The GOP Establishment Has Itself and George Bush to Blame for Trump’s Rise

With each passing day, it appears to be increasingly likely Donald Trump captures the Republican nomination given his committed base, strong national numbers, a lead in New Hampshire that is insurmountable so long as “establishment” candidates like Marco Rubio, Jeb Bush, John Kasich, and Chris Christie split the vote, and a Teflon-like insulation from his own statements. From George Will declaring a Trump nomination could be the end of the Party to discussions of an anti-Trump PAC, the establishment is up in arms over Trump’s rise and seems to be blaming the base for his success: supporters are falling for a cult of personality, they’re unsophisticated, just looking for a loud candidate, and so on.

I too am a Republican who is no Trump supporter but am tiring of the establishment’s blame game. If they want someone to blame, they should try looking in the mirror lest we forget how Trump was treated in 2012. Rather than ignoring him as a fringe figure, Mitt Romney gladly visited the Trump International Hotel in Las Vegas to receive his endorsement in person. Plus, Romney originally planned to have Trump make an appearance at the Convention, only to be cancelled due to a Hurricane. Rather than ignore Trump, the Party decided to embrace and therefore legitimize Trump. If Trump is to be considered a monster, then Romney and the establishment are Dr. Frankenstein. They’ve lost control of their creation (as though they ever had control), and he’s turning out to be quite popular with the villagers.

The establishment’s blame goes beyond the actions in 2012 and is more fundamental. The Republican Party has a George W. Bush problem, and his economic record is partly responsible for Trump. The establishment has yet to come to grips with the economic failings of Bush’s Presidency, which left the working and middle class in worse shape.

The core of Trump’s support comes from working people. For instance, the latest national CNN poll showed Trump with 42% among those earnings under $50k and 46% among those who did not graduate college. The CNN poll is consistent with other national polling. Blue collar workers have clearly gravitated towards Trump.

Now, I am no defender of Barack Obama’s economic policies, and GDP growth during this recovery has been slower than under President Clinton or Reagan. Like many Americans, I blame subpar growth on Obama’s tax and regulatory policies, and the facts are that while job growth has been solid, real median incomes have fallen to $53,657 in 2014 from $55,313 in 2008, per the Census Department. Additionally, in December 2008, America had 12.9 million manufacturing jobs. As of November 2015, that number is 12.3 million, according to the Bureau of Labor Statistics.

For many Americans, the state of the economy is still fragile, and angst remains. Unease with Obama policies could explain why voters are seeking change, which would imply more support for Republicans, but it does not explain why so many voters are totally ignoring establishment choices in favor of someone as unorthodox as Trump. It is here where Bush comes in.

On the positive side, under President Bush, we enjoyed nearly 3 consecutive years of unemployment at 5% or less, roughly full employment. However, the Bush economy was not great for everyone. GDP growth averaged a meager 2.1% during his two terms, and the middle class did not enjoy much of this growth. Just as under Obama, real median incomes fell under Bush, from $57,724 in 2000 to $55,313 in 2008. Even more importantly to understand the Trump phenomenon is the decline in manufacturing employment, from 17.2 million in December 2000 to 12.9 million in December 2008. Of course, millions lost homes in a financial crisis for which Bush bears some responsibility. The political establishment of both parties have failed working and middle class Americans for at least fifteen years now.

Unsurprisingly, republican voters are willing to look outside the establishment, which has failed them economically for years. Moreover, the establishment, by focusing all of its ire on Obama, has not reached out to workers in a compelling fashion to explain how the GOP can make the economy work for them. While he may be selling a false bill of goods (what makes for good politics is not necessarily good or plausible policy), Trump has made a clear and simple case to workers, essentially: you’ve been screwed by incompetent politicians who work for donors not you, who negotiate terrible trade deals with China, and who have let illegal immigrants undercut wages whereas I will work for you and bring back your jobs. Let’s be honest, if you’re a white guy working in manufacturing, it has probably been a tough decade, and this pitch is compelling.

At the very least, Trump is making an overt effort to show he cares about the middle class, something other candidates and the establishment at large have been unable to do. Rather than recognizing the problems of today differ from 1980, we often reflexively revert to Reaganism (perhaps because Bush policies didn’t work so well). Some, like Carson, push flat taxes that would likely hurt the poor. Senator Cruz is pushing a Business VAT that would disincentivize employment (probably not a good sell to workers), and while Rubio has more interesting economic policies given his new child tax credit, he has not made a sustained pitch to the working class on economics, focusing on foreign policy instead, though that may be changing.

For Republicans to win national elections and possibly put Upper Midwest states in play, they need to do better with working and middle class Americans. To do so, the establishment must recognize its economic policies have failed in the 21st century (as have Democratic policies). In many ways, workers are worse off than 20 years ago, which is a stinging rebuke of our political establishment. Until the republican establishment admits failings and modernizes conservative principles to solve 21st century problems (for example, negative marginal tax rates), the GOP establishment will justifiably continue to lack any credibility with its working and middle class voters.

Trump’s proposals are ultimately simplistic and essentially are “blame the other guy (with other guy being China, Mexico, Vietnam, Donors etc.),” but he is the only major candidate arguing to workers he cares about their well-being. No wonder they are flocking to him. The base is not failing the establishment. The establishment has failed its base for 15 years with lousy, outdated, and unoriginal economic policy offerings, and until they recognize this, blue collar republicans will be receptive to outsiders like Trump.

Bush failed the middle class. Unless the GOP intellectual elites cede this and make necessary policy updates, Trump won’t be an aberration. He’ll be the first in a long string of populist outsiders while the power of the establishment continues to atrophy.

A Conservative Argument for the Estate Tax

On this “Giving Tuesday,” Mark Zuckerberg announced in a public letter to his just-born daughter that he and his wife would be donating 99% of their Facebook stock. The gift is aimed at advancing “human potential and promote equality for all children in the next generation.” This gift is a massive commitment of $45 billion (at Facebook’s current share price) that has the potential to truly better the world. Don’t feel too badly for their daughter, Max, who is still in-line to get about $450 million (at today’s market price), or about 2x Mitt Romney’s net worth.

In light of Zuckerberg’s action, it seemed pertinent to briefly discuss the estate tax, and why I actually think conservatives should support it (despite deftly dubbing it the “death tax”) as I have alluded to in the past. My view is admittedly out of the orthodoxy and runs counter to our slate of Republican Presidential contenders who want to eliminate the tax.

Briefly before delving into my argument, I would emphasize my support for an estate tax in principle and not for our idiotically concocted one. Under current law, all estates beyond $5.4 million pay the same marginal tax rate of 40%. A small business owner with $30 million faces the same marginal rate as Warren Buffett, which is absurd. A primary concern of mine (and all conservatives…hopefully) is the ability of the super-wealthy to maintain their status for generations, which cannot be done at $30 million but can be at $30 billion. That small business owner or farmer also likely has less liquid wealth, and heirs could be forced to sell to pay the taxman, which argues for a lower initial rate. For illustrative purposes, I would propose a progressive estate tax of perhaps 15% for $5-15 million, 25% for $15-25 million, 35% for $25-$50 million, 50% for $50-$250 million, and 70% for $250 million and higher. I would also allow one’s tax burden to be nullified by charitable donations. That would mean the Zuckerberg estate would face no estate tax liability as it is donating over 70% to charity.

 

  1. Tax Code Efficiency

As some government spending is required and 100% debt funding is unsustainable, we have to tax. The conversation turns to how much we have to tax (dependent on how much we spend) and how we structure our tax code to generate the requisite revenue. Some liberals have this fixation on a “fair” tax code with no discernible definition of fairness. Conservatives focus on an efficient tax code, which is to say the code that has the least retardant impact on growth. Such a tax code would allow the economy to perform the best, all else equal, and help the poor and middle class improve their standing and their standard of living.

This requires taxing the least productive segments the most and most productive the least. Plus as we need to generate a certain amount of revenue, the decision to tax one party is in a sense a decision to not tax another (dynamic scoring adjusted). The estate tax generates about $20 billion in revenue per year or less than 1% of total federal revenue, so it isn’t particularly big (though I would put forth that $20 billion is still a lot of money, call me old-fashioned). If we want to generate the same aggregate revenue, we would have to increase other taxes by that $20 billion. One could argue income and corporate taxes are on today’s productivity whereas an estate tax is on the accumulated productivity of the past. Which tax would appear to drag on economic growth more?

From a different perspective, the estate tax in a sense takes money away from the ensuing generations (the heirs), and as I explain in point 2, it is very uncertain they will use the funds in a productive fashion whereas income is more clearly associated with productivity. Whom would you rather tax if you want a tax code that is likely to impact productivity the least? While there are individual exceptions no doubt, in aggregate, the estate tax targets less productive capital (from either vantage point), meaning we can tax more productive capital and labor less (to the tune of about $20 billion/year), which at the margins should support growth. (In full disclosure, I would note the Tax Foundation seems to disagree with me, though I would suggest it overstates the productivity of the estate capital taxed).

I would also note that I actually hope my estate tax generates no revenue because individuals choose to donate to charity in lieu of paying a tax to the government as my concept would allow. On the whole, charities can be far more productive users of capital than government bureaucracy. While this would lead to lower revenue, it would alleviate the welfare burden on our government, allowing spending to fall (in all likelihood more than the tax revenue shortfall).

2. Capitalism Requires Meritocracy and Efficient Use of Capital

For a capitalist society to work efficiently, individuals and organizations need to benefit based on merits. The most talented should do better and accumulate wealth because they are superior allocators of capital. It is a good thing Warren Buffett has $75 billion and your Uncle Billy doesn’t because Buffett is more adept at making wise investments and is more likely to pursue projects that generate value. Individuals should rise and fall based in large part on their ability and willingness to work hard.

Large estates are large because someone had a talent and was able to generate value. A just and efficient society is glad and benefits from their accumulation of wealth. However, there is no guarantee their children are equally talented/hard-working. Without an estate tax, those funds can be passed down to a generation that wastes the funds (the Paris Hilton’s of the world if you will). Now, some inheritors do tremendous things with the inheritance, but just as many (more I would argue) do not. In aggregate, society does best when capital is tied with those who are the best allocators of it not those with the best last name.

The American Dream is founded on the idea anyone with enough hard work can rise in society. An aristocracy enjoying the fruits of past generations’ labor can stifle advancement and lead to economic malaise, undermining the advancement of others. That isn’t a capitalist or conservative society. It is a corporatist society benefitting entrenched, status quo players. If we really thought passing down things blindly was so great, why did we ever revolt against monarchial rule? The American experiment is directly juxtaposed to aristocracy, which can arise without an estate tax.

Now, this is not to suggest passing down money is bad. It is wonderful to give one’s children the ability to do anything (problems arise when they have so much they can afford to do nothing). The ability to provide a better life for one’s children, even after one’s passing, can be a key motivator that increases productivity. The danger doesn’t lie in someone passing down $5 million, which can easily be wasted in a generation (or shorter), the danger is in the $5 billion passed down that can let numerous generations ride on the coattails of success. That is why a progressive estate tax is far more rational as it more directly deals with the meritocracy issue without punishing parents for wanting to give their kids and grandkids more opportunity.

Inherited wealth on a large scale can breed laziness and an under-productive over-class in an extreme. For families to rise, some inevitably must fall. An estate tax actually helps to engender meritocracy and thereby enhance growth over time.

3. The wealthy are already disbursing their estates to society

Since launching several years ago, Bill Gates and Warren Buffett’s The Giving Pledge has been a stunning success, getting 138 billionaires to pledge half their wealth (or more) to charity. Again, these participants, under my conception of an estate tax, would essentially face no estate tax liability, since I would fully credit any charitable contributions against the theoretical tax liability. It is telling that so many of the most fortunate choose to give away the vast majority of their wealth. They are beneficiaries of my second point (meritocracy) and understand the importance of preserving that structure, rather than letting future generations fritter away their hard earned wealth. Of course beyond the pledge, countless wealthy individuals are exceptionally generous as well.

Now admittedly, not everyone is a member of the pledge, and some would probably prefer to pass on everything. However, there is some wisdom to the crowd—that is a basic tenet of market economics. For instance, stock prices are fairly efficient and good (probably the best) barometers of fair value because a wide crowd, everyone in capital markets, is buying and selling to the crowd-determined appropriate price. History has proven it hard to beat. Perhaps, the actions of the world’s richest signals the proper policy? While I wouldn’t blindly follow the crowd, it does merit some thought. Moreover, given how much wealth is being donated anyway, the estate tax, if done right, will actually be used in very few instances.

4. It really isn’t double taxation

A common refrain conservatives use against the estate tax is that it is double taxation (taxing already taxed income). That is a bit simplistic, and I would note much of our tax structure, including sales tax, some income taxes, some capital gains taxes etc. are double-taxes. If possible, eliminating all forms of double-taxation would require increased taxation on primary forms of income (unless you are willing to shed hundreds of billion in revenue per year). It isn’t clear that is a preferable system.

Now some estates are as classically argued “double taxed,” but most of the largest estates are not. Most large estates come from entrepreneurs and business founders whose wealth is the equity in their business. This wealth is not taxed prior to death. To illustrate, let’s take the case of Mark Zuckerberg and assume he died Monday before deciding to donate money. He has $45 billion in Facebook stock, but this wealth has never been taxed because it is paper wealth. We tax income (which his Facebook holdings are not) and realized capital gains, and since he is still holding FB shares, the gains are unrealized. When he dies (in the hypothetical), he has actually never been taxed on his wealth. The estate tax would be his first tax not a double tax. Most large estates are similar; much of the estate tax revenue is primary not double taxation.

Plus under current law, the cost-basis of an estate is “stepped-up,” meaning that $45 billion capital gain disappears as his heir marks up the cost-basis to the market price at death. If you eliminate the estate tax without eliminating the step-up feature, his wealth is never once taxed as it passes generation by generation. Meanwhile, workers and W-2 earners (almost all Americans) pay taxes every paycheck. That does not strike me as an efficient structure. Now, we want to incentivize entrepreneurship as they create jobs but no taxation is a bit much. Plus, our current system, in which taxes are deferred until gains are realized, is already an incentive as it lowers the present value of an entrepreneur’s tax bill relative to an employee.

Even if double taxation is inherently bad, which is far from clear and would require a far more drastic overhaul likely resulting in a large consumption tax (which has many negative side-effects), much of the estate tax revenue, particularly from the largest estates, is not a double tax but actually a primary tax. The true picture is a bit more complicated than the political talking points suggest (how unusual!).

5. The confiscation argument against the estate tax doesn’t hold

One constant argument against the estate tax is that it is the confiscation of hard earned wealth, which the government should not be in the business of doing. We could use that rationale for any tax however. The income tax also confiscates the earnings of individuals. Taxation is inherently coercive (optional taxes tend not to generate much revenue), so unless one is willing to argue against all taxes, it is hard to justifiably singling out the estate tax. In any functioning society, there has to be some taxation to pay for public goods. Someone worth $10 billion can still pass down over $3 billion after taxes/charity, which is still a tremendous sum despite my highly progressive proposal. Every tax is by its nature confiscatory and coercive. It is inconsistent to use this argument, often put forth by conservatives sadly, to oppose an estate tax while supporting other taxes.

 

Recognizing this can be an emotional issue for some, hopefully, these arguments at least give pause for further reflection. People of good will and of different political persuasions can disagree on this issue as I don’t see the estate tax as a clear conservative/liberal issue despite how our political parties use it. Ultimately, conservatism is best served when we push for comprehensive tax reform that, yes, includes a reformed estate tax. A conservative-oriented, merit-based society that has an efficient tax code actually necessitates an estate tax, and the two most frequent criticisms of the taxes are a bit lacking.

Death to the death tax is neither conservative nor wise policy.

Why We Tax–Moving Beyond Carried Interest

For the past few weeks (alright years), it feels like the debate on tax reform has centered around the “carried interest loophole” whereby private equity managers get their income taxed at a low rate. Based on the tax plans of Jeb Bush and Donald Trump, it appears the GOP is willing to remove the loophole as part of broader tax reform. Ultimately, removing the loophole is barely relevant, perhaps increasing revenue by $3-4 billion/year. Rarely has so much time been spent on an issue that matters so little. However, there are important policy lessons to be gleaned from the carried interest debate that actually have profound impacts on how and what we tax.

The Democrats have largely argued the point on “economic fairness” grounds, and republicans must be careful not to let the debate slip into this territoy because the fairness argument is misguided.

Let’s begin with the fundamental question: Why do nations tax? Nations tax to generate revenue that funds the government and associated social programs. Via these programs, the government (at the federal, state, and/or local level) provides national defense, education, welfare, economic and social security, etc. With the revenue, we can provide some comfort during retirement (ie Social Security and Medicare) or help those in hard times (ie unemployment insurance and food stamps), whatever that society deems fair and appropriate. The goal of taxation then is to provide the necessary amount of revenue while having the least impact on growth and the economy as in the end economic growth and not government provides the path for upward mobility and superior standards of living over time.

At the Federal level, we probably need to generate around 17.5-19.5% of GDP as tax revenue to provide services and run a roughly balanced budget. The challenge is finding the right mix of taxes that achieves this revenue run-rate while having the least negative spillover into the economy and capital allocation. By choosing not to tax X, we have to tax Y, so the economics savings of X better outweigh the costs of Y. It is at this level where the rationale for the carried interest loophole collapses. Was there really no better use for that $3 billion than exempting private equity managers from income tax rates? Almost certainly not. We are better off spending that $3 billion lowering taxes on the middle class who will spend their tax savings.

Economic fairness is a challenging, intangible concept, and typically, the side getting the benefit is the one who deems the action is fair, irrespective of reality. Fairness is a powerful political argument in the short-run that wreaks havoc in the long-run. Theoretically, what is fairer than a communist system where all join in the spoils equally? Yet in reality, such systems atrophy, breed corruption, cronyism, and collapse (see the Soviet Union). Economic fairness quickly erodes into an effort to help out connected industries and firms, unleveling the playing field. Focusing on making the tax system more efficient (ie maximizing revenue while minimizing economic distortions and mal-incentives) often yields the same results while promoting a balanced, growing economy that benefits all over time.

It is from this perch that republicans should argue tax and economic policy, and the potential for change is breathtaking with carried interest just a drop in bucket. Whenever a financial decision is made for tax rather than economic reasons, chances are that an inefficient tax policy is in place, and the shining example of this is the deduction of corporate interest expense, something the Bush and Trump plans actually start to address. Under current law, corporations cannot deduct dividend expense but can deduct interest expense, which makes debt artificially inexpensive.

Making something artificially cheap tends to lead to more of it, and debt is typically not something you want to incent the creation of. Leveraged systems have greater fixed charges and can be more vulnerable to shocks. A major reason why the tech bubble bursting only lead to modest recession while the Housing bubble nearly precipitated a global depression was the tech wreck was (primarily not exclusively) an equity issue whereas the housing crash was (again primarily not exclusively) a debt issue. Put simply, you cannot go bankrupt if you don’t owe anyone money. Equity losses are painful, but being unable to pay back debt can be devastating. Now, this is not to say the government should actively disincentivize debt, which can play a critical role in a capital structure and is a preferred asset class for many investors.

Rather, the government should neither incentivize debt nor equity over the other, instead letting the pure economics lead to the decision. Unfortunately, we have a system of financial arbitrage (a clear sign of an inefficient tax policy) whereby companies issue debt to repurchase stock because tax savings make interest expense less than the cost of the stock’s dividend. Similarly, private equity firms can sometimes can generate excellent returns, merely by issuing debt to take out equity and enjoy a sizable tax break. Now sometimes, these transactions make good economic sense, and as such, they would continue without the tax deduction. However, transactions that don’t make sense would not occur, and that capital would be free to be used in ways that are actually economically justified, which would be supportive of long term growth.

Removing interest deductibility on nonfinancial firms (financial firms like commercial banks need it to operate as they are in the maturity transformation business) would raise around $120 billion/year (about 40 carried interest loopholes!). To make up for this lost revenue, we have to maintain absurdly high marginal rates, and in the end, less indebted firms are subsidizing heavily indebted firms. It just so happens that these less indebted firms are often in technology, healthcare, and many start-ups, which are the primary engines of growth and innovation. The firms we need to invest for our economy to grow are the ones saddled paying for someone else’s subsidy.

By removing just this one deduction, we could bring headline corporate rates down to about 25-27% from 35%, making the US tax regime much more competitive immediately while giving our most innovative companies more after-tax profits (as they are no longer subsidizing heavily indebted firms) to invest in the future. Recognizing that some small business rely on bank loans to fund growth, we could continue to permit the deduction of interest expense on the first $25 million of debt without meaningfully impacting the amount of incremental revenue.

Now obviously any reform has to be phased in over about 5 years to allow companies who have built capital structures based on tax policies time to adjust and move to equity funding in a gradual fashion to avert a shock. In the end, moving on interest deductibility is the logical next step in the carried interest debate, and it actually will generate meaningful revenue with which to lower rates. Plus by no longer incentivizing debt over equity, we will build an economy more appropriately funded and insulated from potential shocks, which will be constructive for long term growth.

Carried interest and interest deductibility are just two examples of inefficient tax policies that lead to the misallocation of resources and unnecessarily drag on growth. Addressing these and other loopholes to bring down rates is the best path to counter the democrats’ politically motivated but doomed-to-fail “fairness” pitch as this conservative approach is the surest way to achieving economic growth and help the middle class regain the ground it has lost under the Obama Administration.