After a wave of GOP defections in recent days and waffling on timing, Goldman's economics team apparently still sees a 65% chance of a tax reform bill being enacted by "early 2018," but warns that the final bill may look nothing like the one recently proposed by the House.
As we pointed out yesterday (see: The Republican Tax Plan Will Crush These Housing Markets), Goldman fully expects the Washington D.C. swamp, led by realtors and homebuilders in this case, to attack various components of the House's bill, including efforts to slash the mortgage deduction cap, but don't think those efforts will be enough to tank tax reform altogether.
Political opposition to the bill seems likely to result in changes to the bill, particularly in the Senate, but it is less likely to block enactment of a tax bill altogether. The National Association of Realtors (NAR), National Association of Home Builders (NAHB), National Federation of Independent Businesses (NFIB), and anti-tax groups such as the Club for Growth have opposed the current House proposal for various reasons.
That said, we believe this is more likely to result in changes to the bill in the Senate rather than a failure to pass a tax bill at all.
These changes—for example, raising the proposed principal cap on mortgage interest deductibility and potentially making the treatment of pass-through income more generous than the initial House proposal—could crowd out other priorities, but don’t seem likely to block passage entirely. There is also a more fundamental political motivation, which is that many congressional Republicans would like to enact at least one piece of major legislation prior to the 2018 midterm election.
So, what does Goldman see changing in the Senate bill? Here's a recap:
Mortgage Deduction: We expect the Senate to be more generous on mortgage interest than the House’s proposed $500k cap on principal on which interest can be deducted. This might involve an initial proposal to set the principal cap at $750k, or possibly keeping the deduction as it is today (principal is deductible on mortgage principal of $1 million and home equity debt of $100k). A $750k cap might raise about one-quarter of the roughly $300bn over 10 years the $500k limitation would raise.
SALT: By contrast, we expect the Senate to be less generous on state and local tax deductions, potentially proposing to eliminate all state and local tax deductibility, whereas the House has proposed to allow up to $10k in property taxes to be deducted (no state/local income taxes would be deductible).
Estate tax repeal: The House proposal would double the amount exempted from the estate tax for the next five years, and then repeal the tax altogether after 2023. We do not expect estate tax repeal to have adequate support in the Senate, which might free up a bit less than $100bn (compared with the House bill) for other purposes.
The corporate tax rate: The Senate’s version of tax reform legislation looks likely to propose a 20% corporate tax rate, but we continue to believe it is likely this will be phased in rather than taking effect immediately in 2018. Our expectation is that the final House-Senate compromise will phase in the corporate rate reduction because of fiscal constraints; we also believe there is a good chance the rate will be higher than 20% and that it will potentially end up around 25%.
Interest deductibility: The House has proposed limiting corporate interest deductibility to 30% of EBITDA. It is unclear what approach the Senate will take on interest deductibility, but some limitation looks likely to be proposed, in our view. One alternative that has been discussed in the past is to limit the deduction to a share of overall interest expense (e.g., 70% or 80% of interest could be deducted). This would have the advantage of reducing the disruption to the most highly levered firms, and might also potentially allow for grandfathering of existing debt.
Base-erosion measures: The House proposal has a few measures aimed at preventing the shifting of corporate profits from the US to other lower-tax countries. One is a 10% minimum tax on foreign earnings (more precisely, 50% of foreign profits above a normal return on capital would be taxed as US income at the 20% corporate rate, for an effective rate of up to 10%). A second measure would impose a 20% excise tax on related-party cross-border transactions (discussed below). We expect the Senate to include a measure aimed at preventing base-erosion in the Senate bill as well, potentially including the foreign minimum tax, but expect the Senate to take a different approach than the proposed 20% excise tax, which has already changed in the House in any case.
Meanwhile, rumors have surfaced of late that suggest the Trump administration delayed an executive order repealing Obamacare's individual mandate on hopes that it could be wrapped into the Senate's tax reform bill...Goldman is skeptical...
Probably not, but it looks like it could be included in the House bill before it passes. There are two reasons this could be an attractive option. First, many Republican voters see ACA repeal to be at least as high a priority as tax reform, so combining the issues would allow Republican leaders to take action on aspects of both. Second, mandate repeal has been estimated in the past to reduce the deficit by more than $300bn over ten years because it would reduce enrollment in subsidized health insurance. This would allow tax writers to fill the hole that has been created by scaling back other revenue raisers already, and the further scaling back that is likely to occur as the process moves forward. However, there is an even stronger argument against including mandate repeal, which is simply that repeal of the individual and employer mandate—so-called “skinny repeal”—failed to pass the Senate over the summer and including it in tax reform could simply sink both efforts. So if it is included in an early version of tax reform, repeal still seems likely to be dropped before tax reform becomes law.
Of course, the much bigger issue is whether the Senate will be able to overcome a very narrow Republican majority while passing a bill that complies with "Reconciliation Rules" and the "Byrd Rule."
Yes, this is one of the reasons we expect the bill to change. “Reconciliation” bills need only 51 votes to pass the Senate if they remain within fiscal targets in the budget resolution and do not violate any existing Senate rules. A violation takes 60 votes (and therefore Democratic support) to overcome. The recent budget resolution allows for a tax cut of up to $1.5 trillion over ten years. After recent changes to the bill in the House, the bill is now estimated to increase the deficit by $1.57 trillion over ten years. A second procedural obstacle is the Senate’s “Byrd Rule”, which prohibits reconciliation legislation from raising the deficit after ten years. The House provisions are mostly permanent, which would violate the Byrd Rule. This leaves the Senate with two options: offset the cost of tax relief with base-broadening or other measures after ten years, or make the tax relief temporary. We expect the Senate bill to do some of each by partially offsetting tax reductions and then allowing whatever has not been offset to expire. This means that the more structural elements of the bill would likely be permanent, such as the limitation on individual itemized deductions and the shift to a territorial tax system for foreign corporate income, while at least some of the tax relief, including individual and corporate rate reductions, would expire after ten years.
So what say you? Will tax reform mark the Trump administration's first major legislative victory or will John McCain spoil the party once again?