The Macro Report | September 2017

Republicans riven by tax reform


Although there may be some fireworks over the debt ceiling, it remains a distraction from the key debate involving taxes and tax reform expected in the fourth quarter.

We can watch the tax debate unfold over the autumn, but there are a few things that are already clear. The first is that the White House is backing out of the process, or at least out of the details of the debate. For a while it seemed as though the White House might be trying to develop some genuine expertise on tax matters in order to have a credible voice in the debate and influence the outcome, but most recently it has shifted responsibility to Congress. The president has promised to give major speeches in favor of reform, but that is pretty much what happened with health care.

Within Congress, or rather within the Republican Party, there remain deep divisions over the way forward. Is the total tax burden on corporations or households, or both, to fall, or is the tax burden to be redistributed in such a way as to enhance short-term or longer-term growth prospects, while keeping total revenue broadly unchanged? If the former, is the deficit to be allowed to grow, or will spending be cut to keep the deficit manageable? If the latter, whose taxes are going to go up to allow taxes on favored sectors to go down?

The border adjustment tax debate revealed the obstacles

These are serious conflicts, and they must be faced pretty much full on. You can buy a bit of room through imaginative accounting, but not enough to make a material difference. We have already learned a fair amount about how the wind is blowing. Under the original House Republican plan, the increased revenue from the border adjustment tax, the BAT, was used to finance lower rates for other sectors. Lots of analysts got quite excited about this, as it seemed a genuine advance in the approach to taxation. It was serious, it was radical, it had a lot of expert support, and it raised enough money to finance other tax cuts. It might even have been growth enhancing. But it ran into a political buzz saw. The two Senators for Arkansas, the home state of Walmart, were key in seeing it off.

It’s hard to come away from that experience and think that any other key sectors and their well-paid lobbyists are going to offer themselves up on the sacrificial altar of longer-term growth. Will the oil and gas industry give up its extraordinary tax privileges? Hmm. Let’s think about that one.

The path of least resistance is one that lowers rates a little on the corporate side, with a bit of tinkering here and there and full use of “dynamic scoring” to gain a bit of wiggle room.

The other ideas that are being thrown around on the household tax side also face problems. The big tax deduction for mortgage interest has very few serious defenders, but it has an army of lobbyists ready to protect it. One other idea that gets a lot of expert support is to abolish the federal deduction for state and local taxes. Red State Republicans, in particular, love this one because high-tax states are almost all Democrat-leaning states, so you enhance tax efficiency and punish your political opponents. The electoral problem, and therefore the political problem, is House Republicans from high-tax states: There are 14 House Republicans from California, eight from Illinois, nine from New York, and six from New Jersey. That is a total of 43 votes from high-tax states when the Republican majority in the House is 32.

Counting federal dollars and Congressional votes

In short, potential sources of opposition to reform appear to be numerous, and there is little evidence of the kind of leadership that could steer a course through these conflicts. The path of least resistance is one that lowers rates a little on the corporate side, with a bit of tinkering here and there and full use of “dynamic scoring” to gain a bit of wiggle room. Of course, this would have only trivial effects on growth in the long run. But let’s not give up on it yet. We can watch the debate unfold in the coming months, and look for signs that the Republicans can come up with compromises that eluded them in health-care reform.


More from Macro Report
Download the Macro Report (PDF)