or any other level because that rate will not apply to investment income. If lawmakers genuinely wanted to signal to the public that they intend to focus on the middle class, they would have closed this controversial loophole.

Instead, tax writers created more special carve-outs for the highest-income households that make the 39.6% top rate seem far less significant by comparison. Most notably, the plan eliminates the estate tax, which only the wealthiest 0.2% pay, as the first $11 million in wealth is exempt from the tax. The sole reason for repealing this tax is to shower more tax benefits on the wealthy. The legislation also dramatically reduces tax rates for corporations and other highly profitable businesses, and repeals the backstop Alternative Minimum Tax (AMT), which ensures that high-income taxpayers pay at least some basic amount of tax, no matter how many loopholes their accounts helped them find. All these provisions would offer an enormous windfall to the nation’s wealthiest families, despite a 39.6% top rate being left in place for salaries and wages.

House leadership essentially has chosen to answer public concerns about inequities in our current tax system by making them much worse, but in ways that can be difficult for everyone except tax accountants and analysts to understand.

Consider the proposed top rate of 25% that would apply to most types of business profits. Business owners would pay rates of no more than 25% on their income, while their employees would still be subject to rates ranging up to 39.6%. This creates a clear inequity and special tax preference for the types of income earned by the most affluent taxpayers. Business income, which makes up around a quarter of the earnings of the nation’s millionaires, is another reason House leaders were so quick to abandon their plan to cut the top tax rate on salaries and wages: precisely the types of income that millionaires are less likely to rely upon.

There likely won’t be much outcry over the top tax rate staying at 39.6%, even among wealthy special interests who are pushing for tax reform, because they’ve already succeeded in ensuring that the House proposal will include enough loopholes to stop that top tax rate from applying most of the time.

My colleagues at the Institute on Taxation and Economic Policy produced an analysis of the September framework, which would have cut the top rate to 35%, and found that the share of the overall tax cut going to millionaires would have fallen by less than 2 percentage points, from 58.6% to 56.8%, if that top rate cut had been left out while the other tax cuts for the wealthy remained intact.

The unfortunate truth is that this so-called millionaires’ tax is little more than a talking point developed to assuage public concern about income inequality and a tax plan that could make it worse by substantially boosting the after-tax income of the wealthiest Americans.

Alan Essig is the executive director of the Institute on Taxation and Economic Policy.