Last Friday, the Republican plan to repeal Obamacare and overhaul the US healthcare system came crumbling down without even going to a vote. President Trump acquiesced to House Speaker Paul Ryan’s request to withdraw the American Health Care Act (“AHCA”) from consideration after it became apparent that the bill did not have enough Republican votes to pass the House. This is a significant blow to Trump and Ryan, and has led many to observe, including Trump, that they should have tackled tax reform first.
Treasury Secretary Steven Mnuchin, some House Republicans, and seemingly most market participants, saw a silver lining in the AHCA’s failure – that tax reform was easier, and would now come sooner. Leaving aside issues of lost credibility and political capital, statements to the effect that tax reform is less complicated than healthcare reform are unlikely to be proven true. Here are just a few of the issues standing in the way of permanent tax reform (vs temporary tax cuts):
1. Repealing Obamacare’s tax provisions would have resulted in a $600 billion tax cut, mostly accruing to wealthy Americans, according to the Joint Committee on Taxation. The Congressional Budget Office estimated that the original AHCA bill would have cut federal spending by $1.2 trillion and tax revenue by $0.9 trillion over ten years, reducing the budget deficit by $337 billion. Having withdrawn the bill, GOP leaders just lost between $0.6 trillion and $0.9 trillion of revenue-positive tax cuts, and $337 billion of wiggle room with respect to revenue neutrality for the subsequent tax reform. If the Republicans still want to repeal some of the Obamacare taxes, they will need to plug the revenue hole some other way.
2. While Republicans are more or less ideologically aligned on tax reform, they need to balance the size of the tax cuts against slowing the increase in national debt – the fiscal hawks in the GOP may object to tax cuts that dramatically increase the budget deficit. The Republicans plan on using the budget reconciliation process to pass their tax reform with a simple majority in the Senate rather than the usual 60-vote supermajority, which would put the bill at risk of a Democratic filibuster. Reconciliation requires the budget bill to be revenue neutral at the end of the ten year budget window in order for the changes to the tax code to become permanent. The Ryan plan is expected to cost approximately $2.4 trillion over ten years under conventional scoring, and much less (close to revenue neutral by Tax Foundation estimates) under dynamic scoring. While the individual tax reform could come close to paying for itself – certainly if the AHCA bill hadn’t failed – it is the corporate tax reform that blows up to a $2 trillion deficit in the budget (without dynamic scoring).
3. The Republicans are also pushing for dynamic scoring, which would allow future economic effects to be included in the revenue calculation. Given Trump’s promises of 4% to 5% economic growth, higher future tax revenue features heavily in a revenue neutral plan. The Tax Foundation estimates that dynamic scoring alone would reduce the $2.4 trillion deficit to only $200 billion, well within the plan’s deficit target of $450 billion. This, however, is highly dependent on generating above-trend economic growth, most of which is expected to come from reviving US manufacturing and Trump’s infrastructure plan – which in turn depend on tax incentives and favourable tax treatment of capital expenditures.
4. The border adjustment tax (“BAT”) contained in both the Ryan and Brady plans is the major revenue generator of corporate tax reform. Ryan’s BAT is expected to generate $1.2 trillion in tax revenue over ten years, offsetting more than half of the estimated cost of the corporate tax cuts. Unfortunately for the Republicans, the BAT is highly divisive, likely to create very clear winners and losers, and already the target of intense lobbying from all industry groups. None of the issues associated with this controversial tax measure have been resolved amongst House Republicans since the plan was introduced in June 2016 – never mind the fact that Senate Majority Leader Mitch McConnell has repeatedly warned that the BAT would be dead on arrival upon the Senate floor. If the BAT is rejected, this blows another $1.2 trillion hole in budget and the reform bill would not be eligible for reconciliation. The Republicans would have to settle for “lite” corporate tax reform, tax cuts that sunset after ten years, or make friends with Democrats.
5. Finally, there is the small matter of what the various Republican factions actually want to achieve with tax reform. Trump wants tax cuts across the board, particularly for middle-class working Americans (his voter base), which would be extremely costly and add to the budget deficit. Ryan’s plan is aimed at promoting economic growth while maintaining revenue neutrality, and provides the biggest tax relief to the wealthiest 1% of Americans. White House press secretary Sean Spicer said on Monday that the White House is “driving the train” on tax reform, which suggests we could see competing House and White House bills on the table. This could drive further public divisions amongst the fractious House Republicans.
The withdrawal of the AHCA bill is an enormous setback for the Republicans and a high-profile failure to deliver on their top election promise. With midterm elections approaching at the end of 2018, House Republicans cannot afford to return to their electorates with no major legislative achievements after two years of controlling the House, Senate and White House. If the BAT or revenue neutrality become sticking points on tax reform, one likely outcome is that the word “reform” is dropped and the Republicans simply settle for limited tax cuts over ten years. While Ryan may see this as a wasted “once in a lifetime” opportunity to overhaul the US tax code, the Republicans could claim a victory and there’s always a chance the cuts are extended after ten years.