April 27, 2017 Tax Reform: Where and When It Goes From Here
What's Happening: National Economic Council (NEC) Director Gary Cohn and
Treasury Secretary Steven Mnuchin unveiled the White House tax plan yesterday
with much fanfare, but little substance. The proposed plan is one page (mostly
bullet pointed), and includes few details that were not in President Trump’s
campaign plan. But it does hold a few clues to the administration's positions, most
notably by largely following the same contours as the House tax plan, but not
including the border adjustment tax (BAT) that House Speaker Paul Ryan (R­WI) is
championing. Why It Matters: Republicans are their own biggest challenge to successfully
passing tax reform. As we described in our April 6th Spotlight Report, “Why
Permanent Tax Reform is More Likely Than Temporary Tax Cuts,” House GOP
leadership will need to incorporate feedback from the House Freedom Caucus
early to ensure they can get a package across the finish line, which almost
certainly means eliminating the BAT. Additionally, the White House will need to
coordinate closely with the Hill to ensure that their proposals do not contradict
each other, sowing confusion and allowing various factions to defect from the GOP
plan. Republican congressional leadership is still insistent on achieving
comprehensive, permanent tax reform. And while GOP infighting on Capitol Hill
certainly complicates legislative efforts to achieve broad tax reform, we believe
that investors are over estimating the negative impact the House’s failure to pass
healthcare reform will have on Ryan and top congressional tax writers' ability to
legislate a permanent tax reform plan that lowers rates and is offset by a mix of
less controversial “payfors” than the BAT. Ultimately, the math will drive how far the
rates can be lowered, not vice versa, and Republicans still have the ability to cut
rates meaningfully, albeit not nearly to the 15 percent corporate rate proposed in
the White House plan yesterday. What's Next: The tax reform process on the Hill will formally get underway in mid­
May, when the House Ways and Means Committee holds its first hearing on the
topic. While we expect the House to pass its tax reform bill before the August
recess, if it does not, that will likely exacerbate tensions with the White House and
increase the likelihood that we get non­permanent tax cuts, rather than tax reform,
which very well could be limited to just a reduction in individual tax rates at that
point. The Senate is prone to far more fits and starts given the upper chamber’s
more deliberative process and the GOP’s narrower majority. Therefore, we do not
expect the Senate will be ready to consider its own tax reform measure on the
floor until at least next October, given the other must­pass measures on the
agenda and difficulty of hammering out the details of its plan, since senators will
be more circumspect about which payfors they use to offset the cost of lower
rates. This timeline leaves only a couple of months for the House and Senate to
come to an agreement in a conference committee, if they are going accomplish
tax reform before Congress adjourns for the year in mid­to late December as they
hope to do.
Impermanence: Good for Meditation, Bad for Tax Reform The White House tax plan highlighted a key difference between President Trump’s tax
goals and those of the Hill leadership­­one that we identify as the difference between “tax
reform” and “tax cuts.” The difference is required by the legislative vehicle, known as budget reconciliation,
Republicans are using to pass tax reform. Budget reconciliation is necessary, because it
allows Republicans to bypass the filibuster in the Senate and pass tax legislation with
only 50 votes, thus avoiding the need for compromising with Democrats as well.
However, the budget reconciliation process does have limitations built in, and one of
those is that any tax plan will need to be deficit neutral after ten years. There are two ways to ensure that Republican tax legislation is deficit neutral:
“Tax Reform”: Congress can use offsets to balance the tax cuts, creating a
revenue­neutral, permanent reform plan that significantly revamps the Tax Code.
This is the preferred plan of the Hill leadership, particularly House Speaker Paul
Ryan (R­WI) and House Ways and Means Committee Chairman Kevin Brady (R­
TX). Earlier today, Brady stated on CNBC that, “the greatest growth for the
greatest years comes about when tax reform is bold, when it balances in the
budget, and when it’s built to last, it’s permanent. Done right, I think permanent tax
reform can double the growth that you get from temporary tax cuts. We’re going to
have that conversation [with the administration] as well." “Tax Cuts”: Congress can make the tax cuts temporary, having the legislation
sunset before it can cause a deficit. This is a fall back plan, technically, but the
White House has expressed comfort with allowing it to happen. At an event
yesterday, Treasury Secretary Mnuchin suggested that the administration would
see both tax reform and tax cuts as a win, telling the audience that, "The goal is to
make it permanent but, you know, there's lot of levers here. And, you know, if we
have them 10 years, that's better than nothing, but we'd like to have permanency
to it." Some in this camp (including Trump) believe it is the better way to go
because it will require fewer offsets and thus be less politically challenging. Others
embrace the supply­side economic theory that argues that tax cuts do not need to
be offset because they pay for themselves by promoting growth.
But although tax cuts seem to be the easy way out, they are actually anything but. For
one thing, it is not as simple as just sunsetting tax cuts after ten years. A recent Joint Tax
Committee analysis found that only a three­year cut of the corporate tax rate to 20
percent would have long­term effects on the budget, and even using dynamic scoring,
would still require an offset of approximately $500 billion for the post­ten year window. In
contrast to the 2001 and 2003 temporary individual tax cuts enacted under former
President George W. Bush, a corporate tax cut ­­ even a temporary one ­­ would have a
significant deficit impact in years 11 through 20 of the budget horizon because of the
magnitude of tax credits that would be accrued and applied in later years. And that
analysis is for a tax cut that is undoubtedly too short to pass. Consequently­­and a bit counter­intuitively­­it would actually be easier to achieve
comprehensive tax reform than tax cuts. Permanent Tax Reform Tax reform is a marathon not a sprint, and we are on mile two. It currently remains our
base case that it will get done. We expect the next big inflection point in the House to be
the August recess­­if the lower chamber passes a bill before recess, then attention will
turn to the Senate. If the lower chamber fails to pass a bill before recess, tensions will
rise between House leadership and the White House, and we expect Trump to turn to
“tax cuts” for an “easy” legislative win, although including corporate tax reform in such an
instance will be difficult while not running afoul of the reconciliation deficit­neutrality
requirement. Starting in the House: Both Ryan and Brady, the top tax writer in the lower chamber,
are prioritizing the creation of a new, permanent pro­growth framework rather than hitting
very low, specific target rates. Ryan told Charlie Rose earlier this year that while he
wants to achieve the lowest corporate rate possible, the math will dictate the rates as he
maintains his commitment to achieving revenue­neutral reform with rate offsets. Ryan
told Rose, when comparing the House and Trump's proposed corporate rate, "The 20
percent is what the House plan is. Now, [the president] has said that he wants to do it to
15. We'd be happy to do that. We've just got to make the math work. We've just got to
have the numbers to add up." As opposed to the 2001 and 2003 Bush temporary tax cuts, which were focused on
individual rates, one of the primary driving forces behind comprehensive tax reform today
is the desire to make the US corporate tax system more competitive on a global basis.
Passage of non­offset tax cuts for only 10 years would not only fail to provide the private
sector the certainty it craves, but it would remove the impetus for true pro­growth tax
reform for at least the next decade. Brady affirmed his and Ryan's position on temporarily lowering rates versus achieving tax
reform recently when he said, "If we’re serious about leapfrogging America back to the
lead of the pack, and if we’re serious about creating jobs and jump­starting this economy,
a 10­year bill will not accomplish either of those. The most pro­growth tax reform is
permanent tax reform, so we’re operating ­­ I’m operating on that basis...Permanence is
a critical part of that.” To achieve their goal, Ryan and Brady will need to do a better job of socializing their draft
legislation within their conference, particularly the conservative House Freedom Caucus,
than they did with the healthcare legislation. This probably means Ryan and Brady will
also have to give up the BAT, which is increasingly looking like a poison pill that will be
entirely rejected by the Freedom Caucus. Ryan and Brady will also need the White House not to work at cross purposes with
House leadership. The White House can be an important partner for leadership, with the
ability to stand as an outside mediator and to twist arms when absolutely necessary, but
if the White House gets involved too late or threatens recalcitrant members too heavily
like they did initially with the American Health Care Act, that could create more problems
than it solves. Their communication appears to be improving, however, as Cohn and
Mnuchin met with Ryan and showed him the tax plan before releasing it publicly. Our current base case is that any legislation passed by August will include the following
provisions, among other others:
create a territorial tax system with a new corporate tax rate in the roughly 25 to 28
percent range; NOT include any form of a border­adjustment tax; limit, but not eliminate, the corporate interest expense deduction; apply a mandatory reduced tax rate for the deemed repatriation of existing
overseas earnings; NOT repeal the taxes imposed by the ACA; reduce the number of individual tax brackets; reduce the disparity between the corporate rate and the rate applicable to pass­
through entities; and all of these changes would be made permanent by keeping the overall package
deficit­neutral.
You can find more details about each of these provisions in our March 28th Spotlight
Report, “Tax Reform is Different Than Healthcare.” Next Moving (Slowly) Through Senate: If the House Republicans can get a tax reform
bill passed by August, then the focus of tax reform will shift to the Senate in the fall. The
Senate is a notoriously slow moving body, and if they do not have a plan by October, will
face increasing pressure from both the House and the White House to get something
done. We expect the Senate to eventually adopt legislation similar to that of the House,
but with less controversial payfors, as senators typically represent a more varied and
larger constituency than House members. Currently, there is a leadership vacuum in the Senate, as Senate Finance Committee
Chair Orrin Hatch (R­UT) has been plodding along with his own concept of corporate
integration for tax reform. Hatch, who is the longest serving Republican senator with over
40 years in office, also prefers to pursue a bipartisan approach to tax reform, which
would have been the typical way of doing business in the past, but is impractical in
today’s hyper­partisan political environment. If Hatch fails to demonstrate significant progress by August, we expect other Senate
Finance GOP members or GOP leadership to fill the vacuum. Senator Pat Toomey (R­
PA) is already pushing behind the scenes to follow the “tax cut” approach, and reportedly
joined a dinner with Speaker Ryan, NEC Director Gary Cohn, and Treasury Secretary
Steven Mnuchin on Tuesday evening before the release of the White House tax plan. But we expect moderate Republican Senator Rob Portman (R­OH) to be the real leader
of tax reform in the Senate. He has the knowledge and background to lead on this issue,
having served as the director of the Office of Management and Budget under former
President George W. Bush. He has the trust of Senate Majority Leader Mitch McConnell
(R­KY), and also a number of close friends who entered the White House, including
White House Deputy Chief of Staff Joe Hagin. Portman is also known to be in regular
communication Cohn and Vice President Pence. Portman will likely be a moderating
force on the White House who can help shepherd tax reform safely through the Senate. Main Discontinuities: But just because we believe “tax reform” is more likely than “tax
cuts” does not mean that tax cuts are unlikely. There are several discontinuities to watch
for that could result in the death of Paul Ryan’s dream tax reform legislation:
Leadership could fail to get various Republican factions on board,
particularly if they continue to push the BAT. This is a real risk, as Brady is
expected to hold the first tax reform hearing on the BAT, and Ryan brought up the
BAT again at an event yesterday, where he at least acknowledged that it needs
some tweaking to gain traction. Ryan told the audience that, “We all agree that in
its present form [the BAT] needs to be modified. We don’t want to have severe
disruptions ­­ if you’re an importer or a retailer heavily dependent on importers, we
don’t want to shock the system so much that it puts them at a disruptive
disadvantage.” But as long as Ryan and Brady continue to tweak instead of
remove the BAT, they will have difficulty moving forward with tax reform. Hill leadership and the White House could fail to communicate. The White
House has been evolving in how they interact with Congress (and has been
learning that it can turn to executive orders when it needs an easy win). As we saw
with the healthcare legislation, the White House first pushed too hard on the
Freedom Caucus and forced a vote when the House was not ready, leading to the
collapse of the original plan. Now, the White House is working more directly with
the Freedom Caucus to create workable legislation, but because they have not
brought moderates to the table, they have created a bill that appears to solve the
problem, but will actually just shift the blame for any failure to the moderates and
leadership. However, it is a good sign that Mnuchin and Cohn held a dinner with
Hill GOP and think tank economists before releasing their tax plan on Wednesday. The House could fail to pass legislation before the August recess. This date
has been seen as a “do or die” for several months, although Brady tried to push
back on that timeline earlier this week when he told reporters, “I'm less focused on
the month than on the year for tax reform — which would be this year, 2017.” But
a failure to pass legislation before August would increase tensions between the
House and president, and we expect Trump would step in to push a tax cut at that
point so as to get his win and be able to move on to his next big promise. The Senate delays too long and does not have time to socialize tax reform
legislation. The Senate can lose only two votes, so it will need a plan that can
appease both the back bench bomb throwers and the moderates. If Senator Hatch
delays too long and no one steps in to clearly fill the vacuum and shepherd
legislation through the upper chamber, a long stall could cause tensions with the
White House and lead Trump to again push tax cuts instead of tax reform.
Website
Twitter
LinkedIn
Email
Copyright © 2017 Beacon Policy Advisors LLC 1701 Pennsylvania Avenue, NW, Suite 300 Washington, DC 20006 | (202) 729­6335 Our Compliance Policy Unsubscribe