Got a strange call the other day from someone claiming to be a teller at a distant branch of my bank. She wanted to know details about a check drawn on my account. She sounded at first like a scam artist, and then, in a flash, I realized what was going on. I had just paid off a home-improvement contractor with a check for $1,290.
“Go ahead and cash the check,” I said. “It’s legit.”
The contractor evidently wanted to turn the check in for some folding money. Hmm. He had deposited checks for progress payments that I had given him earlier, totalling $2,700, in his business account, which was at another bank. He could have done the same with the final payment. Instead, he chose to pay an $8 fee to my bank, where he was not a customer, in order to get cash.
As I hung up the phone I thought about marginal tax rates, and about the tax plan outlined by the Republicans. Cutting rates will unleash a burst of economic activity, they tell us. Supposedly the tax cut will just about pay for itself.
Will it? I have doubts, because of workers like this contractor. He faces a very steep rate on each incremental dollar of profit. As far as I can tell, the Trump plan won’t cut his marginal rate one bit.
This workman is skilled, and makes a decent living, but he’s not on Easy Street. He works solo. He’s 45, and, except for a short stint in the military, has had a trowel in his hand since he was 13. His wife works full-time. They juggle schedules to take care of kids aged 10 and 4.
I can’t condone cheating on taxes, but I do understand incentives. Let’s look at what happens to the marginal dollar that goes through this guy’s business account.
Worker’s comp. This takes 15% off the top. (For some work categories in some states, the insurance is as high as 40 cents on the payroll dollar.) Construction is dangerous. Lose your hand in a saw and you’re out of work. So my contractor is motivated to get coverage but to underreport his income.
The Republican tax plan has nothing to say about this de facto tax.
Self-employment tax. Social Security/Medicare runs to 15.3% of what’s left after the worker’s comp insurance. Trump’s plan? No change.
State income tax. I and this contractor live in a high-tax state, and it’s likely his state bracket is above 6%. What does the Trump plan do here? It effectively raises the state tax burden by removing the federal deduction for it.
Federal income tax. The contractor’s federal bracket is probably 25% now, and it will probably remain 25%.
Add up these nicks out of the contractor’s income and you have a marginal rate under present law that is close to 51.5%. The Trump plan would kick this number up to 53%.
Trump wants to double the standard deduction to $24,000 for a couple. That would deliver a tax break to some middle-class families in low-tax states. It probably won’t help my contractor. In any event, changing the standard deduction does absolutely nothing to change marginal rates.
Your marginal rate affects your willingness to put in more time on the job to get another dollar. It also affects your motivation to skim some income off as hundred-dollar bills.
The Republican plan does have a big change in marginal rates, but it’s not going to help my contractor. The proposal includes knocking 16 percentage points off the tax rate for people who own businesses. Someone with a construction firm that employs 100 people and clears $1 million a year would enjoy a cut in his or her federal income tax bracket from 40.8% to 25%. (The 40.8% includes the effect of a deduction phase-out.)
Much private business is organized as “pass-through” entities like LLCs, and the idea is to energize the economy by lowering the tax on their profits. That would, we are told, motivate business owners to work harder. Their enthusiasm would trickle down to the rank and file.
Whatever becomes of the construction company millionaires, there won’t be any burst of entrepreneurial enthusiasm from self-employed masons and carpenters. Middle-class salary earners won’t fare much better either, as detailed in this story.
Originally published at Forbes