The Cost of Lower Taxes

The following article by Andrew Soergel was posted on the U.S. News and World Report website November 10, 2017:

Lawmakers are in the midst of a battle to keep constituents and interest groups happy without exploding the deficit.

The Capitol dome in Washington. (Brendan Smialowski/Agence France-Presse via Getty Images)

President Donald Trump rode into town on the backs of several ambitious campaign promises.

But after one year in office, his border wall along America’s southern border remains unbuilt. The Obamacare legislation he vowed to gut while on the campaign trail remains in effect.

And although he’s had more success on deregulation through executive orders and memoranda, the ongoing tax reform battle on Capitol Hill represents the president’s last, best chance for a big-ticket legislative victory this year – and arguably before the 2018 mid-term elections.

But at what cost?

Lawmakers for weeks have been tinkering with a GOP-constructed framework that would allow them – if all goes according to plan – to slash the corporate tax rate from 35 percent to 20 percent, retool the country’s personal tax brackets, scrap certain deductions and credits from the system entirely and spark the repatriation of trillions of dollars currently parked overseas and outside the taxman’s reach.

After a week of inter- and intra-party debate, representatives in the Ways and Means Committee on Thursday managed to get enough lawmakers to sign off on a proposed tax overhaul to push the bill to a full House vote, which is expected to take place by Thanksgiving to keep with the president’s ambitious legislative schedule.

The odds of maintaining that time frame have been described by many analysts as lofty, and even House Ways and Means Committee Chairman Kevin Brady, R-Texas, has previously suggested the sky wouldn’t fall if deliberations carry into 2018. But House Republicans have to this point remained on track despite the introduction of a handful of new amendments to their bill throughout the week.

Tax writers in the Senate, meanwhile, have been hard at work on a plan of their own, on Thursday releasing specifics of their own. The two plans appear to diverge on specifics but are likely to share the same price tag before all’s said and done. In order to access reconciliation proceedings in the Senate and potentially pass tax cuts with a simple majority rather than the standard 60-vote threshold, the GOP-backed tax overhaul can’t carry a price tag north of $1.5 trillion over a 10-year window.

But interest groups and independent analysts have made the case in recent days that the ultimate cost of the tax tweaks under consideration can’t be summed up with that round $1.5 trillion total.

“While even this $1.5 trillion was a concession by deficit hawks, it means that the bill will have losers as well as winners as the proposed cuts far exceed this total,” John Lynch, chief investment strategist at LPL Financial, wrote in a research note Thursday. “While limiting the impact on the deficit is a virtue, it will create the battles that are most likely to sink the bill.”



These squabbles are already on full display in and around Capitol Hill as lawmakers fight for tax terms that they feel are best for their constituents. Division has already emerged within Republican ranks over state and local tax dedcutions, which lawmakers from high-tax states like New York and New Jersey say is crucial for those they represent.

Lobbying groups, meanwhile, have hounded lawmakers over particular breaks and incentives that are expected to be wiped out entirely. The National League of Cities has blasted the possible elimination of state and local tax deductions. The National Association of Homebuilders has spoken out against a retooled mortgage interest deduction in the House plan, which would lower the cap on the amount of money homeowners can write off each year.

And the AARP has challenged the House’s proposed elimination of medical expense deductions, which the association says could place a greater burden on sick and elderly Americans. AARP estimates nearly 8.8 million Americans utilized the medical expense deduction in 2015, with the average amount claimed sitting just north of $9,900.

“Washington, D.C.’s K Street is the geographical heart of the nation’s lobbyists and advocacy groups, and they will all be trying to advance their constituents’ interests,” Lynch said. “The longer the bill takes to pass, the more it will be watered down with compromises and influenced by lobbyists, even if it still satisfies its broad intentions.”

Trying to make all of these groups happy while remaining under that $1.5 trillion bar is no easy task, and House Republicans repeatedly this week were forced to tweak the tax bill to keep it under the reconciliation deficit cap.

But some have even questioned the accuracy of that $1.5 trillion benchmark, given the number of phase-ins and phase-outs the tax overhaul may include. And Democrats on the Ways and Means Committee this week were quick to note that the $1.5 trillion figure doesn’t account for inflation. When all’s said and done, the final deficit hit is expected to come in closer to $2.3 trillion.

The Penn Wharton Budget Model, meanwhile, projected this week that the House bill would reduce government revenues by between $1.4 trillion and $1.7 trillion over 10 years and increase U.S. debt by as much as $2.1 trillion over the same window.

By 2040, the budget model estimated the bill as it stood earlier this week have added up to $6.8 trillion more to the national debt than would have been accumulated under the current tax code. And that’s scored on a dynamic basis, taking into account the potential economic positives produced by the tax tweaks.

Scott Anderson, chief economist and executive vice president at Bank of the West, described the “likely swelling of the federal deficits over the next 10 years” as “troubling” in a research note last week, noting that “any short-term benefits from the tax cuts could be wiped out if they force more draconian tax increases or government borrowing down the road.”

Democrats and deficit hawks, similarly, have raised objection to the overhaul’s expected impact on America’s debt burden. Republicans, however, have pushed back against their left-leaning colleagues for selectively worrying about the country’s spending. The GOP has also argued that the bill’s expected debt concerns will be mitigated by stronger economic growth in the years ahead.

Their theory goes that if more businesses are able to repatriate earnings and the U.S. restructures how it taxes international earnings, the government’s revenue stream will widen. And as economic growth picks up through business and personal tax tweaks, more people and more companies will spend more money, thus giving the government more tax revenues and leaving everyone better off.

And, indeed, independent analysts tend to believe the tax tweaks will have a modest impact on America’s gross domestic product in the short term. Anderson said he expects a “marginally positive” economic boost and has “penciled in about a two-tenths of a percentage point increase in GDP growth for 2018” should the tax bill make it to the president’s desk in the near future.

The bill’s inclusion of language that would allow companies to write off the costs of capital expenditures such is particularly enticing to many in the pro-business community. Such a provision would theoretically make the purchases of new equipment more affordable, allowing businesses to invest in their operations and raise productivity.

The Wharton model, similarly, suggests the country’s GDP in 2027 would be raised “between 0.33 percent and 0.83 percent” relative to its current trajectory if the House’s tax plan was adopted. But “as more debt accumulates,” Wharton projects the country’s GDP in a worst-case scenario would be 0.25 percent smaller by 2040 than it would be if tax rates were left untouched.

Debt accumulation limits the government’s spending flexibility, eventually raises the possibility of a partial default or, more immediately, a downgrade to the country’s credit rating. Fitch Ratings on Tuesday issued a statement in which it suggested the GOP’s tax agenda effectively “worsens” the country’s public finance outlook.

“Tax cuts may lead to a short-lived boost to output, but Fitch believes that they will not pay for themselves or lead to a permanently higher growth rate,” the ratings agency reported. “From a macroeconomic perspective, adding to demand at this point in the economic cycle could add to inflationary pressures and lead to additional monetary policy tightening.”

Indeed, certain aspects of the plan could create chaos for Federal Reserve Governor Jerome Powell, who was recently tapped by Trump to succeed Fed Chair Janet Yellen when her term expires in February. With the economy already eight years into its recovery, concerns have been raised that giving the country a shot in the arm this late in the game could unnecessarily rock the boat and force the Fed to move with a heavier monetary policy hand than its officials would prefer.

An overheating economy typically leads to higher inflation. If inflation gets out of control, the Fed could be forced to adjust its benchmark interest rate more quickly than anticipated and, in a worst-case scenario, clip the recovery’s wings, sending the U.S. into a recession in an effort to avoid runaway pricing pressures.

Economic recoveries don’t necessarily die of old age, but some are skeptical that such a significant shift in fiscal and tax policy at this point is a good idea.

“The U.S. unemployment rate is already near historical lows at 4.1 percent. More fiscal stimulus from Washington could tip the scales toward economic overheating; forcing the Federal Reserve to take away the punch bowl just as the party gets started,” Anderson said, noting that corporate tax reform, in particular “would have been a better idea at the beginning of the cycle.”

“If the Fed reacts by raising interest rates more aggressively, it could easily cancel out many of the intended positive effects of this tax reform plan,” he said.

The president has set an ambitious goal of ironing out tax reform legislation by the end of the year, with a bill hopefully on his desk by Christmas. But given the costs and division associated with what could be the first big-ticket tax overhaul in three decades, that timeline may prove lofty to maintain.

“While completing the entire process by Christmas seems unrealistic, passage of the House version by the end of the year could still be considered reasonable progress and would keep the first quarter in play for final approval,” Lynch said. “In a two-party system like ours, there’s a wide range of views within each party and common ground on the details may be hard to find.”

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