Senate Bill is Out

And now the tax battle is afoot…

As you all know, on November 2cnd, the House Ways and Means Committee released their tax bill.  Chairman Brady’s markup soon followed and seven days later, the Senate Finance Committee released their bill and Chairman Hatch began his markup.

And on the 7th day, the tax reformers … rested…

For those into the details please see the attached power point (from our Holsinger CPE Day – right after the House bill came out on 11/2t) which gives a 20 page summary of the House bill.  The news is that the Senate bill (released a week later) largely mirrored the House bill.  And both bills are politically… challenging (a.k.a. impossible).

The take away is this.  The “Tax Reform” as proposed by both Senate and House bills lowers the corporate tax rate from the highest in the industrialized world to 20%, which is slightly below our major European countries / “competitors”.  Further it does not tax offshore dividend repatriation.  It is notable that unlike our European friends, the US has no Value Added Tax (VAT) system (a tax which has no votes in Congress… yet).  Therefore:

  • moving the corporate rate downward with zero rate dividend repatriation on offshore corporate earnings, and …
  • moving pass through rate (owners of Partnerships and S Corps) down to 25%++++ (see attached power point), creates …
  • A HUGE revenue loss for the Government fisc.
  • And the ZEN game for business owners is – what happens if the Democrats take over with huge majorities in 4 years….  This is the larger modeling exercise….

Because you can’t have corporate “reform” paid for by the lowest earning Americans, the lower end of the tax scale gets simplification and tax relief.  The middle pays about the same.  Doctors, lawyer and accountants pay more (do I hear some cheering?)….  Republicans (to survive the mid-term elections) must successfully sell that the tax reform bill will actually produce jobs and an increase in wages.  That is an economic debate which is over my pay grade.

For those into the politics of how the attached power point (tax reform) can happen, please keep reading.  …  Those not interested….  We will brief you after the 27th out of the baseball game.

First I think it helpful to understand how a bill becomes law and this slide shows the process:

As of this juncture we are at about step 4….. (depending on what time you read this as each Congressional day now = 1 dog day).   Neither house of Congress has had a vote for either of these bills.  All that has happened is the tax committees of each house have sponsored bills for consideration.  A couple dozen Republican tax committee members voted “yea”.  Democrat tax committee members unanimously voted “no”.

But we now have tax bills and Step 5 & 6 are all important.  I suspect President Trump will sign anything that looks like any of these two bills (or looks like Tax Reform with one eye closed).

Because I am an accountant (and a pessimist), here are 6 reasons why these bills will not become law:

  1. While the Tax Cuts and Jobs Act (TCJA) under consideration in the House will likely satisfy reconciliation instructions requiring it add no more than $1.5 trillion to the deficit, as written it would violate the ALL IMPORTANT Senate “Byrd rule“.  The Byrd rule prevents passage of bills through the Senate with merely 51 votes, if the next day after the 10 year budget window (starting on 1/1/28) there is projected to be a budget deficit of as little as $1. ….  Currently the Joint Tax Committee estimates the legislation would add about $155 billion to the deficit in 2028.  Therefore, absent a fix to the legislation raising annual revenue $155B in 2028, the Byrd rule is invoked in the Senate.  This means the reconciliation process requiring merely 51 votes to pass budget and tax legislation is no longer sufficient and Senate rules now would require 60 votes (and at least 8 Democrats) for the tax legislation to pass in the Senate.
    1. Unfortunately, the “easy” options to solve for this problem – namely, allowing the corporate, individual or pass-through tax rate cuts to expire or rise on 1/1/28 – would undermine much of the purpose of the bill (“Tax Reform”) and reduce or reverse any effects it may have on economic growth. The only reasonable way to pass real pro-growth tax reform in the Senate, therefore, is to put forward a bill significantly more fiscally responsible than the Tax Cuts and Jobs Act as currently written.
      1. For those of you who are political junkies the Byrd rules is explained here http://archives.democrats.rules.house.gov/archives/byrd_rule.htm
    2. The Republicans have vowed (about 3 months ago) to uphold the Byrd rule, and hence:
      1. the final bill must be substantially different than its current construct (a.k.a. less tax breaks, higher business / corporate rates), or
      2. They need 8 Democrats to join them in the Senate, or
      3. They will destroy the Byrd rule (which will likely take time, and time is not a friend of Republicans trying to push legislation), or
      4. The could repeal the Obama Care Individual Mandate which would add sizeable ($338b) in revenue to the Government fisc, which combined with other revenue raisers, may get them to balance in 2028 and avoid the invocation of the Byrd rule.
        1. Combining the Individual Mandate repeal with tax legislation would be an amazing feat given Republican’s dismal efforts over the last 12 months in the health care debate.
  2. There are exactly zero Democratic votes for either the House or Senate bills.
  3. The sound of doom tolled early for Republicans late last week. The Virginia Governor’s race, where a very main stream Republican got trounced and Democratic turnout propelled the opposition Democrats (subject to recounts) to control of the Virginia State House is evidence of the electrification of the Democrat “no-more-Trump” base.  The Virginia Republican candidate received more votes for Governor than had ever been cast in the history of Virginia. Nonetheless his democratic rival trounced him by 10% points as a tidal wave of turnout, (particularly suburban women, younger voters and minorities), swamped the Trump base in western Virginia.  This process was repeated (way easier as my daughter living there will attest) in the New Jersey gubernatorial election.  While a couple of elections do not make a trend, this combined with the rabid growth in Democratic fundraising will make for sleepless nights amongst Republican party leaders.  –  Note to clients – SEE MY 4th BULLET POINT ABOVE…
  4. Tax Reform is once or twice in a generation event because it is so difficult to cobble together constituencies of support.  While the Trump base may be completely solid, his base is not wide enough to influence Republicans in “blue-er” states. See my slide on the politics of the removal of state and local tax deduction as these Republicans may be the early defectors.  This is especially true if they fear for their seats due to #3 above.
  5. If I am a house Republican, why make a principled stand for tax reform, only to have our bill be Dead on Arrival in the Senate due to #1 above?   Watch for a potential Republican stall in the House until the Byrd rule somehow gets solved.  And stalling is probably not good for any legislation lacking bi-partisan support.
  6. The longer the legislation takes, the more likely a Black Swan event could derail it.  For instance, if Republican Rory Moore wins the Republican Senate seat in the run-off election of the super Republican state of Alabama (necessitated by former Senator Jeff Session becoming the US Attorney General) this sets up an uncomfortable calculus Republicans (for those of you not following along see https://www.nytimes.com/2017/11/09/us/politics/mcconnell-roy-moore-sex-teenagers.html  ).  All Republican leaders, and most notably Senate Majority Leader Mitch McConnell backed Moore’s Republican opponent leading up to the runoff.  If Mr. Moore wins the runoff election, what retribution will he extract (like so many Obama Care Democrats) for his “yea” tax vote?  But if Alabama Republicans want to do better, they could split their vote with write-in candidates and a Democratic winner (heresy!) could emerge.  Watch for the Republicans to endeavor to get tax legislation done prior to the distraction of Senator Moore’s (or the rarest of species) an Alabama Democrat’s arrival in the Senate on December 15.

Four reasons why this will absolutely pass by December 15:

  1. You all probably know friends who, unfortunately have had a hard time in their marriage (like the Republicans in Washington)…
    1. Just imagine… perhaps you’ve experienced an evening (say 11/2/17 when the House bill came out) when your friends (the House and Senate) confess that they think the best way for them to move forward in their relationship is to have a baby (tax reform)!!!!  All of these proposals, in the current environment have that kind of feel.  However, Republicans are warming up to a shellacking in 1 year unless they do something (HAVE A BABY!!!).  Fear for losing your own Congressional seat has a way of focusing the mind.
  2. Tax reform is one of the few things that unite Republicans and if anyone can do it, they are the ones.  It is their native tongue.
  3. The White House appears to be on task for this.  Let’s see if we get some advertising for tax reform and hear about calls from the White House to Capitol Hill as this will make clear that the President is behind it.
  4. If they solve the Byrd rule then this has a chance.

Summary:

I think the best way they can make it happen is via repeal of the Individual Mandate.  It combines the undoing of Obama Care and gives enough cash into the system to BEGIN to pay for Tax Reform.  (Also helpful that the Individual Mandate is hated by the young “Indestructible’s” – a.k.a. 20 somethings like my son who hate to go to, much less pay for, the doctor).   Query if there are enough votes for a bill that combines Tax Reform, Budget Reconciliation, and a major blow to Obama Care all by … Thanksgiving (or at least 12/15)??

My vote is that they can’t get the above paragraph done and we get a watered down version of “reform”…. a.k.a. some tax candy but nothing that makes US Corporate Tax rates more globally competitive (any rate > 25% is uncompetitive at the expense of the broadening of the tax base).

What are my “odds”….

  • If Republicans don’t repeal the Individual Mandate, then there is no true tax reform and the bill lumbers through with some goodies on the edges –odds of this happening  = more likely than not…. I give this the likely option…say 75% will happen
  • If they repeal Individual Mandate, true reform has a shot … say 45% will happen.

Stay tuned as this is a delicious time in politics and taxation…

Bill Collier

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