Tax Reform: There’s Will, But Is There a Way?

Tax Reform: There’s Will, But Is There a Way?
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Tax Reform: There’s Will, But Is There a Way?

Congressional Republicans’ efforts to reduce taxes and reform certain elements of the U.S. tax code have been impressive thus far. In a matter of weeks, the House has passed its version of a bill, and the Senate is hoping to take up its own bill later this week. To put this in perspective, it took President Ronald Reagan and Congress nearly three years to complete a tax reform bill.

While the political will to get something done is at a fever pitch, investors should nonetheless be mindful of some pitfalls that could delay tax reform or even derail it altogether.

Getting the votes may be an uphill battle

The biggest obstacle, of course, is simply getting the 50 Senate votes needed to pass the bill. Because Republicans are using the reconciliation process to consider the bill, it will need only 50 votes (not the usual 60). As of now, however, it appears that none of the 48 Democratic senators will vote yes, meaning Majority Leader Mitch McConnell will need to get 50 out of 52 – or 96% of his conference – to support the bill. This was the same math that ultimately doomed the healthcare effort. As of now, more than half a dozen Republican senators tentatively oppose the bill or have been noncommittal.

The potential holdouts cite a variety of concerns. There are the deficit hawks worried that the true cost of the bill, which the Congressional Budget Office “scored” at roughly $1.4 trillion over 10 years, is likely higher given the expectation that many individual tax cuts set to expire in 2025 will simply be extended. Others have concerns about the repeal of the “individual mandate” – a cornerstone of the Affordable Care Act. Another handful of senators worry that the bill doesn’t do enough for “Main Street.” Related are concerns about the bill’s popularity; its current approval rating of about 25% would make it the least popular piece of legislation passed in this century (lower than Obamacare or the Troubled Asset Relief Program).   

While it may be possible to assuage some of these senators’ concerns, addressing them all is likely not realistic, since doing so would be expensive (e.g., by cutting individual rates further). This highlights another pitfall: The use of the arcane reconciliation process prevents the Senate bill from adding to the deficit in year 11 or beyond, thereby constraining the steps Majority Leader McConnell can take to turn potential “no” votes to “yes.”

If these concerns start firming into “no” votes, and the tax bill slips into next week, tax reform will quickly be tied up with another politically tricky issue – the need to fund the government by 8 December or face a government shutdown.

Squaring the two bills: a further hurdle

Even if Majority Leader McConnell lives up to his reputation as a legislative maestro and gets the Senate bill passed, one more obstacle could stand in the way: the need to iron out the differences between the House and Senate tax bills. While there are many similarities between the two bills, some key differences could jeopardize ultimate support of the conferenced bill when each chamber has to vote.

Overall, while there is significant political will to get a tax bill passed, investors should be mindful of the obstacles that still lie ahead.

For more of our views on how public policy is moving markets, see our U.S. Policy Outlook video.

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Libby Cantrill is PIMCO’s head of public policy and a regular contributor to the PIMCO Blog.

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