This Is The Nightmare Scenario For The GOP: A $2 Trillion Funding "Hole"

When one strips away the partisan rhetoric and posturing, the practical impact of Friday's GOP failure to repeal Obamacare has a specific monetary impact: approximately $1 trillion.

Since the ObamaCare repeal bill would have eliminated most of the 2010 health law’s taxes, this would have lowered by a similar amount the revenue baseline for tax reform. Essentially, with the ObamaCare taxes gone, it would have been easier to pay for lowering tax rates. Now, if Republicans want to eliminate the ObamaCare taxes as part of tax reform and ensure the bill does not add to the deficit - which they need to do to assure Trump's reform process continues under Reconciliation, avoiding the need for 60 votes in the Senate - they will have to raise almost $1 trillion in revenue.

In other words that - all else equal - is how much less tax cuts Trumps and the republicans will be able to pursue unless of course they somehow find a source of $1 trillion in tax revenue (or otherwise simply add to the budget deficit) to offset the Obamacare overhang.

Considering Paul Ryan's statement on Friday, it appears that at least for the time being, Republicans would leave the ObamaCare taxes in place.  “That just means the ObamaCare taxes stay with ObamaCare,” he said. “We’re going to go fix the rest of the tax code.”

Ryan also pushed back on the idea that the setback on healthcare previews difficulties with other items on the legislative agenda  “I don’t think this is prologue to other future things, because members realize there are other parts of our agenda that people have even more agreement on what to achieve,” he said. “We have even more agreement on the need and the nature of tax reform, on funding the government, on rebuilding the military, on securing the border.”

While the failure to pass the healthcare bill makes tax reform harder, “it does not in any way make it impossible,” Ryan said. “We will proceed with tax reform, we will continue with tax reform." Earlier in the week, Treasury Secretary Steven Mnuchin said that the administration has been working on tax reform for two months and plans to release a plan in the near future. House Ways and Means Committee Chairman Kevin Brady added in a statement that Republicans on his panel “are moving full speed ahead with President Trump on the first pro-growth tax reform in a generation.”

Still, quick action on legislation is unlikely; in fact while the market narrative changed on a dime last Friday, with traders now convincing themselves the delay of Obamacare means tax reform passes quicker, this is not the case. As Larry Lindsey, a former economic adviser for George W. Bush, told CNBC's "Power Lunch" last Friday, one of the "silliest" things he's heard from people is that the health-care proposal not passing will be good for Trump's tax reform. "Absolutely not," he added.

A replacement for Obamacare "was necessary for budgetary reasons, for tax reform, because it was a revenue gainer," said Lindsey. Trump's goals for economic growth should also be questioned now, he warned.

"They might move on to [tax reform] next, but when you have a president who can't deliver his own caucus, then the president's position will be weakened on all issues," Lindsey said. "If you're in Congress and you don't like something, you now have an example of how you can 'roll' the president."

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But wait, there's more.

While the GOP will be hard pressed to find $1 trilion in offsetting savings or revenues, their headaches could be doubled if the proposed border adjustment tax fails to pass next. As a reminder, BAT is expected to generate as much as $1.18 trillion in offsetting revenues; should BAT no be DOA, that's another $1.2 trillion in potential government revenues that is gone. 

According to James Pethokoukis of the American Enterprise Institute of Economic Policy, the fact that the Republicans failed to pass a health-care reform bill makes the odds that they will pass a border adjustment provision much smaller, and "the odds of getting a bigger stimulus plan will drop, too", he told CNBC on Friday. Investors "won't get to see cuts to a 15 to 20 percent tax rate" in corporate and marginal tax rates such as those Trump has proposed, Pethokoukis added. Instead, it will likely be closer to what Obama worked toward — something closer to a 30 percent tax rate, he said. It raised the specter of more discontent among Trump's longtime supporters, considering he campaigned on that specific promise.

Echoing this sentiment, Jared Bernstein, a senior fellow from the Center on Budget and Policy Priorities, said in an interview that tax reform and the health-care proposal were "intimately connected for precise reasons. Trump once suggested achieving growth of 2 to 4 percent, but this might look more like 1 to 2 percent now because of budgetary constraints, he added. Now, the government has less money available to hit "high revenue targets," Bernstein said.

Summarizing the above, as a result of Friday's failure, the tax revenue "hole" Republicans have to fill now is at least $1 trillion bigger, and perhaps as large as $2.2 trillion.

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But wait, there's even more.

As the WSJ writes overnight, in theory rewriting the tax code could be easier than revamping the whole health-care industry. Republicans pride themselves on ideological unity in favor of lower tax rates. And the stakes appear lower for Americans -- paperwork and money are far different than matters of life and death. "Tax reform is less visceral," said Rep. David Schweikert (R., Ariz.) "I can pull up a calculator and say 'it's this or this''s hard legislating to anecdotes and stories."

But scratch deeper, and the GOP quest for a full overhaul of the tax code is fraught with squabbles, procedural hurdles and difficult trade-offs. The party's failure on health care - after having seven years to prepare - shows how hard it is for Republicans to write complex legislation that attracts support from their moderate and conservative wings. "It's just a reminder of how incredibly hard transformational legislation is," said John Gimigliano, a former GOP congressional tax aide now at KPMG LLP.

As the WSJ adds, to succeed, Republicans need to bridge at least three big gaps.

  • First, they need to balance competing desires to cut tax rates sharply and to slow the rise of national debt. Republican leaders in Congress say they want a revenue-neutral plan - one that brings in about as much money as today's tax system. Faster economic growth might help, but it doesn't fully bridge the divide. To accomplish revenue neutrality while sharply lowering rates, they will attempt to whack popular tax breaks, such as business deductions of interest on debt and individual state and local tax deductions. They will meet resistance from groups that want to protect those breaks.
  • Second, they have to reconcile alternate visions of what they are setting out to accomplish and who will benefit. Mr. Trump has said his priority is middle-class tax cuts for individuals. "Not the top 1%," said Mr. Mnuchin. House Speaker Paul Ryan (R., Wis.) and Ways and Means Chairman Kevin Brady (R., Texas) want an overhaul primarily focused on promoting economic growth, even if that means tax cuts that favor the very top of the income scale.
  • The plans they all campaigned on are tilted to the top, according to independent analyses. Third, the party is at odds over the Ryan-Brady plan for border adjustment - taxing imports and exempting exports. The Trump administration has been ambivalent and sometimes critical of the idea. Senate Republicans are outright cold to it. Messrs. Ryan and Brady say it's crucial because it provides about $1 trillion to offset corporate-tax-rate cuts and it discourages companies from shifting profits abroad.

None of those divisions inside the GOP have been resolved yet, and dozens more are lurking, including debates over tax breaks for renewable energy, credits that aid low-income households, and the treatment of carried interest income for private-equity managers.

"The notion that tax is easier than health is not borne out by the facts, " a Senate GOP aide told the WSJ. "Having discussed health care for seven years, Republicans were 75% in agreement on the policy. On tax, none of the foundational questions have been answered."

In short, the market is about to be significantly - perhaps "tremendously" - disappointed once again, and quite soon.