Investors beware: there are four reasons (at least) why tax reform may not happen this year.
1) Democrats have been told it’s “us vs. them” and to obstruct any and all Republican initiatives.
2) There is only one individual in the White House with any tax policy credentials, but there are many loud voices.
3) The failure to pass Paul Ryan’s healthcare bill makes it harder to enact tax reform through reconciliation.
4) The House and the Senate disagree on the way forward.
Taking these points in order, we note first that the solid resistance from Democrats in Congress means that wide-ranging tax reform will have to proceed along party lines. The Left, enabled by groups like We Will Replace You, is threatening to mount a primary challenge to any Democrat that “colludes” with Trump…on anything.
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Consequently, some think Republicans should attempt a more limited tax overhaul, in hopes that it could attract some Democrat supporters. For example, they propose combining a one-time opportunity for U.S. firms to bring home profits stashed overseas, paying only a modest tax, with an infrastructure program.
An estimate from the Joint Committee on Taxation estimates at least $2.6 trillion is held overseas by U.S. firms. If a 10 percent “repatriation” tax was levied on those funds, the Treasury would collect a $260 billion windfall. Those revenues could provide funding for a private-public program to rebuild our tunnels and airports. That popular idea would be tough for Democrats to resist.
The repatriation opportunity received bipartisan encouragement in the past, but that was then. There’s no assurance Dems would go along, and in any case, the GOP wants more than a quick fix to our dysfunctional 75,000-page tax code; they want to “go big.” They campaigned on lower taxes for individuals, not just corporations, and they need to deliver.
As a result, Republicans will try to pass broad tax reform as part of the budget – a process called “reconciliation.” The trick here is that they must follow the so-called “Byrd” rule governing that approach, and come up with a plan that is “revenue neutral for ten years and beyond.” Trump and his team want to slash individual and corporate tax rates; policy makers need to find extra revenues to avoid blowing up the deficit. Ways and Means Chair Kevin Brady’s solution is the border adjustment tax (BAT), which aims to encourage exports.
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That idea has not won the backing of the White House. Trump initially called it “too complicated;” members of his economic team are searching for alternatives. Gary Cohn, who is White House Economic Council Director, has apparently taken the lead in this pursuit, even though the former Goldman Sachs president is new to tax policy. He reportedly suggested a carbon tax to balance the books, but that idea was almost immediately shot down. (He has since denied that he considered such a levy.)
Other administration players reportedly weighing in on tax strategy include National Economic Council member Shahira Knight, Steven Mnuchin and his Treasury colleagues Craig Phillips and Justin Muzinich as well as advisors Steve Bannon and Jared Kushner. Only Knight, a former lobbyist for Fidelity Investments, is a tax policy wonk. Others are still early on the learning curve.
Complicating the consensus-building at the White House is a profound split in ideology. Gary Cohn, Mnuchin and Phillips lean left; all have contributed to Democrats, and their take on tax reform (and everything else) is viewed with suspicion by their Republican colleagues.
Meanwhile, GOP tax architects were dealt a heavy blow when the Freedom Caucus nuked the healthcare plan. Contained in the AHCA was a trillion-dollar tax cut. That was the total amount, stretched over a decade, expected to be saved by rolling back the different fees and levies contained in Obamacare. (Apparently the Freedom Caucus didn’t get that memo.)
Since that trillion-dollar cut to taxes did not come through, cutting tax rates will result in considerably higher lost revenues. The quest for a balancing mechanism becomes even tougher.
Related: Trump Team Could Pull the Plug on Obamacare Subsidies for 2018
Brady’s BAT, which would slap a 20 percent tax on imports, creates winner and losers and is therefore controversial. Americans for Prosperity, funded by the Koch brothers, is running an ad campaign opposing the BAT focused on how the levy might drive up the cost of living. It fails to mention that lower tax rates are expected to offset higher consumer prices, or that some expect currency values to adjust for the import fee. It powerfully warns the tax will harm lower and middle-income Americans.
Georgia’s David Perdue picks up that refrain and is a leading critic of Brady’s approach in the Senate. Formerly the CEO of a discount retail chain, Perdue wrote in a letter in February, "this 20-percent tax on all imports is regressive, hammers consumers, and shuts down economic growth." Tom Cotton of Arkansas, home to Walmart, also opposes the measure, which is considered damaging to retailers.
Assuming the border tax fails, Republicans need to either find another revenue source or change the rules governing reconciliation. The latter is more probable. They can move the goalposts; instead of “ten years and beyond,” they can determine that any change will not increase the deficit over 15 years, or 20. In 2001, Congress changed the window from 5 years to 10, because legislators didn’t want the Bush tax cuts to expire after only five years.
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Tax reformers can argue that if the goal is to entice companies to make long-lasting investments in the U.S., the changes should extend beyond a decade. Extending the timeframe would also accomplish this: now that the CBO is allowed to use dynamic scoring, it can project growth from tax cuts extending farther into the future. This will help portray tax reform as revenue neutral.
This is where we are. It isn’t pretty. The central players in this drama confront numerous obstacles, including many of their own making. They will get it done, but those working behind the scenes now see success at best by the end of this year. Beyond that, voters will run out of patience, markets could falter, and the GOP could take a serious licking in the midterm elections.
