Business Ethos Blog

Is There Really A ‘Next’?

Dr. David Mielke, Retired Dean of the College of Business at EMU

After the defeat of all Senate attempts to reform health care, the Republicans are now talking about the “next” agenda item in an attempt to get something done.  It seems that tax reform is a topic that may get some bi-partisan support in the Senate although, if the Democrats stick together with a “no” to everything the Republicans try to accomplish, that attempt seems futile as well.  But are there areas of agreement that make tax reform possible?  Rather than one massive tax bill to cover both individual and corporate taxes, should they attempt to pass separate bills?  For example, most members of Congress would agree that corporate tax reform is needed, lower rates, provide an opportunity for companies to repatriate earnings at an even lower rate and move to a territorial system that only taxes earnings in the US.  But will Congress move to pass 2 bills?  Will there be agreement on the basic principles for reform that were just released by the Republicans?  What about President Trump’s suggestions for tax reform?  Will tax reform be even harder to pull off than repealing and replacing Obamacare given how politicians have laced the tax code with subsidies and carve outs?  What is the “Right Thing to do?”  Let’s look at some issues:

  1. Last week, the so-called “Big Six” Republican tax negotiators released their tax reform principles without any real specifics, vowing to have the committees in both the House and Senate to write the bills.  One specific was the elimination of the Border Adjustment Tax that had been floated to tax imports that would have raised about a trillion dollars to pay for lower tax rates.
  2. Economic growth is a priority after 12 years of a lackluster economy, with an overriding goal to lift annual GDP to 3% or more.  To accomplish this, rates for individuals, especially the middle class, must be reduced.  This is a primary focus.
  3. In addition, the US corporate tax rate has to be reduced enough to compete with the rest of the world and to return the $2 trillion in capital US companies have stashed overseas.  A corporate rate much higher than 20% won’t do the job and a rate below that is necessary to bring the profits back to the US.  The evidence of economic research is overwhelming that cuts in corporate tax rates flow to workers in higher wages.
  4. The tax code should be simplified.  This means the potential to reduce individual deductions, like state income and property taxes, and special subsidies, credits and deductions for individuals and corporations alike.
  5. The cuts should be immediate, retroactive for 2017.  One temptation in every reform debate, as we saw with the health care reform bills, has a phase in period to try to manage the potential budget impacts.  This is a potential growth killer as individuals and investors delay decisions to wait for lower rates.
  6. There is a priority for permanence.  It is possible that the Republicans could pass tax reform using budget reconciliation, that is, passing the legislation with only 51 votes in the Senate.  However, any bill passed using this tactic expires in 10 years.  Tax rates fixed in law with the normal process, meaning 60 votes in the Senate to avoid a filibuster, reduce the opportunity for Congress to change them in the future.
  7. The goal is tax reform, not just reducing rates.  That means, for example eliminating the interest expense reduction for corporations, state property, sales tax and state income taxes for individuals and eliminating subsidies for things such as electric cars,real estate and ethanol.  If that becomes too difficult, the temptation will be to abandon reform and just reduce rates.
  8. The budget outline now moving forward through the House promises a balanced budget in 10 years including tax reform.  In addition, it is likely that reform will be deficit neutral.  That is, any immediate reduction in revenues must be offset by reductions in spending.  This analysis depends on the Congressional Budget Office and Joint Tax Committee estimates.  The problem is that these estimates are static, they do not account for the increased revenues from faster economic growth, underestimating the growth impact of the tax cuts.  An initial deficit must be accepted, that will fall and eventually cause tax revenues to boom as they did with the Reagan tax cuts in 1981.
  9. The Republicans propose that the specific bills be written in the joint Republican-Democratic committees.  The real question is whether they can agree on true reform or just rate reductions.  Another question is whether or not 8 Democrats will vote for any bills to make the reforms permanent or if the Republicans will be forced to use budget reconciliation, causing any reform to expire in 10 years.

How likely is it that any tax bills will be passed this year?  Congress must still deal with the debt ceiling and the budget for next year.  Those 2 objectives will face additional opposition from both sides of the aisle, potentially causing more reluctance to compromise and work in a bi-partisan manner.  Would it be easier to do 2 separate bills, corporate reform first, because it seems there is more agreement on what should be done now that the Border Adjustment Tax plan has been dropped?  Will the Democrats criticize this move as favoring the rich?  Are middle class tax reductions a higher priority?  Will any bills be passed with 60 votes in the Senate?  Can Republicans afford another failure after health care reform?  Will tax reform determine whether or not Congress was worth electing?  What is the “Right Thing to do?”  The core principles sound good and using the usual Congressional committee approach sounds great, but as they say, the devil is in the details of any bills proposed.  For example, the Democrats will oppose elimination of the deduction for state taxes.  What is the likelihood they will agree to eliminate the green subsidies?  The Republican deficit hawks will likely oppose any initial increase in the federal debt brought about by tax rate cuts and look to cut spending.  The tax bills should truly be reform, not just the reduction in rates.  They should be permanent and if 60 votes cannot be gained in the Senate, use the nuclear option to pass the legislation with 51 votes.  The cuts should be immediate, for 2017, assuming they pass the legislation this year.  A corporate tax bill should be passed first.  Any massive bill covering individual and corporate tax reform with so many moving parts will cause opposition from person to person depending on individual interests and lobbying pressures.  Republicans and the President need a major legislative accomplishment.  The question is whether not tax reform is “next”.  My guess, no.  They will be fortunate to get a budget for next year passed and a debt ceiling resolution by October 1st.  If tax reform, not just rate reductions, are not passed this year, this Congress was not worth electing.