Tuesday, February 21, 2023

The Kansas Tax Debacle - When People Don't Understand Taxes

Double-taxation of corporations is an issue.  You don't solve this by eliminating taxes on "pass-through" Subchapter-S corporations!

In recent years, Republicans have been a one-note Johnny on taxes.  "Cut taxes!' Cut taxes!" is all they seem to say.  In action, they cut taxes for the wealthiest Americans.  The Trump "Tax cuts for the middle-class" had a built-in expiration date.  The tax cuts for the highest brackets never expire.

But in discussing taxes, you realize how many people just don't understand how they work.  And a lot of folks, who pay little or nothing in taxes, are often outraged at being "over-taxed!"

Take the Gifts and Estate tax, for example.  Republicans label it a "death tax" because if you control the language of a debate, you control the debate.  The reality is, of course, that you are not taxed on the first eleven million dollars or so of your estate.  If you want to leave your trailer home to little Bubba and his common-law wife, well, you need not worry about any "death tax".

You'd be surprised how many poor people are up in arms about the "death tax" - but fail to realize that repealing it (as happened for one year) would benefit only the mega-mega-rich.

When talking about income taxes, you have to talk about marginal rates - and people don't understand what that means, because "math is hard" and "you don't need to know math in real life."  I pity what passes for "real life" for such folks - just watching television and consuming endlessly, I guess.   But until one understands how marginal rates work, and the difference between a tax deduction, and a tax credit,one doesn't really have any sort of valid opinion about tax law.  It is like asking an anti-vaxxer for a recommendation of a good Doctor.

I mentioned before how we double-tax corporations in this country - something that is alien to a lot of countries, worldwide.  We tax corporate entities on the "profit" they make, and then tax the shareholders on their dividends and capital gains.   So, for example, a corporation makes $100 in profit, they pay corporate income tax on that.  They pay out a dividend from that profit of $1 to each of 100 shareholders, each of them pays income tax on that as well.

Of course, there are games played here.  Corporations can structure themselves so they pay little or no income tax.  You sell your "Intellectual Property" to an offshore division in Ireland, and then license it back for an amount strangely equal to your corporate profits.  You show zero income as a result, while your Irish subsidiary shows all the profit - but pays little or no tax in that country because of their favorable tax laws.

In the higher brackets there are all sorts of games to play.  And shareholders can avoid paying taxes on dividends if the company doesn't pay dividends, but instead retains earnings (which can be taxed) or buys back stock to inflate the stock price (which used to be illegal for obvious reasons) and thus the shareholder is only taxed when they sell shares, and even than, only at lower capital gains rates.

So it all evens out.  Even with double-taxation, there are still a lot of corporations in the United States who seem to somehow eke out a living despite this "burden."

For smaller companies - like a Mom & Pop Shop, there is something called the Subchapter-S corporation - which provides you with (you hope) insulation from personal liability like the big corporations get, but without the double-taxation.  Subchapter-S (named after a portion of the IRS code) corporations "pass through" profits to the shareholders, who pay taxes on those profits as ordinary income. 

Yes, in theory, you could pay yourself in dividends - although there are limits as to what is a dividend and what is ordinary wage income.  A friend of mine tried this game - encouraged by his accountant - and the net result was an audit and penalties and back taxes owed.  Turns out it was audit-bait and that accountant is now in jail.

The other problem for my friend is that since he was paying himself in dividends, he wasn't paying Social Security and Medicare taxes (payroll taxes - doubled for the self-employed!).  When you are young, this seems like a cool deal, but as he approached retirement age, he realized he didn't have 40 quarters of reported income and thus would not qualify for either Social Security or Medicaid.  He spent the last decade of his working life paying those taxes so he would qualify.

Sometimes these clever deals can backfire in a big way.   But I digress.

The point is, Subchapter-S corporations are not double-taxed at all.  So it made no sense whatsoever when Kansas decided to go Big Republican with a nonsense tax bill that eliminated all State income taxes on Subchapter-S corporations.  The net result was that people who didn't have a Subchapter-S corp quickly formed one.  And the bulk of the people who were spared State taxes were wealthy business owners and professionals, such as doctors and lawyer and dentists - as well as the guy who owns the car dealer or the local auto parts store.

In other words, in Grand Republican Tradition, it was a big tax cut (down to zero!) for the upper-middle-class and the wealthy, but didn't do bubkis for the poor.  The proponents of this bill argued that these business owners would "hire more people" if their taxes were cut.  But I have addressed the folly of that argument before - if you need more people to make more money, you hire them.  You don't hire people willy-nilly simply because your personal tax bill went down.  I mean other than perhaps a pool guy, a maid, and a gardener, I suppose - employees who are personal expenses.  But for your business?  Hiring decisions are not made based on your take-home pay.

The net result was, of course, none of this "trickled down" to the poor, nor did it encourage hiring.  And since it left a huge deficit in the State budget, it had the opposite effect - spending on necessary things like roads and bridges had to be slashed. The Kansas economy did not take off.  And dissatisfaction with the law was so great that the legislature not only voted to overturn the law, they overrode the governor's veto.  This poorly conceived idea pretty much killed off Governor Brownback's Presidential ambitions.

Now granted, tax cuts can stimulate an economy, particularly when taxes were onerous.  Kennedy cut taxes in an era where marginal rates were 70% or more.  Economists will point out that if you raise taxes high enough, you end up collecting less money as you strangle the economy and people spend most of their time on tax-avoidance schemes, rather than productivity.   But when rates are already low, cutting them further can starve a government - which is often the plan.  Some Republicans want to shrink government so small that it would fit in your bedroom.

Regardless of whether you thought tax rates in Kansas were too high or not, cutting the rates to zero for a selected class of wealthy individuals is an extreme and dramatic action - and favors only certain people.  The party that decries "Picking Winners!" certainly picked some here.

The funny thing was, when the law was enacted, many people rushed to register their Subchapter-S corporations, including a lot of lawyers who had previously been solo practitioners or partnerships.  People got wind of this and, since everyone hates lawyers - were outraged by it.  So Governor Brownback promised to amend the law to exclude lawyers and other "service providers" - again, the party that eschews picking winners, picks winners.

So how did this nightmare come to being?  The simple answer is, your average citizen doesn't understand the tax code because they don't understand math.   Your average wage-slave thinks that their "tax refund" is free money from Uncle Sugar and not his own money he overpaid being returned to him.  I mean, granted, there are incidents with tax credits where you are getting free money, but by saying that just now I confused the fuck out of half the readers who, again, don't understand the difference between a tax credit and a deduction. What's worse is that most people don't want to know, and will actively thwart you if you try to teach them.

They will put their hands over their ears and shout, "La, La, La, La - I can't HEAR you!" because they prefer ignorance to knowledge.  Then they will chant "tax cuts! tax cuts!  Own the libs!" because they believe they are paying "a lot of taxes" which is going to "welfare" so that black people can sit around all day doing nothing except planning their next riot.  No, they really believe this.

You try to explain to people that TANF (Temporary Assistance to Needy Families) is limited to five years for your lifetime and that other benefits, such as "Food Stamps" (SNAP) and Medicaid have a working requirement that you either have a job, are actively looking for one, or have some valid reason why you can't work (in school, disabled, etc).   But no, they heard on Fox News about "Welfare Queens" whose families were "on welfare" for "generations" and get free cars and furniture and stuff from the government. Fox News would never lie to us, would they?

Now, most of use don't live in Kansas, and not many people actually do live in Kansas.  So this Kansas debacle was of no concern to the rest of us.  When it all blew up in their faces, everyone had a good laugh because it didn't affect us and illustrated the stupidity of the people of that State for voting for this sort of crap.

But we shouldn't have laughed.  Because the "Kansas Experiment" illustrates how easy it is to pass bad legislation and horrific legislation - and there is ample precedent for this. Prohibition was based on a Constitutional Amendment that went horribly wrong.  A whole legion of people call themselves "Constitutional Warriors" without ever having read it - or understanding how, at one time, it condoned slavery as well as outlawing alcohol.  The Constitution is not some sort of Bible that is sacrosanct, but rather is a framework we are supposed to use to work things out - and change when conditions warrant change and the framework is no longer workable.

But again, ignorance. Many of these "Constitutional Warriors" are now in jail or on trial for treason as they tried to usurp the Constitution on January 6th when votes were being counted according to the process set fort in the Constitution.  But just as these sort of folks don't really understand (or have even read) the Constitution (or the Bible for that matter) they had no understanding of how the tax code works.  They only know what they are taught to think - by far-right media outlets.

Even today, Republicans and "Libertarians" are claiming that the Kansas "Experiment" was a success - but that a "rural recession" hampered it and the "liberal media" is lying about it.  But numbers don't lie, and whatever "rural recession" they are talking about somehow evaded all the neighboring States whose economies grew while Kansas receded.

Of course, to repair the damage, the legislature had to repeal the tax cuts and rebuild reserves and catch up on all the delayed infrastructure projects.   While they are doing the heavy lifting and taking responsibility and governing, the detractors sit on the side lines and say,  "See?  They raised your taxes!  Biggest tax increase ever!  That's what you get for electing Democrats!"

And the Ignorati believe this sort of thing.  Deep down, they believe that a society can exist with no taxes whatsoever and that roads will magically pave themselves and school teachers will work for free and the Police don't need to be paid.  And there are countries like that in the world - with no taxes, just horrendous import duties.   You pay top dollar for any imported good.  The roads are treacherous and schools are only for the wealthy.  And the Police?  Corrupt - they favor whoever pays them the biggest bribe.

It seems that some folks want to see this in America - see us turned into a third world country.  And if they get their wish, they won't have to worry about "migration" anymore - no one will want to come here!

Does this mean all tax cuts are a bad idea?  No, only when they are not accompanied by spending cuts.  And spending cuts are only justified if spending is not needed or can be reduced.  Sadly, this is the other half of the tax-cut debate:  Republicans under-fund programs (such as Medicare and Social Security) and then let the fail - and claim that "big government doesn't work!"   And this is not limited to the United States.  We see in both Canada and the UK an effort to undermine national health care by intentionally under-funding it to "prove" it doesn't work - and then privatize it.

It is a plan that will only work if we let it....