How Tax Reform Will Unfold

In evaluating where the White House and GOP congressional leaders will focus their efforts following  the demise of Trump-Ryan health care reform, consider the following: $1 trillion in new infrastructure spending is a heavy lift due to significant conservative opposition to new spending and few indications of a move toward bipartisanship; and the White House budget plan calling for $54 billion in defense increases, offset by cuts to widely supported domestic programs, is a non-starter because adjusting the spending caps and enactment of Appropriations bills both require 60 votes in the Senate. Tax reform is likely to be next in the legislative queue.

White House and GOP Congressional leaders are likely to begin Tax Reform this Spring using the FY 2018 congressional budget process, to take advantage of Budget Reconciliation’s filibuster-proof fast-track in the Senate. Here’s how it works:

  1. House and Senate Budget Committees will this Spring develop an FY 2018 Budget Resolution laying out total spending, revenue, and deficit levels for Fiscal Year 2018 (which begins October 1, 2017). The Budget Resolution will include “Reconciliation” instructions to the House Ways & Means and Senate Finance Committees to report fast-track, filibuster-proof tax legislation.
  2. After passage of the respective budget plans by the House and Senate, the two chambers will resolve differences between the two plans in a House-Senate conference and Congress will adopt a final FY 2018 Budget Resolution, likely by late Spring. (Important note:  passage of the FY 2018 Budget Resolution by Republicans could be more contentious than the FY 2017 Resolution adopted in January to launch health care reform.)
  3. Ways & Means and Finance Committees will develop tax bills in response to Budget Reconciliation instructions. The key constraint is the Senate’s Byrd Rule which prohibits the tax bill from causing deficit increases beyond the 10-year budget window.

THEREFORE, tax cuts must either expire after 10 years (like the 2001 Bush tax cuts) OR the tax-writing committees will have to fully offset the outyear costs of the tax cuts by closing existing deductions and credits.

  1. Speaker Paul Ryan has publicly stated his preference for a deficit-neutral tax bill so that tax cuts can be permanent.
  2. Last year, House GOP leaders and then-candidate Trump released tax outlines, giving some indication where their objectives converge:
    • Both plans reduce individual brackets from 7 to 3.
    • Both plans would reduce the individual top rate from 39.6% to 33%.
    • Both plans would eliminate the alternative minimum tax (AMT).
    • Both plans would repeal the estate and gift tax (impacting the top 0.2% of taxpayers since more than 99% are already exempt).
    • Both plans would increase the standard deduction and repeal personal exemptions.
    • Both plans would limit itemized deductions with the House plan repealing all but charitable and mortgage interest and the Trump plan capping all itemized deductions.
    • Proposals in the Trump plan also include eliminating carried interest which allows some fund managers to treat investment income as capital gains; increasing the Earned Income Tax Credit (EITC); and creating a new credit for child care.
    • Both plans would cut the corporate tax rate from 35% — Trump to 15% and House to 20%;
    • Both plans would have a reduced rate for businesses taxed as pass-throughs – Trump to 15% and House to 25%.
    • House plan includes a destination-based, border-adjusted cash flow tax (BAT) and Trump has hinted at support for a BAT. Under the BAT, all goods destined for domestic consumption are taxed and goods produced for foreign consumption would not be taxed — so that off-shoring business operations becomes irrelevant.  (However, the BAT is highly contentious, with retailers and other importers strongly opposed.)
    • Both plans are estimated by the nonpartisan Tax Policy Center (TPC) to have high revenue costs – the House plan at $2.2 trillion in the second decade, and Trump at $8.9 trillion in the second decade; the Senate’s Byrd Rule requires that outyear costs are fully offset, unless the tax cuts expire after 10 years.
    • If macroeconomic effects are factored in, TPC’s revenue estimates are somewhat smaller in the second decade for the House plan, but larger for the Trump plan.
    • In the first year, the top 1 percent of taxpayers would receive 76% of benefits under the House plan and 47% under the Trump plan.
    • In dollar terms, in the first year, the middle quintile of taxpayers would see an average tax cut of $260 under the House plan with the top 0.1 percent getting over $1.2 million; and the middle quintile getting an average cut of $1,010 under the Trump plan, with the top 0.1 percent over $1 million.
  3. Timing of Tax Reform: The FY 2018 Budget Resolution must be adopted first, then work can proceed on a Reconciliation Tax Reform Bill in the Ways & Means and Finance Committees.  Legislation of this type is extremely complex – technically (tax law is inherently complex), economically (the economic implications of tax changes are highly complex and include effects on the value of the dollar), politically (with different economic sectors locking horns on each provision and repeal of ObamaCare taxes now adding to the political load), and internationally (due to potential implications of existing trade agreements on tax provisions that directly impact imports and exports).  We can anticipate a lengthy, contentious, and complex process.
  4. For more details see FedWeb’s Tax Reform webpage, Reconciliation-Byrd Rule webpage and subscribe to FedWeb’s blogs for up-to-the-minute, expert analysis of developments.

Charles S. Konigsberg has served as General Counsel at Senate Finance Committee, legislative adviser to three White House Budget Directors, Minority Chief Counsel at Senate Rules Committee, and counsel at Senate Budget Committee.