The Big Three: Budget Resolution, Tax Reform, and FY18 Appropriations

As we begin the new fiscal year (FY18), we know that congressional Republicans want to accomplish two major goals: passage of a budget resolution and a tax reform package. And when you add in, FY18 appropriations, which Congress must address by December 8, that is a very ambitious agenda. Other things will have to get done as well; Congress has to address CHIP, the NDAA, flood insurance, and numerous other expiring provisions, but the budget resolution, tax reform, and FY18 appropriations will dominate Congress’ agenda.

Budget resolution: The House will move the resolution to the floor this week, with the rule coming out today and opening remarks tomorrow. The full Senate will attempt to pass its own version of the budget resolution the week of October 16, likely undertaking fifty hours of debate and a vote-o-rama, and finishing early the morning of October 20th. The same senators that were a problem for healthcare could be a problem for the budget resolution. How the two versions will be conferenced remains to be seen, as there are significant differences to address. For example, the House version is revenue neutral, but includes deep entitlement cuts; it also broke the cap on defense spending. The Senate version is not revenue neutral and does not include entitlement cuts, and it used the recent tradition of Overseas Contingency Operations (OCO) to include additional defense spending. The budget resolution will likely be more about tax reform, and less about deficit vs. defense hawks. In the end, we expect the final budget resolution to look more like the Senate version than the House’s version.

Tax reform: Congressional Republicans’ goal is for the committees of jurisdiction to work through tax reform in October and November. Some worry that tax reform could unfold in a manner similar to the healthcare debate, but cutting taxes is more in Republicans’ wheelhouse. Like the budget resolution, the same senators that were a problem for healthcare could be a problem for tax reform. Even under the best circumstances, some feel that comprehensive tax reform cannot be completed by yearend, and the more realistic timeframe is around Easter 2018. If Republicans can be satisfied with more of a tax cut, they could package a $1.5 trillion cut with some extenders by the end of the year.

So far, the only big payfor is the elimination of the state and local tax deduction, which is already receiving serious pushback, not just from Democrats, but also from Republicans from states that would be negatively impacted. On the eventual identification of other payfors, retiring Senator Corker and noted deficit hawk, has said “the spinach comes later.” Our view is whatever Republicans do, whether tax reform falls back to a tax cut, it is likely to include provisions to stimulate the economy (tax cuts retroactive to this year, 100% expensing for the next five years), in line with President Trump’s promise. Bottom line: setting aside all of the specific provisions that people will work to protect (interest deduction, municipal bonds, etc.), the success of tax reform is going to be determined by two things: 1.) how well Republicans can sell it as something that benefits the middle class. To that end, though President Trump is relying on doubling the standard deduction, the top rate could get pushed back up from the proposed 35% to the current 39.5% rate. And 2.) How the debate shakes out over paying for it vs. adding to the debt.

Appropriations: With the current Continuing Resolution (CR) set to expire December 8, Congress will have to either come to an agreement of FY18 appropriations or pass another continuing resolution. The House has passed all of its appropriations bills. The Senate has not acted on the last four. Financial Services can be completed whenever the chamber decides to proceed. Defense is being held up because of a lack of budget. Homeland Security is held up because Republicans have not decided what to do on the wall. Interior awaits finalization as Republicans decide which riders to attach. It typically takes four to five weeks for appropriators to draft an omnibus once budget numbers are finalized, so appropriators are forced to wait to finalize their negotiations. We expect Congress to lift the sequestration cap, and the question then becomes how do the chambers treat defense and non-defense spending. If Congress does come to an agreement on appropriations, the measure could become a vehicle for a whole host of other things, from the DREAM Act to the border wall to additional funding for hurricane relief and several expiring provisions. We know that the White House would like an increase in defense spending and funding for the border wall. The latter seems to be a nonstarter for Democrats.