Last month, the New York Times reported that President Donald Trump paid no income taxes at all in 10 of the previous 15 years. And in 2016 and 2017 the New York Times reported he paid $750 in individual income tax liability each year.
In a recent Bloomberg Tax article, Seth Hanlon of the Center for American Progress argues that Trump’s tax returns are an indictment of the tax system as a whole. He claims that in order to address the problems that led to Trump paying little individual income tax, Congress should increase funding for tax enforcement with a focus on high-income returns. In addition, he argues that Congress should directly address “loopholes” in the current tax code that allow high-income households to avoid tax.
While Hanlon makes a convincing case that Congress should adequately fund tax enforcement, it is not clear that Trump’s tax return saga tells us much about how to reform the tax code.
The New York Times reported that Trump claimed several expenses on his tax returns that have been described as “questionable.” According to the story, he may have paid his daughter nearly $1 million in consulting fees, which may have allowed them to avoid gift taxation. In one year, he claimed around $70,000 in expenses for hair care related to his appearance on “The Apprentice.” And as Seth mentioned, it is also possible that he received a $73 million refund due to a loss on a business that he continued to have a stake in.
It’s not clear that any of these expenses constitute fraud or tax evasion, but at the very least they are aggressive. In fact, the IRS is currently auditing Trump for the transaction that led to the $73 million refund.
Regardless of Trump’s specific situation, the IRS must make sure that all taxpayers are following the rules. Falling IRS funding and audit rates indicate that our tax authorities may not be able to keep up. Over the last decade, IRS funding has fallen by 21% in real terms. At the same time, audit rates on high-income households have fallen by 61%.
Improved enforcement can help close the tax gap, but we should be realistic about how impactful increased enforcement would be. There are various estimates of how much additional enforcement funding could raise. Some estimates suggest the federal government could raise nearly $1 trillion over 10 years, but there are reasons to be skeptical. A more reasonable estimate by the Congressional Budget Office estimates that investing $20 billion in additional enforcement could raise $55.3 billion over the next decade.
Hanlon also argues that lawmakers should scale back several tax breaks that real estate investors benefit from. Provisions such as accelerated depreciation for rental properties and like-kind exchanges are two such examples. He also proposed limiting the step-up in basis on capital gains at death, increasing the tax rate on capital gains income, and scaling back the 20% deduction on business income (Section 199A).
Some of these provisions are in need of reform and scaling them back would raise taxes on high-income households and raise revenue. However, it is not entirely obvious that they are directly applicable to Trump’s tax situation. The New York Times story suggests that the primary reason for years of low or no individual income tax liability is that Trump suffered significant losses on his business operations. As stated previous, the New York Times reported that Trump received a $73 million refund for losses in the late 2000s. Before that, a previous leak of his returns showed that he reported slightly more than $900 million in losses, which allowed him to wipe out most of his income tax liability throughout the 1990s.
As New York University Law School Professor Daniel Shaviro recently said, Trump’s primary tax strategy wasn’t particularly clever and required him to lose a lot of money.
Given Trump’s significant use of losses, lawmakers may consider limiting losses. Lawmakers recently limited them as part of the 2017 tax cuts, although these limits were recently lifted temporarily as part of the federal government’s Covid-19 response.
Further limits to losses would be counterproductive. Loss deductions are an essential part of a well-functioning income tax. Businesses typically make multi-year investments. Those investments may lose money in some years and make money in other years. The ability to carry back losses to offset previous years’ taxes and carry forward losses to offset future taxes ensures that the tax system accurately measures income. Without loss deductions, a tax system would be biased against investments that may lose money for many years before turning a profit.
It is also worth noting that part of Trump’s tax liability story reflects policy choices made by Congress. For example, the New York Times suggests that Trump benefited from tax credits, such as the historic preservation credit. The historic preservation credit was enacted in 1976 and is meant to encourage businesses to rehabilitate and re-use historic buildings. Trump’s restoration of the Old Post Office hotel in Washington, D.C., qualified for the credit.
Going forward, the New York Times story on Trump’s tax returns may push Congress to do something. However, lawmakers need to understand what Trump’s tax returns tell us and what they do not. A tax system should properly define an accurate measure of income. This means businesses that lose money should not pay income taxes. Loss deductions are an essential component of that system. At the same time, taxpayers should be confident that everyone is following the rules and that the deductions that give rise to losses are legitimate. In the end, Trump’s tax returns may say more about Trump and tax enforcement than the tax system as a whole.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Kyle Pomerleau is a resident fellow at the American Enterprise Institute (AEI), where he studies federal tax policy.