Four years ago, Republican Presidential candidate Mitt Romney severely criticized 47% of the American people. He said, “These are people who pay no income tax. 47% of Americans pay no income tax.” They are wholly “dependent on government,” and taxpayers will “never convince them they should take personal responsibility and care for their lives.”
So let’s fast-forward four years. Does Romney’s Republican Party still support the notion that people who pay no income taxes are failing to take personal responsibility and care for their own lives?
Apparently not. In response to the New York Times’ story that Donald Trump may not have paid income taxes for two decades, Republican Mayor Rudy Giuliani claimed that “The man’s a genius. He knows how to operate the tax code …” And Republican Governor Chris Christie concurred that “there’s no one who’s shown more genius …” than Trump.
So which position is correct? Is a person an irresponsible, uncaring free-loader when he doesn’t pay income taxes? Or is that person a genius? For some American politicians, the answers to those questions appear to depend on whether the person is an ally or a foe.
Nevertheless, it may be helpful to consider the facts that we actually know about the Trump tax situation. And, in turn, we may consider (or perhaps reconsider) a central presumption that serves as a foundation of our tax code.
Let’s begin with the fact that the Times revealed pages from Trump’s personal tax returns, and not from his business tax returns. That fact casts a harsh light on Mayor Giuliani’s assertion that Trump “had no choice but to utilize” the tax deductions.
Why does Giuliani believe this? Because, according to the Mayor, “If he didn’t take advantage of those tax deductions of tax advantages that he had, he could be sued, because his obligation as a businessman is to make money for his enterprise and to save money for his enterprise.” Furthermore, claimed Giuliani, these plaintiffs would be “investors in his business, people who loan money to his business, banks that loan money to his business.”
That argument would make perfect sense if Trump declined to claim deductions on his business tax returns. After all, his business stakeholders are impacted by the tax liabilities of his business. But his stakeholders are never affected by anything that Trump chooses to claim on his personal tax returns. That’s why the Mayor’s argument is simply not correct.
And yet Giuliani’s argument raises an interesting question. Why does the tax code allow a business loss in one year to eliminate tax payments in other years? Why should one year affect any other(s)?
The answer to that question reflects a fundamental assumption that underlies our tax code. Although we all file taxes on an annual basis, the code does not presume that a year necessarily reflects an appropriate period of time to determine the profitability of a business.
Here’s a simple example. Let’s assume that you open a business on December 30th, and that you spend your first dollar on December 31st. But you don’t earn your first dollar until January 1st.
Have you made a profit during those three days? Well, no; you haven’t done so. Simple arithmetic calculates that a dollar of expense and a dollar of revenue yield no net profit. And thus, based on common sense, you would pay no income tax.
Now let’s assume that your tax year ends on December 31st. For the period ending December 31st, you would file a tax return that shows no revenue and a dollar of expense. And for the subsequent period, you would file a return that shows a dollar of revenue and no expense.
Should you pay any income tax on the dollar of revenue that you earned during the second period? Again, based on common sense, you wouldn’t do so. After all, the December 31st filing cut-off date is an arbitrary one; you still haven’t earned any profit in total during those three days.
This illustrates a core premise of our income tax code. Namely, its tax period cut-offs are arbitrary dates that do not affect the overall profitability of an entity.
Therefore, if a businessman loses $1 billion in a single year but earns $50 million a year during the twenty year period surrounding or following it, he would earn no profit during the entire twenty year period. And he thus needn’t pay income tax on the $1 billion of revenue, given the aggregate $1 billion of expenses in other year(s).
To be sure, it is not correct for Trump’s Republican supporters to say that he could’ve been sued if he had declined to claim his business loss on his personal tax return. And yet it is also not correct for his Democratic opponents to claim that he is not “paying his fair share” of taxes.
So which side is correct? Well, neither side is correct. And in a political year when each side simply wants to win at any cost, it may not be surprising that no one is bothering to ask whether a central tenet of the tax code is itself correct.