The Bear’s Lair: Distant gleam of freedom

Donald Trump’s tax plan, revealed at the Economic Club of New York on September 15, does not add up, as most Presidential candidates’ tax plans don’t. Still, it did contain one provision that is fiscally insignificant but economically enormous: by capping all tax deductions at $100,000 for single filers, $200,000 for married couples, without exceptions, it went a long way to eliminate the charitable tax deduction scam. Removing that, and thereby shrinking the nonprofit sector, would be a gigantic blow for economic freedom second only to abolishing the Fed.

By capping tax deductions, even at such a high level, Trump has taken an ax to the most egregious feature of the U.S. tax system, by which billionaires often pay less tax than their secretaries. Warren Buffett has whined about this anomaly, with the implication that the solution is the left’s favorite panacea of higher tax rates. Of course, that would merely allow the lobbyists to insert yet more loopholes into the U.S. tax system, increasing the power of politicians to allocate resources and removing the U.S, economy even further from anything resembling a free market.

There are three major tax allowances that would be capped by Trump’s proposal. Of these, the home mortgage interest deduction is least affected, because of today’s ultra-low mortgage interest rates. $100,000 in mortgage interest would only be incurred on a $3 million mortgage, at today’s interest rate of 3.3%. Of course, there are people with mortgages larger than this, though the limitation of home mortgage interest to the first house makes their number relatively small. Mostly, the cap would affect mortgages in ultra-high cost areas such as Manhattan, San Francisco and Silicon Valley, perhaps knocking the top off the excessively bubbly real estate markets in those areas.

Trump’s cap on tax allowances would also affect the state and local tax deduction. Here an individual with an income of a bare $1 million living in Westchester County, who would not be in the top New York state tax bracket, would run up $100,000 in tax deductions from state tax of about $68,000 plus about $32,000 in local real estate taxes on his $1.2 million home. The limit thus catches a much broader swathe of the upper middle class, especially those in high-tax states like New York, New Jersey or California.

However, the tax deduction most seriously affected by Trump’s cap on allowances would be that for charitable donations. This is the favorite tax-avoidance strategy of the super-rich; by giving vast sums of money to charities, whether genuine or phony like the Clinton Foundation, they end up paying minuscule amounts of tax. Indeed, as the Congressional Budget Office showed in 2013, by far the greatest beneficiaries of the charitable tax deduction are the top 1%, who benefit by about 1.4% of their income, compared to a 0.7% of income benefit to even the next richest group, between the top and the fifth percentile of the income distribution. Capping this tax deduction would remove the largest current loophole from the current U.S. tax system.

Trump’s proposal would cap the sum of the deductions at $200,000 for a married couple; it would therefore severely limit the tax deductibility of charitable donations for wealthy people who had already used up much of their allowance in mortgage and state/local income tax deductions.

As we are beginning to see from accounts of the Clinton Foundation, tax-deductible gifts to “charity” may be used to generate benefits elsewhere, often much larger than the gift itself. This is clearly a scam of the first order; not only is the Federal budget being deprived of much-needed revenue, but costs are often also imposed on government through favors to the charitable donor.

Even when “charities” are not abusive political slush funds like the Clinton Foundation, the charitable tax deduction is highly damaging. For one thing; it redistributes from the poor to the rich. When a hedge fund executive deducts $1,000 for the cost of a charity dinner to boost his tawdry social life and make new contacts, there is $396 less at the federal and maybe $80 at the state level that is no longer available for necessary programs, at least some of which benefit the worse off. Given the expenses, legitimate and illegitimate, incurred by charities, even if their activities benefit the poor, the inefficiency of the charitable tax deduction may well be net damaging to the interests of the poor and especially to the working poor.

However, in reality most charitable giving does not benefit the poor. There have been few studies of this important question, but one by Indiana University in 2005 suggested that only 31% of charitable donations go to the poor, with 69% going to the non-poor. Religion, elite colleges and the arts are especial non-poor beneficiaries.

The billionaire leaving $100 million to be incompetently invested in hedge funds by the Harvard Endowment gets a handsome tax deduction, while making sure that none of his money goes anywhere near the poor. One is reminded of the Saki (H.H. Munro) short story “The Soul of Laploshhka” in which the protagonist cheats the uncharitable miser Laploshka out of a few francs, and is then horrified when the miser dies:
“To have killed Laploshka was one thing; to have kept his beloved money would have argued a callousness of feeling of which I am not capable.” The protagonist therefore goes to endless lengths to give Laploshka’s money to a non-poor beneficiary, ending by donating it as charity to a shabbily dressed multi-millionaire. Truly the spirit of Laploshka is rampant among those claiming the charitable tax deduction.

Combine these two figures together, and you have a remarkable result. On average, of a $1,000 charitable donation by a taxpayer in the top bracket, $476 is returned to him in deductions from his taxes, $690 goes to the non-poor and only $310 goes to the poor. In other words, charitable giving is on balance reducing the funds available for the poor, by $166 per $1,000 in this example. This is a truly disgraceful result, and illustrates the iniquity of the charitable tax deduction, even without considering the charities that are outright scams.

The charitable deduction costs the Federal budget directly about $60 billion per annum, a figure that is almost certainly an underestimate, because as in the case of the Harvard endowment, money given to charity is often invested in tax-free funds that earn returns that also escape the tax net. A more complete figure can be calculated from The NonProfit Times estimate that the tax-exempt sector “contributed” $887 billion to the U.S. economy in 2012, 5.4% of Gross Domestic Product. That is all money allocated by the murky though processes of charities, and thus not available for the truly productive private sector; in itself it represents a major drain on the U.S. economy and the current anemic productivity growth therein.

Tax that $887 billion at an average rate of 40%, including income taxes, sales taxes and excise duties, and you will generate over $350 billion per annum to the fiscal balance, more than half even the current swollen budget deficit. And, as I said, the economy will be more productive, the poor will be better off, and the Clintons will be deprived of their principal source of funding. A win all round, it appears to me.

If Trump is elected, state and local governments of high-tax badly run states like New York, New Jersey and California will raise all kinds of hell to get themselves exempted from his deductions cap, because forcing rich residents to pay the full costs of the states’ fiscal profligacy would drive the last of their long-suffering residents to more civilized locations. There will also be attempts by the realtors’ lobby to remove the cap altogether or exempt home mortgage interest, although in this case only a modest percentage of their income comes from residences with such huge mortgages, so the squawking will be muted.

However, the lobbying from the states and the realtors will be as nothing compared to the massive and revolting PR campaign that will be waged by the charity lobby. Pictures of starving and diseased children will be all over the airwaves. K Street will see new records of activity, as Washington’s swollen armies of lobbyists swing into action, with the charities calling in past favors, so the farm lobbyists, the Pentagon lobbyists, Hollywood’s copyright lobbyists and Silicon Valley’s patent lobbyists lend their efforts to block Trump’s proposed legislation, or at least exempt charities from it. Money will pour into the coffers of every Congressman prepared to sell his soul for just one more betrayal of the people who elected him. The battle will long and vicious, and with allies like the feeble Speaker Paul Ryan and the Republican Congressional corruptocrats it is most unlikely that Trump will win.

But the battle is worth fighting. Of all possible tax reforms to revive the U.S. economy and return prosperity to the American people, that to de-fund the charitable Leviathan, divert its resources to more productive uses and make the rich pay their fair share of taxes is the most important.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)