My Turn: Trump plan underscores problems with N.H. tax system

For the Monitor
Saturday, May 06, 2017

President Donald Trump’s tax plan is a bad deal for New Hampshire. The plan is bad for working Americans no matter where they live, but the plan is bad for anyone who lives in New Hampshire and exposes some of the weaknesses in our state tax system.

The Trump plan has two central features – replacing the current seven individual tax brackets with just three brackets, and reducing the corporate tax rate to 15 percent. These changes will simplify tax calculations and provide significant tax savings to corporations and some individuals, but simplicity has costs as well.

In this case, the primary cost of simplicity is increasing the tax burden on working Americans. The current tax system has seven tax brackets for “ordinary income” (wages, business income and interest on bank accounts) earned by individuals, starting at 10 percent on the first $9,325 of taxable income, 15 percent on taxable income between $9,325 and $37,950, 25 percent on taxable income between $37,950 and $91,900, and continuing through three more brackets (28 percent, 33 percent and 35 percent) until the final bracket of 39.6 percent on all taxable income over $418,400.

The Trump plan eliminates the 15 percent bracket for individuals, and taxes income currently taxed at that rate at 25 percent instead, which amounts to a 67 percent increase in the marginal tax rate for workers earning between $37,950 and $91,800. Higher-wage earners will face a similar increase due to the elimination of the 28 percent and 33 percent tax brackets. The Trump plan proposes to mitigate these rate increases by doubling the standard deduction. That will indeed blunt the impact of the rate changes, but only for workers who take the standard deduction. Workers who claim itemized deductions will bear the full brunt – and more – of the “simpler” tax rate structure.

All of these changes are pretty standard, trickle-down economics fare – increasing regressivity in the tax system to benefit the wealthy at the expense of the middle class – but the truly radical aspect of the Trump tax plan is adopting a flat corporate tax at 15 percent (compared to the current tiered rates that result in most corporations paying about 35 percent). Reducing the corporate tax rate may be a good idea, but only if it is coupled with common-sense changes in the taxation of dividends and capital gains.

The Trump plan appears to leave in place the current preferential rates for dividends and capital gains so that they are taxed at no more than 20 percent. The combination of a 15 percent corporate tax rate and a 20 percent capital gains rate creates perverse incentives for people to provide services through corporations they own rather than as employees or independent contractors.

Under current law, a person getting wages pays less in taxes as an employee than she would if she owned a corporation that received the same amount of income. Under the Trump plan, however, she could be better off by forming a corporation and paying the 15 percent corporate tax rate and the individual capital gains rate instead of paying the ordinary income tax rate and employment taxes.

Better off, that is, unless she lives in New Hampshire, and here is where the Trump plan exposes the weaknesses in the New Hampshire tax system. New Hampshire does not tax wages received by individuals. This system, plus the absence of a general retail sales tax, creates what many people call the “New Hampshire Advantage.”

New Hampshire corporations, however, do pay income tax at 8.2 percent, and corporate shareholders pay a 5 percent tax on dividends they receive from corporations. (New Hampshire residents also pay the 5 percent tax on interest they earn on bank accounts.)

These New Hampshire taxes negate the incentives created in the Trump tax plan for individuals to form corporations rather than work for wages. That means that people who want to take advantage of the Trump plan incentives will move out of New Hampshire, probably to South Dakota or Wyoming where there is no individual or corporate tax. The people motivated to do this may be just the sort of entrepreneurs New Hampshire should seek to attract and retain.

There are both federal and state solutions to this problem. At the federal level, we can further increase the simplicity and fairness of the tax structure by increasing the amount of ordinary income taxed at 10 percent and by eliminating the preferential tax rates on dividends and capital gains.

Increasing the amount of income taxed at 10 percent helps the middle class, and eliminating the capital gains preference makes us all better off by getting rid of an artificial inducement to set up a corporation to do work rather than working as an employee. Forming a corporation will still be the right choice for some people, but that choice should not be dictated by the tax result.

At the state level, we can either repeal the tax on interest and dividends altogether, or we can choose to tax all forms of income equally. Alternatively, we could switch to a broad-based sales tax and eliminate income taxes on both businesses and individuals. Because of constraints in our state Constitution, all of these changes would be regressive, but we would reduce tax barriers to entrepreneurs’ moving to, or staying in, New Hampshire.

Without some common-sense changes like these, the Trump tax plan will be a bad deal for New Hampshire.

(Paul Burkett is a tax lawyer in Bow.)