The Trump administration announced the nine-page outline of a set of tax “reform” proposals yesterday. Bloomberg’s editorial board grumbled that the plan was far too sketchy, but that misses the point. Tax bills don’t just originate in the House of Representatives but its staff also drafts the language. Even though various Administrations devise and promote various changes in tax laws, this is very much Congress’ sandbox. For instance, the reason the border adjustment tax proposal failed wan’t just that a whole bunch of companies, starting with WalMart, screamed bloody murder about it. It was the Administration had presented a tightly-woven bill that needed to be implemented in full for it to work. That isn’t how things get done on tax bills.
Thus the sketchiness of Trump’s tax plan isn’t in theory that big a deal. But in practice it will be. It is another reminder of how thinly staffed the Administration is and how it doesn’t seem to be sufficiently in tune with or concerned about how things are normally done in DC. This is a town run by lawyers, used to at least the appearance of being buttoned up, and not businessmen with short attention spans who’ve been fed a steady diet of PowerPoint.
Making Congress fill out more details than usual, or having it push back on the Administration and demand more specifics, can have some perverse effects as far as Republicans are concerned. First, assuming Congress takes up at least some of the slack, is that filling in the blanks will put various factions at odds with each other even more so than usual. If one group took loses in an initial draft, it would be faced with the prospect of justifying its case and clawing ground back. The vagueness increases the odds of infighting. The failure of Obamacare reform has increased divisions in the party, so it’s not as if Republican Congresscritters have either a font of good feelings for each other or even recent success in finding compromises on supposedly critical initiatives.
A second negative is that the Republicans are already behind their own timetable for getting a tax bill done. They wanted it in committees for mark-up in September. Treasury Secretary Mnuchin is trying to pretend that Congress can pass a bill by year end. Conventional wisdom is that it is hard to get anything important done in an election year, so the longer this goes into 2018, the more the odds increase that a tax bill will be tinkering as opposed to the grand “reform” that had been promised. And again, giving Congress less rather than more to start isn’t consistent with the perceived urgency.
But don’t let the thinness of the plan lead you to think that they Republicans won’t get some sort of tax bill done. Republicans love tax cuts, plus they desperately need to be able to claim some sort of accomplishment before the 2018 midterms.
And there are some features that you can tell now will get done, and others that will obviously change, and are likely to change in a way that will fall so short of expectations as to disappoint Republican voters who are on the tax reform bandwagon.
Keep your eye on the ball on the corporate side. Even though the press will be sure to spill a lot of ink on changes to individual taxes, the real action will be on business taxes.
The no-brainer tax “reform” event is deemed repatriation of deferred foreign earnings at a low rate. Corporate American wants that, since as they did in the last tax holiday, in 2004, they will use the extra reported profits as an excuse to pay higher dividends and/or executive comp. And the government will get tax revenues from this, which will allow them to make some of their much-loved cuts elsewhere.
This was intended to be lead to implementing a quasi-territorial system, meaning US companies would not be taxed on foreign business profits ….but that is super contentious and no one has figured out how that would work, so don’t expect anything on that front.
The big reason the rest of the tax reform bill is likely to disappoint many Republicans is that they not only won’t get anything resembling real cuts, or to use their misleading formulation, “tax stimulus” but that progress on their biggest goal, cutting the statutory corporate tax rate, currently 35%, is likely to be modest.
And here is where Republicans are hoist on their own petard. One of the mechanisms that Republicans have used to weaken government and make it incompetent and unpopular is via deficit scaremongering (mind you, they have plenty of fellow travelers among Democrats). They’ve also incorporated deficit fetishism in Congressional budget rules. Mind you, the appearance of making the number add up is a headfake, since the ginormous military black budget isn’t counted, plus how big the deficit winds up being is due to factors largely outside Congress’ control, meaning how much tax actually gets collected (a function of growth, wages, and employment) and spent (which again varies with the state of the economy).
But on paper, any tax cuts, and a big cut in the statutory tax rate represents a tax cut, have to be matched either by spending cuts or by closing loopholes. With Federal spending at roughly 20% of GDP, the US already spends vastly less than other advanced economies, so there’s not much that could be cut. And on the loophole side, as we’ve discussed, every one has a constituency, so getting rid of some for the supposedly noble purposes of tax simplification and rate reductions will still lead to howling from those whose particular oxen are being gored.
For instance, even some top tax experts had assumed that one of the measures that the Administration has proposed earlier to simplify individual taxes, that of getting rid of the deduction for state and local taxes, would go through because it would hurt blue states and districts. I was skeptical because affluent Republicans in high tax districts (remember, nice homes often come with high property tax bills) would be up in arms. And that backlash has started. From the lead story in the Wall Street Journal, Republican Tax Plan Quickly Hits First Hurdle:
A day after announcing their ambitious tax plan, Republicans debated scaling back one of their largest and most controversial proposals to pay for lower tax rates: repeal of the individual deduction for state and local taxes.
Faced with the potential for defections by House Republicans from high-tax states such as New York and New Jersey, Republicans are exploring ways to satisfy those lawmakers without backing off the lower tax rates they promised….
The fight over the state and local deduction, with more than $1 trillion at stake over a decade, is an early signal of the bruising battle ahead for Republicans trying to pass a tax bill that hasn’t garnered Democratic support and that faces narrow GOP margins in the House and Senate. It is the most obvious case of a bloc of pivotal lawmakers holding a specific concern, but it won’t be the only one.
“The notion that you fix this and then it’s smooth sailing?” Mr. [Representative Peter] Roskam said. “How naive.”
And on cue, the deficit scolds started finger wagging:
The preoccupation with the deficit plus the size of the constituencies for many of the current tax breaks is what will make any reform underwhelming. For instance, one of the big corporate giveaways is allowing companies to expense capital investments immediately. That would replace depreciation and would be a very costly item in the current budgetary framework. Including that is at odds with the level of rate reduction that the Administration wants.
Trump repeatedly touted a statutory tax rate of 15%. The “framework” presented yesterday promised a reduction to 20% for corporate income and 25% for passthrough entities. We’ve been saying virtually from the outset that was not going to happen, based on tax maven Lee Sheppard’s call that the final rate was going to be more like 29%. MarketWatch chimed in:
In short, even under the most optimistic assumptions about repealing existing tax preferences, Congress is likely to cut the corporate tax rate to 25%, rather than the proposed 20%, in order to meet the terms of the budget resolution.
Yet we have more Administration bluster, as Reuters tells us: Treasury’s Mnuchin: Trump’s proposed corporate tax rate ‘not negotiable’:
U.S. Treasury Secretary Steven Mnuchin said on Thursday that President Donald Trump’s proposal for a cut in the corporate income tax rate to 20 percent was “not negotiable.”
Come on, does anyone believe that? If a bill arrives on Trump’s desk with some sort of headline rate cut and simplification, he’s gonna sign it.
And we have Trumpian mixed signals on other fronts. The president had earlier promised to eliminate the carried interest loophole, which would be a non-concession if hedgies and private equity barons instead could use a 15% passthrough tax rate. Then Treasury Secretary Steve Mnuchin curiously mentioned only getting rid of it only for hedge funds….which don’t use it much since most of their profits are too short-term in nature for them to make use of that tax gimmick. Yesterday, there was nary a mention of the carried interest loophole, leading DealBreaker and others to take notice of the absence. Today, the story was the carried interest loophole was a goner for hedgies and private equity types both. From the Financial Times:
Gary Cohn, head of the White House economic council, said on Thursday that Mr Trump had not wavered in his determination to close a “loophole” that is worth billions of dollars to Wall Street money managers.
It’s easy to make that concession because these money managers will wind up in more or less the same spot with a 25% passthrough rate. Again from the pink paper:
Len Burman, co-founder of the Tax Policy Center think-tank, said the biggest boon for hedge fund and private equity managers would be a proposed reduction in the rate they pay as members of legal partnerships, falling from almost 40 per cent to 25 per cent….
The carried interest break lets hedge fund, venture capital and private equity managers pay a 23.8 per cent capital gains tax rate on earnings they receive as a cut of long-term investment gains.
Critics say there is no justification for it, arguing that the managers’ earnings are essentially the same as a salary and should be taxed at the top personal tax rate, which is now 39.6 per cent.
But what happens if Lee Sheppard is right and all the Republicans can get to is a 29% rate? Will the carried interest loophole be saved despite all the promises to scrap it?
Thanks to the Administration’s refusal or inability to provide Congress with what it expects in the way of a starting point, the wrangling is going to be even messier than usual. Pass the popcorn.