Understanding Trump’s Income Tax Tweet

Posted: May 09, 2019 12:01 AM
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Understanding Trump’s Income Tax Tweet

Source: AP Photo/Jacquelyn Martin

A May 8, New York Times (NYT) article declared “Decade in the Red: Trump Tax Shows Over $1 Billion in Business Losses.” The column went on to say that “Newly obtained tax information reveals that from 1985 to 1994, Donald J. Trump’s businesses were in far bleaker condition than was previously known.”

President Trump quickly responded with a tweet saying the column was “highly inaccurate” and tried to explain why.  While Trump really does have a legitimate position, he seems to not communicate that position well.

For instance, Trump notes that depreciation expense is used to minimize income tax liability. It is a justifiable expense because it allows for the recovery of a capital investment.  This is necessary to ensure that capital is re-invested back into the economy often in ventures that carry large risk.

In other words, suppose a businessperson buys or builds a factory for $100,000.  She uses capital that came from income earned after paying income taxes. The IRS says they will allow that person to recover her investment over say a 25-year period at $4,000 year.  That capital can be recovered without paying taxes on it, from the profits generated by that factory.

Now suppose the factory generates $3,000 in profit the first year.  With no depreciation expense their total tax bill could be as much as $1,400, leaving them just $1,600 cash flow.  But with the $4,000 depreciation expense, the income would be negative (a loss), so the businessperson pays no taxes.  As a result, the cash flow is $3,000.

In finance, that is referred to as the depreciation tax shield. Trump referred to it as a tax shelter.  It results in negative income but smaller tax liability and larger positive cash flows.   Nothing is illegal, immoral or wrong about that.  It is precisely for that reason that Trump’s tax returns show negative income (losses) while his cash flow was very positive and he became very successful.

Trump’s tweet said, “You always wanted to show losses for tax purposes....almost all real estate developers did - and often re-negotiate with banks, it was sport.

The last part of that tweet is interesting. Trump called re-negotiating with the bank a “sport.” Many large developers and very successful business people often view certain negotiations, particularly with a bank, as a game or a sport.

Banking is one of the very few industries where the product offered is what economists would call “perfectly homogeneous.”  That means every bank is offering exactly the same product; the use of money.  Since businesspeople always try to minimize their cost, they many times negotiate with many lenders. It doesn’t matter which bank agrees to financing a project, since money is money.

In these negotiations it is not simply the interest rate that is negotiated but many other conditions like minimum balances, up-front fees, contingencies, timing and flexibility.  Many developers often say that the terms of the loan are more important than the actual interest rate.  These conditions often result in spirited negotiations.

In the end, the developer does business with the lender that offers the best overall package of price and terms.  Many view the negotiations as a sport which results in a competition that produces winners and losers.  That’s how business operates.

The President says the NYT article is just another “Fake News hit job!”  It looks like he is right.

More disturbing is that the column shows that the writer’s simply do not understand business and are therefore writing about a topic without sufficient knowledge.  In Journalism that is usually viewed as a “no-no.”

Perhaps the real motivation is simply to continue the narrative that Trump is a crook, liar etc.   The New York Times as well as most other major media outlets have be writing very biased and often inaccurate stories about the president ever since he won the election in November 2016.

Trump’s right.   There is a lot of fake news out there.