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History Of How The Tax Code Allowed Businesses To Carry Their Losses Forward

TONYA MOSLEY, HOST:

The week began with much of the country reacting to a story about President Trump's income taxes. But as Sarah Gonzalez with our Planet Money podcast reports, federal income tax is a relatively new idea in the U.S.

SARAH GONZALEZ, BYLINE: Back in the 1890s, there were federal tariffs on imported goods. There was that. There were also taxes on things, like on alcohol, but no income tax. And these tariffs and taxes on alcohol and food and clothes meant that poor people were spending a greater percentage of their incomes on taxes than rich people.

ISAAC MARTIN: Before the 1890s, yes. Workers were really angry that so many rich people were escaping more or less tax-free.

GONZALEZ: Isaac Martin specializes in taxation at the University of California, San Diego. And he says that around the 1890s, workers started pushing for an income tax just on very rich Americans. And in 1913, they got one through a constitutional amendment. And almost immediately, like, on Day 2 of the income tax, Martin says rich people start looking for ways to avoid paying some of it. The deductions, the exemptions start creeping in.

MARTIN: They're creeping in at the beginning, and they kind of gradually accrete over time like barnacles on a ship.

GONZALEZ: To the point that today, all over the tax code, income tax or other kind of tax, there are all kinds of weird and small provisions that apply to the tiniest subset of people. Like, in 2008, Congress worked in a tax deal for the makers of toy wooden arrows relative to other kinds of arrows.

MARTIN: Yes. A specific provision was put in that said, but if they're toy arrows, less than this in diameter, intended only for play...

GONZALEZ: Made out of wood.

MARTIN: Made out of wood, yeah, then the tax is lower. I think it was, like, five or six different companies basically on planet Earth (laughter) to which this provision applied.

GONZALEZ: There have been a few times when Congress tried to simplify the tax code. They got rid of a bunch of deductions and exemptions.

MARTIN: But each time it happens for a brief moment partly, and then they start accumulating again as different groups lobby successfully for special provisions for their particular circumstances.

GONZALEZ: And there's this one provision of the tax code that The New York Times called the background music to Mr. Trump's life, a provision that lets you carry forward leftover losses.

MARTIN: So that's another one that was there from the beginning, from the beginning...

GONZALEZ: Oh.

MARTIN: ...Or about the beginning. I think it's 1918.

GONZALEZ: Here's what it is. Let's say you're a business, and you make a ton of money and profit this year. Well, you're going to have to pay taxes on all of that profit. And you don't want to because you're going to have to pay a huge chunk of taxes on it, right? So you can point to last year. You can say, last year, I had these big losses. I didn't make a profit last year, so I should pay less taxes on all of this year's profit because of my previous losses. And originally back in 1918, if you lost money one year, you could use that loss to reduce your taxes for next year, but only for that one year. Martin says it was meant to help struggling businesses.

MARTIN: You kind of don't want your tax system to bankrupt a viable business just because it has a bad year, right?

GONZALEZ: But then later, Congress said, well, now you can carry forward losses for two years, then 15 years longer.

MARTIN: But depending on, you know, how clever you are about your investments and how you go about booking what counts as a loss, there's lots of room to kind of game it with creative accounting.

GONZALEZ: And in 2017, about 100 years after the start of carryforward, Trump signed into law the Tax Cuts and Jobs Act. Among many provisions, it allowed businesses, like the president's, to carry losses forward forever.

Sarah Gonzalez, NPR News. Transcript provided by NPR, Copyright NPR.