Republican leaders from the White House and Congress on 28 September introduced the much-anticipated unified framework for tax reform. The nine-page framework comes after weeks of discussion and is successor to the one-page proposal the White House introduced in April. However, stripping out the buzzwords, it is really still just one page long and contains nothing new. The overall purpose is to simplify the tax code and lower rates, only partly financed through broadening the tax base by removing deductions.

 

There is no point in running through the various items as a final bill will be significantly different from the broad strokes presented in the framework. It is now left to congressional committees to do the dirty work and sort out the details – if and when the two chambers agree on a budget resolution. The budget resolution is necessary to trigger the reconciliation process in the Senate, which allows for a simple majority rather than the usual 60 votes. The Senate budget resolution proposal allows for an increase in the deficit of USD1.5 trillion over the next ten years, which makes room for some dynamic scoring – that is to assume tax cuts and reform have a more positive effect on economic growth than the static scoring used by the CBO.

 

The unified framework is deliberately not mentioning any of the thorny issues that now have to be worked out. On personal taxes only deductions on charitable donations and mortgages are mentioned, and Republicans are particularly aiming at the deduction for state and local taxes. That would hurt high-tax states the most – all deeply blue; among them California, Illinois, New Jersey and New York. 32 Republican house members come from these states, complicating the path to a majority. For corporations, most issues are outstanding including interest deductibility. As every deduction has its own constituency, lobbying will be frantic over the coming months.

 

The perilous state of Senate Republicans

When it comes to taxes, the devil is in the detail and Senator Corker (R-TN) put it mildly, when he said that health care reform was “a piece of cake” compared to tax reform. Majority leader Mitch McConnell (R-KY) and President Trump are barely communicating. John McCain (R-AZ) is gravely ill, but has made it his mission to return the Senate to “regular order” meaning the usual parliamentary process of committee work and amendments. He sank the Republican health efforts twice on this point. Corker – a close ally of McConnell – has announced his retirement, making him a free agent. Corker cannot support a tax bill that increases the deficit after some common-sense dynamic scoring is applied. On 12 December, Alabama is likely to elect the firebrand Republican Roy Moore as new senator, further complicating the path to a majority. Republicans are hoping to pick up the votes of a few centrist Democrats running for reelection in Republican leaning states, but that will very much depend on the content of the tax package.

 

One interesting dynamic over the comings months will be how to square the President’s rhetorical focus on the middle class with the obvious benefits for the highest income groups in the unified framework. It is very unlikely a Republican Congress raises taxes on the wealthiest. It is equally unlikely that spending cuts or entitlement reforms would be part of a bigger package that could satisfy the few remaining fiscal conservatives. It remains to be seen how the ultra-conservative Freedom Caucus will handle a situation where tax reform is not used to lower spending.

 

Modest positive growth effect, if…

While tax reform is going to be very difficult to achieve, Republicans are under tremendous pressure to come up with something. The President needs a legislative win – as does House Speaker Paul Ryan and Mitch McConnell. Considering the packed legislative agenda over the coming months, I doubt anything will be completed until early next year.

 

My working assumption is a tax package that will lower the tax burden by less than USD100 billion per year – distributed between households and corporations, but mostly benefitting higher income groups. However, the odds of a complete Republican meltdown remain high. The payment of the repatriation tax on foreign accumulated profits is likely to be spread out over several years, minimizing the growth impact – and impact on the dollar. While not a massive boost to the economy, modest tax cuts are likely to support economic growth in the near term and hence also solidify Federal Reserve’s resolve to continue rate normalization.

 

Related documents:
https://www.treasury.gov/press-center/press-releases/Documents/Tax-Framework.pdf