Next Up: Tax Reform
Facing continued uncertainty about the fate of the congressional healthcare debate, we’re thinking a lot about the next issue on congressional Republicans’ wish list: tax reform.
It’s hard to really tell what Congress will be able to accomplish with regard to tax reform until we know what happens on healthcare.
Much like healthcare, the administration and Congress are discovering that comprehensive tax reform is proving too complicated to fast-track as they had initially planned. Considering tax reform’s historical track record, it may be prescient to conclude that the process is just beginning. It took more than two years to pass bipartisan tax legislation in 1986. Though a tax reform package is no longer expected before the August recess, if congressional Republicans hope to accomplish the effort this cycle, they will need to do it soon, before it becomes too difficult undertake in an election year.
The White House released a one-page tax plan in late April that outlined tax cut goals but did not provide particulars on how to pay for the reductions. National Economic Council Director Gary Cohn initially indicated that the administration would issue a more detailed plan later in the summer, but the House, Senate, and administration now plan to release unified legislation.
While the specifics of a plan remain elusive, everyone seems to agree that the House, Senate, and White House need to get on the same page before attempting to move forward, rather than taking the approach they used with healthcare. House Energy and Commerce Chair Greg Walden (R-OR) has posited that tax reform will be much smaller as well as delayed until next year if a healthcare bill fails to become law. And though there is agreement on process, there remain substantial disagreements over policy specifics.
Though comprehensive tax reform appears to us to be a heavy lift at this point in the legislative calendar, Treasury Secretary Steven Mnuchin said that the administration is committed to completing a tax reform package, and not just tax cuts, and to ensuring that they are paid for, though there is some disagreement in Congress about whether paying for a tax reform package is necessary. Senator Ron Wyden (D-OR) has indicated that a bipartisan tax package would be impossible if Secretary Mnuchin could not commit to a reform effort that avoids a tax cut for the country’s highest earners. Separately, Secretary Mnuchin has expressed support for allowing a longer time horizon for tax cuts that would add to the deficit, along the lines of Senator Pat Toomey’s (R-PA) proposal to expand the horizon to 20 or 30 years, from the current 10, and Senator Hatch has also warmed to the idea.
Senate Finance Committee staff are looking through historical tax proposals for ideas on how to proceed with overhauling the tax code. They will be particularly focused on provisions that could raise revenue. As can be expected, former House Ways and Means Committee Chair Dave Camp’s (R-MI) 2014 draft and Senate Finance Committee Ranking Member Ron Wyden’s (D-OR) Republican-backed legislation top the list. Senate Finance Committee Chair Orrin Hatch (R-UT) said recently that Congress needs to be flexible about their policy priorities in order to accomplish comprehensive tax reform. He is particularly interested in whether it is feasible for the United States to transition from a global tax system, where corporations based in the U.S. pay income tax on all income, regardless of where it is earned, to a territorial system, where only domestic income is taxed by the U.S. The Treasury Department is also considering the issues and questions surrounding a territorial tax system as international tax reform efforts continue to unfold. Senator Hatch is also focused on his corporate integration plan that would eliminate tax on the dividends companies pay by allowing deductions for the distributions. Underscoring his open mind to the tax reform proposal process, Senator Hatch has said that, though it faces significant opposition in the upper chamber, a border adjustment tax (BAT) as well as a value added tax (VAT) should be considered as possibilities for changing the domestic corporate tax system and offsetting rate cuts.
In the meantime, the House GOP blueprint includes a 20 percent corporate tax rate and a 25 percent business passthrough, while the White House suggested a 15 percent rate in April. The House is still wedded to their BAT proposal, with Ways and Means Chair Kevin Brady (R-TX) maintaining that BAT is a necessary part of tax reform to promote economic growth, even if it includes a five-year transition period. Chairman Brady and others are increasingly indicating that transition rules will ease concerns that some industries have about how the import tax would impact their business models. The blueprint also calls for reduced tax on investment income, including capital gains, dividends, and interest income, and it is uncertain whether the reduction would apply to both passive and active investments. Some members of the Senate Finance Committee are also concerned about pairing interest deductibility and immediate expensing in the measure because it would result in some taxpayers with debt-financed investments having negative tax rates. Furthermore, the Senate is keen on neither eliminating interest deductibility nor the BAT, which are two of the primary revenue raisers in the House package. Speaker of the House Paul Ryan (R-WI) has called for eliminating the deductibility of interest, which would raise an estimated $1 trillion over 10 years, providing revenue to help pay for rate cuts and other tax measures. Along with the Senate, the Trump Administration prefers to retain interest deductibility since it allows companies to subtract interest payments from taxable income. As a result of disagreements on numerous complex components, there is growing concern that Congress will not be able to reach a consensus on the details of tax reform before the window of opportunity closes.
Tax reform will be easier if Congress can get healthcare across the finish line. But even now, the way the Senate is trying to get healthcare passed, Senate Republicans are giving up the taxes. Healthcare could have some bearing on tax reform whether Congress gets it done or not.
There’s no more sense of agreement in the Republican caucus on tax reform than there is on healthcare. That being said, many in the caucus feel that one way or another they’re still going to try to do some form of tax reform or tax cut package. Our instincts are that we’re going to see something very similar on tax reform to what we’re seeing today on healthcare: gridlock within the Republican caucus.
We think that after a lengthy year end session, rather than taking the chance of losing out on a second major issue, congressional Republicans may come back in January and combine tax reform with infrastructure in order to get the votes. If they go that route, they’ll do an infrastructure/tax reform/tax cut package via regular order in January.
But before that, one of the other barriers that they’ll initially have to address is that Senate Republicans have been planning on doing tax reform via reconciliation, which means that they’ll need a budget resolution. We’ll see shortly whether House Republicans can get a budget resolution out of the lower chamber, which will be no small feat, given the intense disagreements between deficit hawks and budget hawks. In order to get it done, like healthcare, they may use very high level numbers and try to sell it to both sides.