clock menu more-arrow no yes

The 7 big questions Republicans have to answer on tax reform

“Is it tax reform at all” is a big one.

Trump, Paul Ryan Attend Traditional Congressional Luncheon For Irish PM Photo by Alex Wong/Getty Images

Having failed to pass anything on health care, the Trump administration and Republicans in Congress appear to be rapidly moving on to work on passing a tax reform package.

Anyone who hoped this would somehow be an easier task than repealing Obamacare is in for a rude surprise.

As with health care, the tax reform effort is expected to be heavily based on the “Better Way” policy program that House Speaker Paul Ryan and Ways and Means Chair Kevin Brady put out last summer. Several of the specific tax reform proposals in that program have already sparked a huge backlash, with the Koch brothers and a coalition of retailers like Walmart and IKEA already lobbying and buying ads opposing one particularly controversial idea.

It only gets tougher from here. The reform bill Republicans put together will almost certainly either blow up the federal budget deficit or create huge losers within corporate America that will fight it to the end — or both. Either way, it has a tough path ahead. Here are just a few unresolved points of contention on tax reform that could blow up Republicans’ push, or at the very least hamper it.

1) Is this tax reform, or a tax cut?

The cost of Paul Ryan’s tax plan, broken down. Tax Policy Center

“Tax reform” in Washington-speak refers to cutting tax rates and paying for the rate cuts by eliminating or curtailing loopholes and deductions to broaden the tax base — to increase the amount of income the tax rates apply to. The canonical example is the 1986 tax reform, which is broadly beloved because it was bipartisan, it involved Ronald Reagan, it reduced the deficit, and there’s a great book about it.

Not all “reform” plans, though, pay for all their rate cuts with loophole closures. The Better Way plan would cost $3.1 trillion in the first 10 years, according to the Tax Policy Center. The plan Donald Trump put forward during the campaign would cost twice as much in the first decade. (Those projections don’t assume much bounce in economic growth rates from either plan.)

Doing a true revenue-neutral tax reform and doing a giant tax cut that you call tax reform have very different implications, economically and politically. One big downside to a revenue-neutral approach is that you end up needing to raise taxes on some people or companies. On the other hand, you can’t use budget reconciliation and pass a Senate bill with just 51 votes if the legislation you’re pushing increases the budget deficit 10 or more years into the future. That means you need 60 votes in the Senate for tax cuts that are truly permanent. George W. Bush got his tax cuts done by scheduling them to expire after 10 years, which made it relatively easy for the Obama administration to partially undo them.

Brady has said he wants tax reform to be permanent. That would require a revenue-neutral reform, trillions of dollars in offsetting spending cuts, or 60 votes in the United States Senate. But his Senate counterpart, Orrin Hatch, and Senate Majority Whip John Cornyn have both suggested they might want cuts that expire after 10 years.

Many conservative groups, meanwhile, are solidly against revenue neutrality — even, notably, on a “dynamic” basis where tax reform is projected to boost economic growth — and are pushing for tax legislation to cut revenues over time.

“The reality is that the federal government has a spending problem, not a revenue problem,” Dan Holler, vice president of Heritage Action, wrote in an email to supporters on Sunday. “Lawmakers do not need to be constrained by 'revenue neutrality' as they pursue much needed, pro-growth tax reform.” In a statement in January, Club for Growth president David McIntyre agreed: “Instead of trading one tax for another, the GOP needs to focus on cutting rates, and cutting spending and the size of government to match.”

So the question is: Will Ryan and Brady try to find more deductions and credits to cut, and maybe agree to cut rates by a little less, to make tax reform revenue-neutral? Or will they do what conservative groups are suggesting and cut spending (maybe Medicaid, which the health bill also would’ve slashed dramatically) to pay for absolute tax cuts? Brady has promised revenue neutrality on a dynamic basis.

2) How are they going to limit individual tax breaks?

Places that benefit most, and least, from the state and local tax deduction Tax Foundation

The Ryan-Brady tax reform blueprint would preserve the two biggest and most popular itemized deductions — those for mortgage interest and charitable donations — but eliminate all others, as well as a few credits.

The biggest deal here is the deductions for state income, sales, and real estate taxes, which together provided $80.4 billion in tax relief in fiscal year 2014. That's more than the mortgage interest deduction. The mortgage deduction is widely viewed as politically untouchable, because its affluent-but-not-super-wealthy beneficiaries will cry bloody murder if it’s threatened.

But that same group stands to lose a lot if the state tax deductions go. Particularly threatened are affluent people in high-tax liberal states such as New York, New Jersey, and California. Normally that wouldn’t be as much of a problem for Republicans, who don’t stand a chance of winning statewide races in those states, but Donald Trump knows an awful lot of rich people in that area and may be sensitive to their concerns. Lower rates will offset this tax hike for many, but some will still lose out in aggregate. This could also be a problem for House Republicans who hold seats in upscale suburban districts in high-tax blue states.

The deduction reforms bring in $1.9 trillion over the first 10 years, according to the Tax Policy Center. The math of the GOP plan doesn't even begin to work without them present. But including them could set up a big backlash.

3) Is the border tax a go?

While the tax reform fight has barely even started, the lobbying war against one of its provisions — border adjustment — has been going on for months. The proposal, which would make corporate income earned from exports tax-exempt and bar companies from deducting the cost of imports, is strongly supported by exporters such as GE and Boeing but vociferously opposed by import-reliant retailers like Walmart, Target, IKEA, and Best Buy. See, for example, the brutal ad from the National Retail Federation above, which labels it an “everything tax” that’ll “tax your car, your food, your gas, your medicine, your clothes — you name it, BAT will tax it!”

Border tax advocates insist that it serves an important purpose in deterring tax evasion by companies, by rendering the most common methods they use to shift income overseas impossible. And while taxing imports doesn’t raise money in the long run, the Congressional Budget Office will almost certainly score the provision as raising money over the next 10 years because the US imports more than it exports. That makes it a way for Congress to pay for deeper rate cuts.

But having retail lined up against it is tough. Retailers are extremely good at selling stuff directly to consumers. Boeing, by contrast, sells to airline executives. Which do you think is going to be better equipped to persuade voters to call their senators and representatives about the border-adjusted tax?

Already the proposal appears DOA in the Senate. Sen. Tom Cotton (R-AR), whose state includes Walmart headquarters, is a vocal opponent, as is Sen. David Perdue (R-GA), a former CEO of Dollar General. Majority Whip John Cornyn (R-TX) says the plan is “on life support,” and Sen. Lindsey Graham (R-SC) has said it wouldn’t get 10 votes in the Senate.

On the other side, Ryan appears to have convinced Trump and Steve Bannon that the border adjustment will boost US manufacturers and keep imports from eroding jobs in that sector. (Treasury Secretary Steven Mnuchin has signaled concerns over it, though.) That image of border adjustment’s effects fits well into the economic nationalist agenda that Trump and Bannon are trying to put together, but it conflicts with what economists supporting the border adjustment say, which is that it will cause the dollar to appreciate and in aggregate would not help exporters or hurt importers at all.

Whether or not their reasoning makes sense, however, if Bannon and Trump begin to see the provision as a crucial part of tax reform that responds to their campaign rhetoric about trade and manufacturing, that could keep the fight over it alive. While just junking the provision would probably help corporate tax reform’s political prospects, the White House might prevent that from happening.

4) Will this be a massive giveaway to Donald Trump, personally?

President Trump Accuses Obama Via Twitter Of Ordering Wiretapping At Trump Tower During Campaign Drew Angerer/Getty Images

One of the most stunning provisions of Trump’s campaign tax proposals was one specifying that “pass-through” income would be taxed as corporate income — not as personal income. That means income from entities like partnerships, sole proprietorships, and S corporations, which don’t pay corporate taxes and instead distribute their profits to their owners, who then pay normal income taxes on them. This is, tellingly, how the Trump Organization is structured: as a collection of pass-through entities, rather than a “C corporation” subject to corporate taxes.

Trump's plans varied a lot throughout the campaign, but the final one he landed on had a 33 percent top tax bracket and a 15 percent flat rate corporate tax. Think about what that would mean for pass-through income earners. It’s not just that people like Trump would see their top rate cut from 39.6 percent to 33 percent. They’d see it fall by more than half, to 15 percent, a truly massive cut.

This would amount to a huge tax break for the overwhelmingly rich segment of the population that relies on pass-through income; about 69 percent of pass-through income goes to the top 1 percent. The Tax Policy Center estimated that this provision as implemented in Trump’s last campaign plan would cost $1.5 trillion over 10 years — more if you include other reforms to the corporate code that Trump would extend to pass-throughs. About $900 billion of that comes from the cut itself, and another $650 billion comes from the new forms of tax evasion it would encourage.

The change would offer a compelling reason for people to incorporate as one-person small businesses. For instance, imagine Trump’s plan took effect, and we were paying the middle 25 percent individual income tax rate in his plan on my wages from Vox Media. We could go to Vox editor-in-chief Ezra Klein and say, “As we’ve explained on the site, Trump gives a massive tax break to pass-throughs. So we propose that instead of working for a wage, we each form a sole proprietorship that then contracts with Vox Media to provide content.” The money Vox paid us then would be business income, and we’d pay a significantly lower rate on it.

This problem is also present in the GOP House plan. That plan would place a 25 percent cap on the pass-through tax rate: not as low as the 20 percent rate it wants on C corporations, but lower than the 33 percent top rate it proposes for individuals. The 8-point gap between individual and pass-through rates isn’t as dramatic as the 18-point one in Trump’s plan, but it could still prompt a lot of tax avoidance.

Trump wavered on this policy a bit toward the end of the campaign. When his third tax plan was announced, the campaign told the right-leaning Tax Foundation that the pass-through cut was a goner. But at the same time, the campaign was also telling a small-business group, the National Federation of Independent Business, that the pass-through cut was still a go, earning NFIB's endorsement in the process. When the New York Times's Binyamin Appelbaum reached out to the Trump campaign, it was vague but suggested the pass-through cut was there to stay.

Campaign advisers told Vox’s Jim Tankersley, then with the Washington Post, that the legislation would include regulations to ensure any pass-through qualifying for the reduced rate would be “a legitimate business with employees” whose profits "must be reinvested in the company and not taken out." But the campaign never released details on those regulations.

This is a very expensive, regressive provision. Putting it in would almost certainly make passing the package harder, as Republicans would have to search for other big revenue streams to pay for it. But it would also help Trump a lot. That alone might keep it in the mix, making the whole tax reform effort more difficult.

5) Will Republicans crack down on banks?

2016 DealBook Conference
Goldman Sachs CEO Lloyd Blankfein.
Bryan Bedder/Getty Images for The New York Times

Another intriguing element of the Ryan-Brady tax blueprint is that it would eliminate the deductibility of interest expenses from corporate income tax. Corporate America in general will miss that provision, but most companies would be compensated by another rule change that allows them to immediately deduct the full value of business investments from their income rather than depreciating them over several years.

A big exception to this rule is the financial sector, which is overwhelmingly fueled by debt and which generally invests in financial instruments rather than tangible physical capital.

The tendency to engage in debt-financed speculation is an important source of fragility in the banking system, and in the wake of the financial crisis regulators have done a lot to require banks to borrow less. Removing the tax deductibility of debt would be another lever for discouraging risky bank behavior, and could have considerable benefits for financial stability.

But Trump’s top economic policy adviser, Gary Cohn, feels that a big problem with the contemporary United States is that banks aren’t allowed to engage in enough risky borrowing.

“Banks are forced to hoard money,” he told Fox Business in February, “because they are forced to hoard capital.”

This is not really how bank capital works, but Donald Trump says his friends have told him they can’t get loans because of these rules, so he seems to agree with Cohn. Cohn, not coincidentally, was the No. 2 guy at Goldman Sachs before going to work at the Trump administration. And indeed, a huge share of the Trump administration’s economic team — including basically all of the political appointees at Treasury and even Bannon, who is supposed to be leading the populist wing — are veterans of the banking sector. Beyond the big global banks, private equity firms that specialize in leveraged buyouts are also worried about this idea.

6) Is the “Mnuchin rule” a real thing?

Chancellor Philip Hammond Meets US Treasury Secretary Steven Mnuchin In Downing Street
Treasury Secretary Steve Mnuchin.
Dan Kitwood/Getty Images

On November 30, Treasury Secretary Steve Mnuchin told CNBC that the incoming Trump administration would absolutely not cut taxes for the rich. Full stop.

“Any reductions we have in upper-income taxes will be offset by less deductions so that there will be no absolute tax cut for the upper class,” he told the hosts. “There will be a big tax cut for the middle class, but any tax cuts we have for the upper class will be offset by less deductions that pay for it.”

Moreover, he pledged to do this without eliminating two of the biggest tax breaks for the rich: the charitable and mortgage interest deductions. "It will still let you do charities, but there will be other deductions that are absolutely limited,” he continued. “We'll cap mortgage interest, but allow some deductibility."

It didn’t take long for Democrats in Congress to seize on those comments. The senior-most economic official in the new administration had set a test for new tax legislation that both Trump’s and Ryan’s tax plans, which dramatically slash taxes for the rich, clearly fail. "I’m going to start calling it the ‘Mnuchin rule,’" Sen. Ron Wyden, the ranking Democrat on the Senate Finance Committee, said at Mnuchin's confirmation hearing. "No tax cut for the upper class."

Obviously a person could draft a tax reform plan that met these guidelines. But would Republicans really do that? Every tax plan that Trump released during the campaign failed that test, as did every budget blueprint Ryan wrote back when he was the top Republican on that committee. Every Republican Party presidential nominee for 20 years has run on a platform that featured lower taxes on the highest-income households. This has never been a particularly popular idea, but Republicans keep proposing it because they profoundly believe in it as a matter of social justice and economic efficiency. It would be very strange to suddenly drop the idea because Steve Mnuchin said something once on television. And yet the Treasury secretary stuck to it in congressional hearings and has never backed down.

7) What about all the new deductions and credits Trump wants?

shutterstock child care
Whither the child care deduction?
Shutterstock

The Trump campaign released proposals, associated with Ivanka Trump, to deliver tax deductions that help cover child care costs. They were pitched as help for the middle class — specifically working families. But because of the way the proposed deductions were structured, they give a lot of financial assistance to affluent families and very little to struggling ones. Trump has also spoken highly of scholarship tax credits, which would be a means to advance conservative school choice goals, including providing direct financial assistance to religious schools.

A comprehensive tax reform bill, which Trump says is his top priority, would presumably be the best vehicle with which to achieve these goals. But those goals would add to the cost of tax reform and not fit the “pro-growth” philosophy that flows from cutting marginal tax rates. The GOP’s struggle over whether to include such provisions is perhaps emblematic of the entire Trump tax reform dilemma.

Trump won election on a platform of large tax cuts, increased military spending, no cuts in Social Security or Medicare, more money for veterans and law enforcement, and balancing the budget while introducing a big new tax deduction and possibly a new tax credit as well. It is not possible to do all those things at once, and mashing them up with Ryan-Brady tax principles that are themselves incredibly ambitious does not make it any easier.

It seems impossible to believe that unified Republican Party control of government will not generate some kind of large tax cut. That’s especially true since interest rates are currently low, and it’s not clear a big budget deficit would be a problem in a practical sense. And yet exactly what kind of tax cut could command majority support and accord with various procedural rules and ad hoc White House commitments is remarkably unclear.

Sign up for the newsletter The Weeds

Understand how policy impacts people. Delivered Fridays.