Which Should Americans Be Angrier About: Trump or the Tax Code?

The candidate’s 1995 returns reveal both a flawed system and a man skilled at exploiting it.

Mike Segar / Reuters

It’s possible that Donald Trump didn’t pay federal income taxes for nearly two decades. That’s the major takeaway of the portions of Trump’s tax returns recently leaked to The New York Times. The documents show that in 1995, Trump reported a nearly $1 billion loss from his businesses—a loss large enough to have potentially allowed him to earn an average of $50 million a year, tax-free, for 18 years.

Trump’s massive 1995 loss likely comes from a combination of factors: hard times at his casinos in New Jersey, a failed airline business, and the need to unload some real-estate holdings at prices lower than what he purchased them for. In 1992, Bloomberg chronicled the dire straits of Trump’s empire, characterizing it like this: “The name is a punchline now, associated with the worst of 1980s extravagance, egomania, and greed. Once, the world marveled at the scope and mastery of Trump's megabuck deals. Today, he's widely regarded as a washed-up real estate mogul who has been stripped of his once lustrous possessions.”

Despite that unflattering portrayal, the same article went on to predict how the precipitous decline of Trump’s holdings could be turned around—with some forgiving debt restructuring from banks (which he was granted), the possibility of a large inheritance when his father died (the elder Trump died in 1999, and there’s no public record of how much was distributed or to whom), and a real-estate upswing (check).

So how might this add up to income-free earnings for nearly two decades? Trump used a provision of the tax code that allows businesses to transfer their tax payments to their owner’s personal tax returns, which in most cases are subject to lower tax rates. This tactic, in which the business becomes what the tax code calls a “pass-through entity,” has been contentious for years, with some—including Trump—saying that it helps small businesses avoid onerous corporate taxes. But suggesting that pass-through provisions mostly benefit small businesses is misleading, says Harry Stein, the director of fiscal policy at the left-leaning Center for American Progress Action Fund. “Most passed-through income, 70 percent, goes to the top 1 percent,” Stein told me.

And just as these businesses can pass their profits onto their owners for a more favorable tax rate, they can also pass losses along too. In Trump’s case, he was able to pass nearly $1 billion of losses through to his individual return as what are called net operating losses—which allow for deductions, real-estate depreciation, and other write-offs available to businesses. In doing so, he could have applied those losses to his future earnings, nullifying any federal income taxes he might have incurred on them. “If you lose money in your business, the tax law allows you to carry back a loss three years and carry it forward for 15. So you can use a loss from today to go back and wipe out income in the past and wipe out income going forward,” said Dorothy Brown, a tax-policy scholar and law professor at Emory University. Net operating losses, she noted, aren’t available for the average individual filer, just business owners.

By preferentially blending bits and pieces of the corporate and personal tax codes, Trump might have gained important financial flexibility that simply isn’t available to most people. “Wealthy people can game the system in a way normal people can’t,” Stein says. Corporations, for instance, are allowed to time their reporting of losses in ways that are beneficial to their bottom line. For instance, Trump could have had his businesses wait to report losses until a new calendar year, in order to help offset gains and reduce his overall taxable income at a more advantageous time, Stein said. And the rules on net operating losses allow an individual to report a loss that will offset income for several years, which could also result in a lower tax rate for owners. These are all options not available to individuals who might make vastly different amounts every month or year. Trump also could have received preferential tax treatment on his real-estate holdings when it came to reworking the loans he owed to banks, Brown added.

Experts say that without seeing Trump’s entire 1995 return, it’s difficult to determine the extent and methods of his tax avoidance, but still Trump hasn’t denied avoiding taxes since The New York Times’s report. Instead, he has flaunted his ability to successfully use tax loopholes, insisting it is a hallmark of being a shrewd businessman. In a statement following the leak of his tax returns, the campaign (which declined to elaborate further for this article) spun Trump’s tax tactics as business savvy:

Mr. Trump is a highly-skilled businessman who has a fiduciary responsibility to his business, his family and his employees to pay no more tax than legally required. That being said, Mr. Trump has paid hundreds of millions of dollars in property taxes, sales and excise taxes, real estate taxes, city taxes, state taxes, employee taxes and federal taxes, along with very substantial charitable contributions. Mr. Trump knows the tax code far better than anyone who has ever run for President and he is the only one that knows how to fix it.

Trump maintained his defense into this week. “I knew how to use the tax code to rebuild my company when others didn’t. My understanding of the tax code gave me a tremendous advantage,” Trump said at a campaign stop in Colorado on Monday.

But based on the documents leaked to the Times, it’s not clear that Trump is all that great of a businessman, or that he has paid a significant amount in federal taxes, at least not recently. And this isn’t the first time that documents have led to questions about whether or not Trump is really contributing his fair share to the tax base, a pool of money from which—if elected president—he would draw a salary. Based on a 1981 disclosure, Trump paid no federal taxes for at least two years in the late 1970s, after reporting negative income.

The revelation that a real-estate tycoon might not have been paying any federal income taxes understandably has sparked some outrage. But while much frustration is directed at Trump, an equal amount of it should be directed at the tax system that enables him, and others like him, to do what he does. “There are very few loopholes available for the average taxpayer to exploit,” says Jeffrey Winters, a professor at Northwestern University who studies wealth and inequality. “It is a different world for the ultra-rich in America. Having a lot of money allows them to use part of their riches to reduce their taxes dramatically. As of 2016, the U.S. tax code has over 74,000 pages, and virtually none of it applies to average taxpayers.”

As a businessman who has done what countless other American businessmen do, Trump need not personally apologize for America’s problematic tax code. But not all businessmen—let alone presidential candidates—have engaged in the sort of hypocrisy and financial obfuscation that he has with regards to his taxes. On the campaign trail, Trump has frequently denounced others for skirting taxes. In one speech, he complained of hedge funders, “They make a fortune. They pay no tax.” To combat that, he vowed to do away with the carried-interest loophole, which allows those money managers to be taxed at a lower rate on their profits.

And yet Trump also wanted to reduce tax rates for pass-through entities, the very same loophole that allowed him to move his billion-dollar losses onto his personal tax return in 1995 and, potentially, use them to reduce his taxes going forward, Stein notes. Even though the most recent iteration of his tax plan doesn’t explicitly promote more advantages for pass-throughs, it remains unclear whether or not he would continue fighting for them. Trump hasn’t introduced plans for a cap on net operating losses or for extending that advantage to individual Americans. His plan wouldn’t close the loopholes that allow business owners to have lower effective tax rates. And it wouldn’t alter the myriad beneficial tax treatments allotted to real-estate owners, or require that pass-throughs be taxed similarly to corporations.

Americans shouldn’t be mad that Trump appears to have successfully done what so many other rich Americans have done: hire cunning professionals to help them preserve their wealth and avoid taxes. As Brown puts it, “It’s not criminal, but it’s awful, it’s unfair, it’s unjust.” So, what’s more deserving of anger is that instead of using his knowledge of the tax code to propose a more egalitarian system, Trump has made virtually no mention of overhauling the various provisions that have helped him stay rich while more and more Americans fall out of the middle class.