Tax Reform: The Week Ahead— October 16th

This Week: The Senate is hoping to bring the FY 2018 budget resolution to the floor this Tuesday, the next procedural step for moving forward on a tax reform package.  Passage would open the door for a reconciliation process for tax reform, allowing the GOP to avoid a near-certain Democratic filibuster.  Unlike the House FY 2018 budget resolution passed on September 14th, the Senate budget will not offset the $1.5 Trillion cut with deficit reductions.  This was to be expected and November will then likely be devoted to getting both chambers on the same page. 

Even with Republican control of both the White House and Congress, passage of tax reform is anything but certain.  The financial community, by and large an advocate of legislation, is tentative on being optimistic.  Goldman Sachs currently puts the odds at 65%, while UBS Office of Public Policy believes the odds are “slightly better than 50/50 over the next three to six months.” RealClearMarkets will continue to monitor the odds as key steps advance or fail.

Inaction this week on a budget would spell serious trouble for the GOP’s goal of getting a bill to POTUS’ desk by the close of 2017.

Please check out RealClearMarkets’ Tax Reform Story Stream for updated commentary, analysis, and video.

November – December: A Senate budget resolution this week would keep the GOP timeline on track for 2017 finalization.   However, time is in short supply and the limited remaining sessions has leadership planning for the possibility of staying in Washington longer than scheduled.  House Speaker Paul Ryan stressed the importance of finalizing tax reform during a speech to the Heritage Foundation this past Thursday.  “We’re going to keep people here for Christmas if we have to.  I don’t care.  We have to get this done.” 

If the Senate Budget Resolution is passed this week, that will set the stage for an eventful November during which House & Senate committees will begin marking up their respective bills.  The House Ways & Means Committee led by Rep. Kevin Brady is hoping to have their bill ready for an initial House vote by the week of November 20th.  On the Senate side, Sen. Orrin Hatch will lead the Senate Finance Committee markup.  GOP Senators hope to have that bill ready for a vote by early December.

What to Watch This Week

GOP Cohesion: 

Success this fall relies heavily on GOP leadership staying unified, both internally in the House and Senate, as well as with President Trump.  The first test of this will come Monday, as Senate Majority Leader Mitch McConnell is scheduled for lunch with POTUS to discuss the fall legislative agenda.  The conversation will focus on the budget and tax reform at a time when the relationship between the Majority Leader and President Trump seems to be at low point.  Yet some of the reports of discontent between the two may be overstated.  Mike Allen of Axios reports that the “two speak behind the scenes more frequently than is leaked, with judges and tax reform as regular topics.”

Another key relationship to monitor this week is that between President Trump and Senator Bob Corker.  Corker and President Trump notably feuded over the past two weeks after the Tennessee Senator announced that he would not be seeking reelection for another term.  Corker’s role in the upper chamber is of particularly significant note this week as he is a member of Senate Budget Committee.

At a stop last week in Kentucky, the Senate Majority Leader said the following of Corker, “Sen. Corker is a valuable member of the Senate Republican caucus and he's also on the Budget committee and a particularly important player as we move to the floor on the budget next week and he's an important part of our team.”  While Corker’s feud with the President is unlikely to change his stance on tax reform, it is still worth monitoring given the slim 52 seat GOP majority.   Corker would not want his Senate legacy to be as the vote that sank tax reform, a measure he’s long been in favor of. 

Thad Cochran’s Health

The aforementioned Senate 2 seat majority for the Republicans could take a hit if the health of Mississippi Senator Thad Cochran doesn’t improve.   The Senator is recuperating at home in Mississippi from a urological procedure. Cochran has missed the previous two weeks the Senate has been in sessions.  While his office has maintains that he will return this week for an Appropriations Committee markup on Thursday the 18th, Politico reported that “several K Street sources and Cochran allies said he's unlikely to be back.”

State & Local Tax Deduction (SALT)

After initially proposing a full repeal of the state and local tax deduction (SALT), Republicans are beginning to consider partial preservation in order to appease many blue state republicans.   A full repeal would generate $1.3 trillion in revenue over the course of a decade, a figure that would help push tax rates down even further.  This may not be feasible for the House Republicans however, as they can only afford to lose 22 votes.  The discussion has shifted to arguments over what income level to cut off the deductions.  House Republicans met Thursday to discuss the cut-off income figure, but have yet to come to a consensus.  Peter King from Long Island, a representative whose constituents disproportionately benefit from the status quo deductions, is pushing for a cut-off of $400,000.  The more likely number will fall in the $200,000 to $250,000 range.

On the Senate side, a full repeal of SALT remains the plan. Senator Tim Scott of South Carolina, a member of the Finance Committee, stated Friday that despite the discussions in the House there are unlikely to be any changes on their end.

Pass-Through Rate

While most of the press around tax cut proposals has focused on moving the corporate rate from 35% to 20%, there’s also an infight brewing around the 25% pass-through rate limit.  S corporations, partnerships, and sole proprietorships currently pay as high as 39.6%, a figure that would drop significantly in the new proposal.  The debate around the pass-through cut stems in the belief that a pass-through rate lower than highest earner income bracket would incentivize individuals to incorporate in order to avoid paying additional dollars.  Many conservatives also argue in favor of “rate parity”, the belief that the pass-through rate and corporate rate should be equal.  If the Senate budget advances this week, expect the pass-through rate to be a point of contention this fall. 

Freedom Caucus Recruiting Democrats

Rep. Mark Meadows, chairman of the House Freedom Caucus, is reported to be courting Democrat votes for tax reform amidst the fear that there could be enough moderate GOP “no” votes to sink a bill.  Meadows, speaking to The Hill, stated “We've been reaching out to Democrats to find areas of consensus and agreement that might ultimately end up in a final bill that reaches the president's desk.”  Democrats would likely require substantial infrastructure investment to even consider voting in favor of any House tax package.

Mortgage Interest Deduction

The realty industry is speaking out against a potential change to the mortgage interest deduction.  The Senate Finance Committee is floating the idea of capping the deduction at $650,000 - $750,000, a move the National Association of Realtors amounts to a de facto tax increase and de-incentivization of home buying.  William Brown, president of NAR, penned a Wall Street Journal Op-Ed on Friday, stating “homeownership isn’t a “special” interest. It’s a common interest. We intend to defend it.”  Expect the NAR to hold to this statement.  Year after year, the trade association ranks as the second highest lobbying spender, behind only the U.S. Chamber of Commerce.  

Estate Tax Optics

Treasury Secretary Steve Mnuchin admitted that the Estate Tax disproportionally helps affluent individuals during a speech to the Institute for International Finance on Friday.  The statement contrasts with previous statements made by POTUS, in which the Estate Tax was sold as measure geared towards boosting small businesses.  It will be a communications and optics crisis for the GOP leadership this week, as Democrats will almost certainly pounce to frame this as a tax cut for the wealthy and a deficit disaster.  We may also see GOP deficit hawks side with Democrats on opposition to the measure.