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By John McNellis

When even the crooked developers think the polls-leader gives real estate a bad name, you know Washington has problems. A short-term phenomenon—the ever braying Donald Trump will soon enough become a quaint footnote—yet his surprisingly successful candidacy has already served its purpose, underscoring the nation’s frustration with politics as usual and the usual politicians. To the misinformed, The Donald is the man with the sword, the cutter of the Capitol’s Gordian knots. Wrong about their candidate, his supporters are dead-on about our problems.

And among those, our Federal Income Tax Code stands out like a sequoia in a wheat field. Even if no one—save perhaps Rand Paul—is trying to fix it, many are using the broken Code like a violin, playing lullabies to their bases.

McNellis
McNellis

On the left, Hillary Clinton has tossed a small bone to the progressives. In the mildest tax-the-rich scheme ever, she is proposing to extend the holding period required for full capital gains treatment from one year to six, gradually reducing the ordinary tax rate of 39.6 percent to the capital gains rate of 20 percent over six years. On the right, the clown car (the field is now at 17) is clamoring for tax cuts, some going so far as to demand the elimination of capital gains taxes altogether, hauling out the old trope of “double taxation on investors.” Whether displaying a ground squirrel’s understanding of economics or simply a willingness to say anything to get elected (likely a combination), these candidates, notably Marco Rubio, swear their tax cuts will result in so much economic growth that tax revenues will actually increase.

Speaking of sequoias, I have a few friends with serious zeros to the left of their decimal points. In wondering whether these guys—the Big Lumber who would actually be affected by Hillary’s proposal—cared about it, I decided to conduct a statistically meaningless poll among them. I found no one, neither republican nor democrat worked-up over her plan. In fact, they were largely indifferent, pointing out that it would have little effect on their own long-term financial strategies.

When I expanded the question beyond Hillary’s modest proposal to the concept of taxing all income at ordinary rates, that is, of eliminating capital gains treatment altogether, the discussions became livelier. A few foresaw the end of the Christian world, while others were ambivalent, actually willing to endorse the idea if only the Code were made fairer, that is, if only other people’s tax breaks were eliminated as well.

In 2012, Mitt Romney famously observed, “…There are 47 percent who are with [Obama], who are dependent upon government, who believe that they are victims, who believe that they are entitled to [government hand-outs].” Mitt was half right. In reality, nearly everyone is dependent upon the government for special treatment. Self-perceived victims or not, nearly everyone feels entitled to his own special tax breaks, to his tax-free bonds or R&D credits or oil & gas depletion allowances or mortgage or charitable deductions. The Code’s more than 70,000 pages channel an endless river of credits, deductions and loopholes for the well-connected.

And that brings us back to Rand Paul and the Big Lumber.

Rand Paul is proposing to scrap the entire Code, eliminate all deductions save two—for home mortgages and charitable giving—and have a single, flat-rate tax of 14.5 percent on all income, whether individual or corporate, in excess of $50,000. All income would be treated the same; anyone could figure out her taxes on a napkin.

Because Paul’s proposal would put the country further in the hole (a 19 percent average tax rate appears necessary to keep revenues constant), I asked the Big Lumber whether they would endorse a proposal that eliminated Rand’s two deductions (leaving none) and set taxes at 14.5 percent for the first $500,000 in income, 20 percent for income between $500,000 and $1,000,000 and 25 percent above $1,000,000. This proposal is not a sop to the super-rich. According to the IRS, the top 1 percent paid 22.83 percent in taxes in 2012 while the fairytale rich (incomes above $62,000,000 a year) paid just 17.6 percent. Despite the hit, Big Lumber said yes.

Now it could be that my handful of rich friends are the only open and fair-minded multi-millionaires out there, but I doubt that. My guess is they are representative of their economic class and that, given the choice between a level economic playing field or one in which they must continuously fight for their own unique tax breaks while every other special interest group fights for theirs, the super-wealthy would take the level field.

While it may start with the rich, the greater problem lies with Congress itself. In 1976, the Nobel-prize winning economist Milton Friedman publicly abandoned all hope of meaningful tax reform, calling it an “impossible dream”—blaming the implacable opposition of tax lawyers, accountants and civil servants whose livelihoods were dependent on the Code’s ever-increasing complexity. (Talk about Nostradamus.) Friedman also pointed out that granting tax-relief was the only thing Congress has to sell, that tax loopholes are to Congress what bread is to a baker. Without bread, a baker is out of work. Without tax breaks, Congressmen would have nothing to sell to lobbyists and would probably have so much time on their hands they could actually talk to real constituents. Maybe even be forced to run on their merits.

Flatten the Code.

John E. McNellis is a Principal at McNellis Partners in Palo Alto, Calif.