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Why Donald Trump Doesn't Want to Reveal His Tax Returns

Guild Investment Management

Monday, 06 June 2016

Whatever else can be said about Donald Trump, and whatever uncertainties surround his claimed net worth, it’s certain that he’s the wealthiest candidate of all those in the 2016 race. Many Americans polled believe he should release his tax returns, even before the completion of an IRS audit. They may suspect that the returns will show that he paid very little income tax at all, in spite of what we may presume is his large income.

Even if this proves to be true when his tax returns are eventually released -- as he has promised they will be -- it will not be very significant. We suspect his effective tax rate to be very low. We do not suspect this because we believe Mr Trump has a predilection for tax dodging. We suspect it because of his chosen business: real estate.

There are many reasons why Donald Trump, a real estate mogul, is wealthier by far than Ben Carson, a neurosurgeon -- the latter being a career that is not for those who are challenged in brainpower or work ethic, to be sure.

Real estate benefits from two significant advantages: the application of leverage, and its scalability. Leverage is inherent in the business; when you buy, you borrow, perhaps aggressively, and thus can amass a large portfolio of properties with cash that would buy you a much smaller portfolio of other assets. (Of course, this leverage also increases risk, hence Mr Trump’s businesses' track record of an occasional tactical bankruptcy, which is also entirely typical for the real estate development business.)

Scalability simply means that when you own a big portfolio of properties, you hire other people to run them… Almost as if Ben Carson could multiply himself, lever up, and run 100 different neurosurgery practices at once. Mr Trump is famous for being “hands on”… But he is also famous for delegating to trusted team members.

However, the decisive advantage of real estate is perhaps not its financial and operational superiority. It is the favorable tax structure that surrounds it.

This is why we will not be shocked to find that Mr Trump has paid little tax on his substantial income. The real scandal will not be that Mr Trump has done this. We are confident that he will be found to simply be taking legal and aggressive advantage of a tax code that benefits thousands of other successful real estate businesspeople. If there is a scandal, it is that real estate receives such favorable treatment -- when perhaps there is little compelling economic reason for the tax code to favor it so heavily.

Financial Times journalist Gillian Tett recently quoted an anonymous “real estate titan” as saying, “If you are a developer who is paying tax, you have to be pretty dumb.”

She goes on to point out many of the outlandish loopholes that permit real estate income and profits to be protected from the tax man: creative classification of properties to exploit benefits intended for agriculture; aggressive depreciation; boundary-pushing appraisal methods; deferred taxes under the “1031 clause.” The real estate lobby is powerful, and has been establishing and strengthening these special treatments for decades.

For several years, the real estate sector as a whole has ranked among the most profitable in the US, while it has ranked in the bottom in its contribution to tax revenue.

Will that change? Probably not. But the controversy about Mr Trump’s tax returns will serve a good purpose if it opens a conversation about why the sector receives such favorable treatment -- and whether that treatment is good for the economy.

Investment implications: The real estate industry has benefitted from decades of lobbying and enjoys tax treatments that offer deep advantages to aggressive developers. We think the tax loopholes and favorable status enjoyed by real estate may start to come under closer scrutiny. Stay tuned.


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