Mark this man’s words. That’s because he is U.S. Representative Kevin Brady, one of the members of the current ‘Big Six’ Trump administration and Congress members working on the Trump administration’s major tax reform effort. As this is a follow up on our September 29th “Trump tax’s troubling tract” post exploring some of the obvious reasons the tax reform plan has certain weaknesses which might make it hard to pass, we suggest reviewing that as well. And after the failure of the health insurance effort to ‘repeal and replace’ Obamacare, the tax reform effort is viewed as critical to administration efforts to accomplish something beyond what can be done by a regulatory rollback of the Obama era’s executive order overreach (at least in the conservative’s view.)
And there is indeed much that has already been accomplished in lowered regulatory interference with business via executive orders, reversing Obama’s very active executive branch dictums. However, that does not compare to anything bigger that can be signed into law and have more durability than even Mr. Obama’s far-reaching executive actions. So it is now onto tax reform as a last best hope for Republicans to ‘accomplish something’ prior to the end of the year.
Same as healthcare reform?
Yet not only was the health insurance reform fiasco a failure in its own right, as we have outlined previous it is also a drag on the tax reform effort due to the continued Obamacare spending. Along with other inconsistencies in current tax reform proposals, there are now the same sanguine assurances coming from Mr. Brady and others. Those are once again that the Republican leadership is working on a tax plan that will appeal to all and which, they can pass into law before year’s end. Yet details are lacking. Don’t take our word for it. Just listen to his assurances delivered last week to CNBC’s Becky Quick.
[Thanks to CNBC for the opening graphic. © 2017 All Rights Reserved.]
For one thing, they allege this is significantly a ‘middle-class tax cut’, which has been refuted by most independent analysts. There is also the very tight deadline that Quick notes: as of today there are 29 dual House and Senate legislative days before the holiday recess begins December 14th, with a few extra sessions for each. Very aggressive to think they can get this done. And what is not in the video is his repeated refusal to provide details, which is a lot like the healthcare effort.
Obvious contradictions remain
Among the most glaring in the attempt to eliminate the state and local income tax deduction reviewed in the original “Trump tax’s troubling tract” post. That is important as it relates to the health insurance reform failure noted above. Before exploring more of the specifics of the state and local income tax deductibility, it is important to note that the health insurance reform failure leaving roughly a trillion dollars of future spending on the books is money that was supposed to ease the way for tax reduction.
And if the elimination of the state and local income tax deduction also fails because there is Republican resistance in addition to the assured Democratic resistance, then that’s roughly another trillion dollars that will not be available to keep the tax reform (or tax cut depending on how things go) affordable.
Historic Context
While it was an earlier era when a billion dollars was still considered a lot of money, there was a wonderful quote from the late great Illinois Senator Everett Dirksen (for whom a federal building in downtown Chicago is named) who once quipped during a budget negotiation, “A billion here, a billion there; pretty soon you’re talking real money.”
While the last portion of that is apocryphal (attributed to a reporter’s embellishment), allegedly Dirksen liked it so much that he let it stand. And that was at the far lower budget overrun concerns in the 1960’s. If it were recast today, it’d be more like “a trillion here, a trillion there…” And in both the failed health insurance reform effort and looming tax reform tight schedule deadline, each is a trillion dollar difference to the federal budget.
Their combined influence will likely be whether the Trump administration reform efforts at least do not worsen the overall federal debt (having just passed above $20 trillion.) In the name of further economic stimulus (after the admittedly significant rollback of the Obama era regulatory overreach) quite a few folks that include fiscal conservatives might tolerate an additional one trillion dollar deficit over the next 10 years. Yet if it is going to be more so the $3-4 trillion that is projected without the combined health insurance reform and elimination of the state and local income tax deductibility, then even quite a few Republicans are going to have a problem voting for the tax reform bill.
Local Tax Deduction Redux
Getting back to an extension of our previous assessment in the original “Trump tax’s troubling tract” post, a bit more detail on what this means in practice is instructive. And for that, we turn to the Tax Policy Center’s (TPC) Briefing Book on State (and Local) Taxes (our mildly marked-up version.) After stressing what a stumbling block this is to the passage of any extensive reform (versus a plain old tax cut) given the exposure of Republican legislators in moderate-to-high local tax states. But first, note that state and local income tax deductibility has been a feature of the U.S. income tax since it was initiated all the way back in 1913. While there have been some adjustments along the way, they have not reduced the overall impact.
For example, “State and local income and real estate taxes make up the bulk of total state and local taxes deducted (about 60 % and 35 % , respectively)”… and “The state and local tax (SALT) deduction is one of the largest federal tax expenditures, with an estimated revenue cost of $96 billion in 2017 and $1.3 trillion over the 10-year period from 2017 to 2026.” While the figure of approximately $1 trillion dollars of lost federal revenue gets thrown around a lot, it is possibly even more expensive than to fail to eliminate it.
Election implications
Now consider the election implications for each party. As noted in our previous post on this topic, the Democrats hold the highest state and local tax state U.S. Congressional seats. Yet there are also quite a few in the solid ‘red’ (i.e. Republican or conservative) states that would be at risk from voting for any elimination of state and local income tax deductibility.
Review of the map on page 3 of the TPC Briefing Book shows that the states with the most prevalent SALT itemized deductions are indeed Democratic strongholds, with commensurately high levels of individual deductions. Yet also note how many of the Republican Senate seat states have up to 30% of their residents taking advantage of the SALT deductions. As just a few examples, the individual deductions in Iowa are $9,600, where over 30% itemize in Wisconsin it is $11,300, with the same sort of % age Georgians deduct $8,700 and the folks in Kentucky who elected Senate Majority Leader McConnell deduct $9,400 of income each from their federal tax returns. Who really believes the razor-thin Republican Senate majority (52-48) will actually deliver a vote to pass this aspect into law with zero Democratic help?
Will it really stimulate business?
While we are generally in favor of lower taxes, the challenge to that particular Gordian Knot being slashed is always whether enough savings can be found to justify it…
OR, whether growth will accelerate to a degree that will leave the reforms either ‘budget neutral’ (i.e. not create more debt) or even possibly have a positive impact on the deficit and debt. The latter is what the Trump administration and its supporters are alleging.
Yet there was a rather well-thought rebuke for that assertion from the Financial Times’ estimable Martin Wolf. In a very interesting analysis last week he pointed out the ways in which the very high earners would see the bulk of the tax benefit. Citing the TPC on that, he also notes that its analysis projects “…taxpayers in the bottom 95 % of the income distribution would see average after-tax incomes increase between 0.5 and 1.2 % ”. This is a regressive plan misrepresented as the opposite.”
He also notes that the proposed U.S. shift to a ‘territorial’ taxation system (versus the ‘international’ system employed at present) does not eliminate the incentives for U.S. corporations to relocate production and sales to the lowest international tax locales.
Even the highly touted temporary lower rate to encourage some substantial repatriation of the estimated $2.5 trillion in profits U.S. corporations have parked offshore to avoid being double taxed will not guarantee any substantial investment back home. There will be nothing to prevent them from using it for dividend distributions and stock buybacks to please their stockholders and stakeholders who own stock options.
As Wolf constructively suggests regarding the decision to shift to a territorial system, “That is a great pity since the destination principle is attractive. An alternative could have been to stick with taxation on worldwide income, with no exemption for unrepatriated income, but at the reduced rate of tax. This would make movement into tax havens for U.S. resident companies fruitless.”
Missing the point
He makes a good point about a low enough corporate tax rate would be a huge incentive to keep corporate headquarters in the U.S., or for others to move here. And much of this necessary change also misses the real point in a world where Wolf also notes “…income inequality and ‘fairness’ are such big issues...”, and the real benefits for the middle class would be to structure a tax reform that rewards training and other productivity-enhancing improvements for workers.
As the OECD and IMF among others have noted, the lagging incomes of workers that are a critical part of the central banks’ lack of inflation conundrum can only be solved through significantly higher wages… which in turn can only be justified by higher productivity. So in addition to Wolf’s excellent overview of the sheer nature of proposed system change lacking a more constructive impact, there is also a lack of focus on the real benefits from any enlightened tax reform
In the meantime, expect almost assured Democratic obstructions to the Trump tax reform in anything resembling its current design (such as it is.) Add to that the very likely lack of Republican appetite for eliminating the SALT deductions, and passage of the “easier to accomplish” tax reform Mr. Brady and others are pushing is likely to meet the same fate as the failed health insurance reform.
We shall see. Yet current deflation of small business confidence signaled this week (more on that soon) and the other signs that the initial Trump honeymoon from the beginning of the year is waning could be a problem for inflated U.S. equities valuations, if and when the tax reform is finally seen to be in trouble. And that will be the same for the U.S. dollar, with countervailing positive influence on the govvies…
IF indeed it fails.