Congress: Will They, Won’t They Enact Tax Reform This Year?


When John McCain definitely withdrew support from the Graham-Cassidy health care bill on Friday, he most likely also extinguished any hope of Congressional tax reform before 2018.  Or did he?

EconVue experts Michael Lewis and Robert Shapiro don’t agree on the future of tax reforms, but both have carefully reasoned arguments for their positions.  Mike thinks that Congress will push through tax cuts this year, but Rob doesn’t think that there is enough support, and if they occur, they will be followed in short order by tax increases. To which Mike replies that President Trump doesn’t care about deficits.  These sentiments are also held by Grover Norquist,  president of Americans for Tax Reform, who foresees massive tax cuts when Congress returns from its recess on Monday.

Econvue experts Robert Madsen and Karim Pakravan then join in the conversation. Robert agrees that tax reforms are unlikely as the Trump Administration becomes distracted with other more pressing issues and says that time is running out.   Karim weighs in on the negative effects if Republicans were to succeed. “A massive tax cut would make an already challenging fiscal situation unsustainable.”

Basically, there are two schools of thought about the possible value of increasing federal debt, either through tax cuts in an economy that is already burdened with debt whose carrying costs will likely rise in the near future, or increased governments spending.  At Jackson Hole, a paper was presented to global central bankers who have grown weary of extreme monetary policy that argues that fiscal spending unsupported by additional revenues is either neutral or beneficial. However Ben Steil  at the Council on Foreign Relations debunks what he calls the Paul Krugman school and says that there is no relationship between government spending and growth, citing the 2012-2016 data.

Please join in by posting your questions and comments below (you can register to comment here). What is certain is that the answer to this question matters. 


Panel Discussion

Michael Lewis
Michael Lewis EXPERT

The U.S. House of Representatives has recessed, but top GOP officials have said that the House, the Senate and White House will be prepared to start moving on federal tax reform as soon as they get back to DC on September 25. Significant details of the tax reform proposal will be unveiled before the end of this month, This, they hope, will start a countdown that will lead a significant tax reform package signed into law by year-end.

Though there are potential pitfalls, FMI believes there is a solid chance that a significant deal will be reached this year, even if it looks somewhat different from the proposals Trump and House Speaker Paul Ryan released during the campaign. With negligible support from Democrats, Republicans will have to be nearly unanimous – they can lose no more than two Senators and 22 Representatives. However, in contrast to the failed Affordable Care Act reforms, tax policy affords more room for compromise. We find it hard to believe that many of the often aptly named Stupid Party will cause another humiliating defeat because the corporate tax rate is cut by only -15% instead of -20%, for example. 

The details are being hammered out by the so-called Big Six:  Ryan and House Ways & Means chair Kevin Brady, Senate Majority leader Mitch McConnell and Finance Chair Orrin Hatch, and Treasury Secretary Steven Mnuchin and Gary Cohn, director of the White House National Economic Council. 

Officially, the plan delivered by the Big Six will be a starting point, but we expect that the final product will be not much different. News outlets this week blared “warnings” from Hatch that his Senate committee would not be a rubber stamp. But that is what any leader would say to keep his committee happy. 

The devil is in the details, of course, determining how much direct stimulus and/or increased efficiency there will be and who pays for it. Still, the basic outline is becoming clear: 
The corporate rate will be cut substantially from the current 35% (but not all the way to Trump’s desired 15%). Corporate deductions and tax preferences will be curtailed, but write-offs for depreciation will be accelerated. And there will be a window to repatriate overseas corporate profits at a very low rate, a reprise of a well-received Bush effort in 2005. 

On the individual side, the number of tax brackets will be condensed from the current seven to three (or four). The standard deduction will be raised sharply, and child care credits will be expanded. Itemized deductions will be reduced.

The deduction for charitable giving will be untouched – the Big Six know well that every effort to rein that in has failed miserably. The mortgage interest deduction has also long been considered untouchable, but this “back-door” approach may work. Raising the standard deduction ensures that only the top 10% of earners, perhaps even fewer, will use the mortgage deduction. Realtors and other usual supporters will find it hard to argue against this. Downplaying the mortgage deduction would reduce what most economists see as tax-directed excess investment in housing.

Trump is also targeting the deduction for state & local taxes. Together with the higher standard deduction, this would increase taxes on “the rich” but mostly on those rich living in high-tax states like CA., NY, NJ, and CT. As FMI pointed out, those states are now predominately represented by Democrats which should, in theory, give Republicans a free shot. Whether they will take it is another question.

The plan will likely include the “Ivanka Plan,” a new paid family and medical leave benefit delivered via the unemployment insurance system. It is Ivanka Trump’s pet project; neither the president nor GOP leaders will oppose it. 

Finally, there will be outrageously flagrant accounting gimmicks, e.g., to pass the bill through budget reconciliation, which cannot be filibustered, it must not add to the deficit beyond the next ten years. So some provisions will likely expire conveniently at that point.  

Robert Shapiro
Robert Shapiro EXPERT

I have to dissent from the account from Mike on the likelihood of tax reform this year.  Set aside the economics of the reforms under discussion, which at best are problematic.   Think like an investor and simply consider how likely it all seems. As a political matter, the piece predicts that a party with slim majorities in both houses and an unpopular president will enact changes that have consistently floundered for three decades.  To be more precise, we’re told, “corporate deductions and tax preferences (sic) will be curtailed” to finance a lower corporate rate.  Trump’s two predecessors and successive Ways and Means Committee chairs talked about doing precisely the same thing, and all failed.  The reason lies in the basic arithmetic of self-interest:  The Treasury estimates the average effective corporate tax rate at 22 percent – with many bearing lower effective rates -- which means that a substantial share of industries and businesses oppose the lower rate if it means giving up their current preferences.

In theory, one could cut the rate enough to satisfy some of them – Trump likes 15 percent, and Mike thinks 20 percent is more likely.  The catch, again, lies in the math:  No one has come up with any roster of reductions in corporate preferences – politically plausible or not -- that could finance anything lower than a 28 percent rate.

The piece is also uninformed in its analysis of the prospects of personal income tax reform, where it claims that lower rates and a larger standard deduction will be financed by ending the deduction for state and local taxes and reducing the value of the mortgage interest deduction.  Again, the pesky math shows that trading off those changes for any significant reduction in rates and a “sharp” increase in the standard deduction would come up more than $100 billion short per-year.  It’s also clear why past proposals to reduce those two preferences have always failed.    For example, the articles claims that ending the deduction for state and local taxes would only involve “high tax states” like “CA, NY, NJ, CT.”   As it happens, there are currently 28 GOP Representatives from those four states alone – enough to sink the proposal in the House – and many more from other states that would also be very sensitive to losing the deduction.  As for the claim that “realtors and other usual supporters will find it hard to argue against” changes that would reduce by half the share of taxpayers taking advantage of the mortgage interest deduction, it ignores the basic political fact that an interest group’s influence relies largely on the numbers of people who care about it.

That leaves us with tax changes that would swell the deficit by hundreds of billions of dollars per-year – more than enough to sink the bill in the GOP caucuses of both chambers, and more than enough to economically swamp the modest benefits arising from cutting tax rates.  

Michael Lewis
Michael Lewis EXPERT

We have a few comments on Rob's response to our analysis.

First, Rob is correct that this tax proposal will not be revenue neutral. It will not match President Trump's boast to be the "hugest tax cut ever!", but it will be a significant tax cut, which is why most Republicans will support it. Yes, this means bigger deficits. That does not bother Trump, and most Republicans will look the other way or lean on implausible accounting gimmicks.

Second, while we pointed out that the 10 states which take the largest percentage deductions for state & local taxes have no Republican Senators currently, a big change from past decades when attempts to strike down the S&L deduction failed.  Rob correctly points out that there are some Republican congressmen from those otherwise quite  "blue" states. However, there are much fewer of them than in past years and, by and large, they represent the more rural, usually lower income parts of those states, e.g., the only GOP Congressman from NYC is in Staten Island.

Overwhelmingly, their constituents would benefit from the Trump/GOP tax plan even if it eliminates the S&L deduction  Politically, those states' Republican parties would also benefit because the end of this de facto federal tax subsidy will make it much harder for the dominant Democrats to raise state taxes and make Republican tax cut proposals more appealing.

Finally, while Rob cites the inherent difficulty in passing major tax reforms, they did happen in 1981, 1987 and 2001 (not to mention by the Democrats in 1963). A president who really wants (and needs) it and a majority on Capital Hill can do it. 

Robert Shapiro
Robert Shapiro EXPERT

Sorry, Mike, but if only “most Republicans” support a huge tax cut, it goes down – as it should.  There’s no evidence that most people will benefit from whatever Trump and his associates come up with – let’s wait until CBO and Joint Tax release a distributional analysis.  And of the “reforms” you cite, Mike, only one really qualifies as such – 1987.  The others were simply tax cuts. 

It’s interesting, of course, that you omit 1982, 1983, 1991 and 1993.  In order, they are the Reagan business tax increases, followed by the Reagan payroll and gas tax increases – all passed to bring down the deficits created by the 1981 cuts – as well as the Bush and Clinton tax increases, which ultimately produced the first balanced budget in over a half-century. Then, there’s the 2009 tax cuts as part of Obama’s rescue–the-economy-from-the-Bush-financial-collapse package.  

If somehow, a big tax cut does pass this year, it will be followed by tax increases, too – perhaps under Trump’s successor (before or after 2020).

Robert Madsen EXPERT

I am skeptical that a tax reform package will be adopted this year.  The most compelling reason to believe something is possible is political cowardice.  The Republicans, and President Trump, desperately want a legislative win, so there will be a lot of pressure on politicians who portray themselves as fiscal hawks to compromise.  It is for the party and most of its members a good time to give money away, call it “reform,” and ignore the financial consequences. 

But the margins are narrow.  As Robert Shapiro notes, the “reformers"—if one can use that term to describe people who primarily want to use the public purse to buy popularity—can only afford to lose a score of Republicans in the House and a couple in the Senate.  That means that virtually everything would have to go right to get legislation enacted.  It is also important to acknowledge that the fiscal debate is not occurring in a vacuum.  If the Graham-Cassidy healthcare effort fails, or if it is railroaded through Congress in a way that alienates any number of Republicans, the damage could take weeks to repair.  Meanwhile the investigative noose around President Trump’s neck continues ineluctably to tighten.  Further revelations on that score could easily shift Congressional and media attention away from legislative matters and preclude rapid progress on tax policy.  

There are in my view too many things that could go wrong and thereby preclude successful tax reform this year. The abolition of Obamacare would need to occur smoothly and without engendering too many intra-GOP disputes, things must remain quiescent on the Russian front, and there must be almost unanimous cooperation between Republican legislators.  That seems like a lot to manage in just three months.

Karim Pakravan EXPERT

Tax reform (or should we say tax structure change) has become a mantra, but tax reform without looking at the context is meaningless.  On one hand, we agree that our tax system, whether personal or corporate, is a mess.  On the other, political allegiance to magical thinking (supply-side economics) is not a basis for such decisions. Furthermore, we need to start any discussion of tax reform by looking at the current fiscal situation as a base case.   Let’s look at the facts (All numbers are from the Congressional Budget Office):
- Personal Income taxes ($1.6 trillion) and corporate taxes ($0.3 trillion) covered about 50% of government expenditures in FY 2017.
- Mandatory spending has reached 63% of total federal expenditures (up from 45% 25 years ago) and is expected to reach 67% by 2027 on current trends.  Defense spending and discretionary non-defense spending each account for about 15% of total spending ($600 billion) in FY 2017.
- Interest payments on the federal debt could quadruple over the next decade, reaching $1 trillion by 2017. 
- On current trends, the fiscal deficit could rise from about $600 billion in F2017 to $1.5 trillion in FY2027. This would increase the net debt to GDP ratio from the current 77% to 87% in a decade.
- About 50% of the national debt is held by foreigners, which makes the US and the dollar very vulnerable to a global loss of confidence.

The GOP has two choices: either make the tax cuts permanent (which entails fiscal discipline) or make them temporary (10 years), hoping that magical thinking will work-- that faster economic growth will make up for lost revenue. Defense spending is hard to reduce (and in fact is likely to increase).  Therefore, if you opt for fiscal discipline, all of the adjustment will fall on the non-defense discretionary, which could in theory be squeezed out of existence.  Such an outcome, while politically desirable to some, would mean savage cuts in education, infrastructure spending, research and development, etc….

These numbers should be food for thought. A massive tax cut would make an already challenging fiscal situation unsustainable.A reform of the corporate tax that would reduce both rates and exemptions, thus increasing the tax base, would be welcome. Unifying the tax code for different kinds of business and doing away with the preferential treatment of carried interest would also be required.Similarly, a simplification of the personal income tax code to make it more equitable would be positive. This would involve actually expanding the tax base and probably increasing top tax rates. Finally, in order to promote economic growth and reduce inequality, we would need to spend more on education and infrastructure, which would need more discretionary spending, not less.