(Bloomberg Businessweek) -- The president needs a win, and he’s picked the federal tax code as the issue on which to take a stand. On March 24, still stinging from his failure to repeal and replace Obamacare, Donald Trump told reporters he’d “start going very, very strongly for the big tax cuts and tax reform.” Taxes, he said, “will be next.”
Judging from the fiasco over the American Health Care Act, there’s good reason to think Trump is about to get in over his head again. The federal tax code is one of the world’s most complicated machines, and he hasn’t even released the outlines of a plan for how to fix it, unless “phenomenal” counts as a description. What we have heard of the plan is inconsistent: Trump has promised big cuts in top income tax rates, which would benefit the rich, while Treasury Secretary Steven Mnuchin has insisted that there will be no absolute tax cut for the upper class. That circle can’t be squared.
Tax reform is hard in the best of circumstances, which these aren’t. “The obstacles to tax reform are at least as great as those that blocked the health-care bill,” Tan Kai Xian, an analyst at consultancy GaveKal Research Ltd., wrote in a note.
Just ask Urban Institute fellow Eugene Steuerle. As a Treasury Department staffer, he led the research project that was the basis for Ronald Reagan’s Tax Reform Act of 1986. The law, which lowered top rates in exchange for eliminating deductions, remains the most important tax reform of the past half-century or more. It took Reagan five years in office to achieve it, Steuerle notes, even though there was widespread agreement that top rates were too high. (The act cut the highest rate from 50 percent to 28 percent; the top rate had been 70 percent before Reagan’s 1981 tax cut. The current top rate is 39.6 percent.)
Trump and his advisers are repeating the mistake they made on health care by focusing on campaign-style messaging, says Steuerle: “They have put so much attention on the symbolism that they wanted to achieve rather than the nitty-gritty of working out the balance sheets, the distribution tables of winners and losers, et cetera.”
Taxation is a tougher nut now than it was in Reagan’s era because the aging of society boosts the cost of Social Security and Medicare, creating a permanent tendency for spending to rise faster than revenues. “They’ve just got a major budget problem that they came into office with and they haven’t been willing to tackle,” Steuerle says. “Now throw a tax cut into that mix and you’re probably only going to compound the problem.” Layer onto that the opposition Trump faces from an emboldened House Freedom Caucus on the right and a unified Democratic Party on the left, and it’s hard to see how he’ll be able to lead on taxation.
The first conflict is that Trump mostly just wants to cut taxes, while House Speaker Paul Ryan wants to rebuild the tax code while raising the same amount of money to keep deficits from growing. Ryan’s A Better Way plan would move the U.S. toward a tax on consumption rather than income. It “would be the most substantial tax reform since the original enactment of the income tax in 1913,” writes University of Chicago Law School professor David Weisbach in a new paper. A key aspect is border adjustment, which would level the playing field for American producers by taxing just what’s sold in the U.S., whether domestic or imported.
Border adjustment probably won’t happen, though, at least not the full version Ryan wants. Exporters like it but importers hate it, and history shows that concentrated opposition beats diffuse support every time. Plus, Trump was burned when he pushed Ryan’s complex, unloved health-care plan. He likely won’t want to repeat the experience with another piece of complex, unloved, Ryan-invented legislation.
Unfortunately for Trump, dropping the border-adjusted tax means losing the $1 trillion or so it would raise over the next decade. Without that windfall, it will be harder for him to cut other taxes without widening the deficit. Trump’s team was also counting on the repeal of Obamacare to create budgetary room for tax cuts. That’s not happening, either.
The budgetary process isn’t Trump’s friend. The next choke point is the April 28 expiration of a continuing resolution that’s essential to maintain funding for federal programs and services. If the resolution is allowed to expire because of stalemate, the government begins to shut down on April 29—which by a twist of fate is the last of Trump’s first 100 days in office.
Trump faces another fight this summer over the 2018 budget resolution, a blueprint for spending in the fiscal year beginning on Oct. 1. Given how polarized his party has become, he’ll have trouble getting enough Republican votes to pass the budget resolution, and if he fails, tax legislation is dead for at least the rest of 2017. (The technical reason: A budget resolution is a prerequisite for the reconciliation process, which is what Trump intends to use to get a tax bill passed with a simple majority in the Senate, evading a Democratic filibuster.)
One glimmer of hope for Trump is that House Freedom Caucus Chairman Mark Meadows of North Carolina is indicating that the group will be less doctrinaire on taxes than it was on health care. He said on ABC’s This Week With George Stephanopolous on March 26 that he wouldn’t protest if tax cuts aren’t fully offset by new spending cuts or new sources of revenue such as a tax on imports.
If Republican leaders do want to keep tax changes revenue-neutral and they don’t pass border adjustment, with its slug of fresh revenue, they may have to settle for a corporate income rate as high as 28 percent, according to top congressional GOP sources. That’s a far cry from Ryan’s goal of 20 percent or Trump’s goal of 15 percent. In fact, it’s the same corporate rate that President Barack Obama sought. (The rate is 35 percent now.) The rates Ryan and Trump wanted “aren’t realistically possible,” says Dean Zerbe, a former Senate Finance Committee staffer who is national managing director at tax consulting firm Alliantgroup LP.
The bottom line is that whatever Trump manages to get done on taxation is likely to be small-bore. “The House will call it tax reform, but it’ll essentially be a tax cut that increases the deficit,” says Stan Collender, a federal budget expert at the communications firm Qorvis/MSLGroup. “The question is whether that can pass in the Senate.” In addition to a small cut in corporate taxes, Congress may pass accelerated depreciation, which encourages investment in equipment and software, and end the carried interest rule that hedge fund managers use to reduce their taxes, says Steven Blitz, chief economist at research firm TS Lombard. “On the personal tax side, there will be a cut for his constituents that he will duly sell as being bigger than it is,” he predicts.
Wall Street seems to be coming around to the idea that the president won’t be able to deliver on all of his promises. Goldman Sachs Group Inc. has been tracking the stock market performance of a basket of companies that pay high taxes. The index shot up after Trump’s surprise election victory, but has receded. Through March 28, its postelection performance was actually worse than that of the Standard & Poor’s 500.
Steuerle, the Urban Institute budget expert, says budgeting always comes down to one question: Whose ox are you willing to gore? A weakened president may find that on tax policy, he’s the one being gored. —With Sahil Kapur, Lynnley Browning, and Justina Lee
To contact the author of this story: Peter Coy in New York at pcoy3@bloomberg.net.
To contact the editor responsible for this story: Howard Chua-Eoan at hchuaeoan@bloomberg.net.
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