So, Donald, is it Appreciation or Depreciation?
It is well known that tax systems around the world carve out all kinds of privileges for certain classes of people. Ordinary people, the largest class, pay a lot of tax. Then there are the privileged few who pay little or none. But how is it that so many have been out-foxed by so few to create these privileged classes of tax elites, or “tax smugglers” as Adam Smith use to call them? One need look no further than the first U.S. presidential debate on September 26th to find the answer. And it came from a source, Donald Trump, who does not appear to have a stellar reputation for insight into the complexities of modern life.
Secretary Clinton mused that the reason why Mr. Trump has not released his tax returns, unprecedented in modern presidential elections, was perhaps because he has not paid any taxes. Mr. Trump just about confirmed the allegation when he replied that he was smart not to pay taxes. Apart from the politically treacherous terrain of implying that if you do pay taxes you are stupid, or just not smart enough, it was an uncharacteristically insightful comment from the Republican nominee, even if he was not conscious of how insightful it was. It was about as close as Americans are probably going to get in this election cycle to a discussion about one of the most important things in their lives.
Now in the realm of tax professionals, or “tax techies” as the Nobel prize winner in economics William Vickrey liked to call them, no one was surprised by Trump’s comment. In fact tax lawyers and accountants will tell you that if you are in the real estate business and you paid income tax it is very likely you would have grounds to sue your tax lawyer or accountant for malpractice and gross negligence. There are all kinds of little known rules for those in finance, insurance, and real estate, the so called FIRE sector, which give them exclusive access to the elite tax clubs of the world.
Mr. Trump is probably a card carrying member of this club. If he is not, then I would not want to be his tax attorney. David Cay Johnston laid out the topsy turvy realm of real estate tax avoidance quite nicely on the PBS NewsHour on September 29th. Here briefly is how it works. If you are a real estate mogul like Mr. Trump you can depreciate lots and lots of buildings. This makes perfectly good economic sense because buildings, being created by humans, have a certain life span and need to be replaced. They have an economic life. If you devote fifteen hours or more a week to the “management” of these buildings or assets, then you get to deduct the depreciation of these buildings against all your other income. Mr. Trump’s income from selling ties made in China, or vodka, or fancy real estate courses can effectively be reduced to zero by means of the deduction of the depreciation of his real estate portfolio.
There are, of course, always wrinkles or flies in the ointment in the above scenario. Did he actually devote fifteen hours a week to the management of his real estate portfolio? Shifting through these regulations and their applicability to Mr. Trump is undoubtedly what animates the IRS auditors. It is hard to imagine Mr. Trump assiduously engaging in fifteen hours a week of management duties during a presidential campaign. But who knows? Maybe it can be done via Twitter. The tax attorneys are well paid for their imaginations.
Now it is unlikely the case that Mr. Trump thinks he is smart because he has read and memorized the Internal Revenue Code. Such a feat cannot be presumed of any law abiding citizen. Furthermore, surely he cannot think he is smart just because he has hired some very able tax professionals? There must be a something else afoot for the wily real estate mogul.
Now we know that Mr. Trump has a high opinion of his net worth. He puts a high value on his name and on his buildings. Real estate crumbles and falls apart as every homeowner knows. Mr. Trump’s buildings are no different. Nonetheless, they also keep getting better, more valuable. How can he have it both ways? Well, the realm of tax law and that of economic reality has created a two-world metaphysic and Mr. Trump is its philosopher-in-chief . The tax man lets him depreciate the buildings over and over again while society at large rewards him with tremendous, yes very tremendous, appreciation of what lies underneath the buildings, i.e. the land and the unique location of those lands, be they in Manhattan, or well situated golf courses, or even money losing casinos.
Wily two-world philosophers know how to have it both ways. They depreciate and they appreciate. It is not an easy dance. If you are good at it, like Mr. Trump, you get everything and society gets nothing. The tax subsidies of Americans allow Mr. Trump to defer indefinitely payments to the public treasury. The money he saves can be invested in whatever he wishes, even presidential campaigns. The tax system is rigged and everyone knows it.
The obvious question for Mr. Trump at the next presidential debate, hopefully from a tax abiding person in the town hall, is how he might “unrig” the tax system, or the “surrealistic pagoda of pestilent greed” aptly labeled by Ferdinand Lundberg in The Rich and the Super-Rich. A really smart two-world philosopher could suggest that what is underneath the buildings be taxed. And why is this smart? It would relieve Mr. Trump of his fifteen hours a week of portfolio management. It would relieve the tax man of endless audits. It would relieve ordinary Americans of their current obligation to subsidize the very wealthy. And it just might lighten the debt loads of all levels of government. Everyone, just about, is a winner.
Francis K. Peddle, J.D., Ph.D.
Dominican University College