In the end, the Republican resolve to lower taxes beat whatever concerns individual members had about process and debt. Senator McCain came onboard Thursday, and the last holdouts got what they needed Friday: Daines and Johnson got additional tax relief for small businesses, Collins got assurances on health care and Flake on migration. Senator Corker (R-TN) was the only Republican to vote against for a 51-49 vote.
The two chambers now meet in conference to iron out the differences and produce a proposal that must be approved in identical form in both chambers before heading to the President for signing. If they cannot agree on a compromise proposal, Republicans have a plan B: let the House vote on the Senate version of the tax bill.
The result in the Senate was not really that close. With only one dissent, Republicans can afford to lose another vote in the Senate, and since Flake and Collins (and McCain) drew few lines in the sand what cannot be accommodated, the conference negotiations have a fair amount of leeway in drafting a common proposal. They got an additional boost on Saturday, when President Trump relaxed his demand of a 20% corporate tax rate. The 20% rate is a central point – and one of the few permanent elements – in both versions.
There are significant differences between the two versions, many of them hidden in the details and yet unknown since few have read the Senate text. The Senate has repealed the individual mandate for health insurance, which the House is likely to approve of; it frees up another USD336 billion that can be used to remove some of the delayed phase-ins and phase-outs that are in current versions. The Senate version delayed the introduction of the corporate tax cuts to 2019 – but terminates the individual cuts in 2025. The House-version reduces the number of individual tax brackets to four, while the Senate keeps all seven. The estate tax is likely to survive for the largest estates. The more ambitious the rewrite, the greater the risk of the process running aground.
Aside from taxes, Congress has a full plate in December. Temporary funding for the federal government expires on Friday, but Republican congressional leaders want to do another short-term extension of two-four weeks, even if conservatives oppose that. President Trump still muses about how a shutdown would benefit him politically, but he is unlikely to veto a short-term deal if it passes Congress. A shutdown would also take focus away from the tax deal and raise renewed concerns about the Republicans’ ability to govern. The debt ceiling can wait until the new year – and Democrats would prefer to do the two together to gain maximum leverage.
A solution to the wobbly health-insurance markets is also needed, and could come up for a vote pretty soon. Conservatives hate this idea (let them collapse!), but a solution was one of the demands from Senator Collins. On migration, Congress should come up with a more permanent solution for the Dreamers (children brought illegally to the US as children) after the President in September terminated the Deferred Action for Childhood Arrivals (DACA) program, that had been protecting them since 2012.
Higher growth, more hikes
The proposed tax cuts are larger than I anticipated in my 2018 GDP-forecast from October (an above-consensus 2.7%). Moreover, the strength in confidence indicators has also surprised, so the assessment of growth and interest rates needs adjustment. Additional military and domestic non-military spending is also in the offing, adding more to overall public spending than I anticipated.
I will await the final tax text before revising the outlook, but it now seems likely that the Federal Reserve hikes interest rates an additional four times in 2018 rather than three. With a hike at the meeting in ten days, the upper band for the Fed Fund Rate will stand at 2.5% end-2018. Hence, 10Y yields (current at 2.4%) are set to move up in coming months – adding tailwind to the dollar as well.