Thrill or Chill on Capitol Hill?

Since the November election, the financial markets have priced in a more friendly business environment, with growth boosted by expansionary fiscal policy. However, the White House does not have absolute power. Congress writes the laws. While the outcome is uncertain, the legislative mechanics suggest that may see little, if any, tax cuts in calendar 2017.

With Republicans controlling the White House and both chambers of Congress, many see this as their best chance for tax reform. The House Speaker Ryan’s "Better Way" plan is expected to be the general blueprint for tax reform, but there will surely be many modifications along the way.

How will tax cuts be achieved, legislatively? The House of Representatives requires a simple majority vote. The journey through the Senate is more complicated.

The first possible path is through a tax reform bill, which would require 60 votes in the Senate. While that seems unlikely, given that the Republicans have only a 52-48 majority, it is not impossible. Republicans would have to get eight or more Democratic senators on board. A compromise plan would likely have smaller tax cuts than is currently anticipated, weighted toward large corporations, not small businesses and individuals. We would expect to see some change in tax rates for overseas earnings as part of the package.

The other Senate path is through budget reconciliation, which would require a simple majority (51 votes). The Senate would pass a budget resolution with reconciliation instructions, then develop legislation that comports to those instructions. However, the Senate can do only one set of reconciliation instructions per calendar year, and this year that set of instructions will be on repealing and replacing the Affordable Care Act. The Senate could add tax reform instructions in the budget resolution this year for calendar 2018, which means that tax cuts would occur next year. Note that the Affordable Care Act was paid for partly by higher taxes, and those increases may be jettisoned in healthcare reform (although it’s unclear what sort of replacement we may see in the months ahead).

The Senate is also subject to the Byrd rule. During the reconciliation process, a piece of legislation may be blocked if it increases the federal deficit beyond a ten-year window. This explains why the Bush tax cuts were not made permanent at their inception (changes would have to sunset to make the long-term numbers work out). This led to a series of extensions, until a compromise solution was reached.

Tax simplification should be a part of tax reform, and the elimination of many deductions would be expected to offset some of the cost of reducing tax rates. Steve Mnuchin, the Treasury Secretary nominee has said that tax reform will be revenue neutral, but that seems doubtful based on the numbers proposed during the campaign.