The Dismal Political Economy of the House Tax Reform Proposal

I’ve been reading and thinking a fair bit about the new Republican tax plan – currently the Tax Cut and Jobs Act (TCJA) though I personally agree with the President that the “Cut Cut Cut Act” would be far superior branding.  Before the GOP embarked on its ill-fated (so far!) effort to repeal Obamacare I tried to analyze it from a 30000-foot perspective based on existing theories of Congress.  I’ve been trying to look at the TCJA from a similar perspective; in short, the outlook is bad. I do not expect a bill materially resembling the TCJA to be signed into law.

The largest obvious problem is procedural – the bill doesn’t come close to meeting the requirements to pass the Senate.  In order to be ruled in order to pass the Senate with 50 votes, a bill must (among other requirements) not expand beyond the short-run deficit by more than specified in the budget resolution and must not expand the long-run deficit at all.  The TCJA barely meets the $1.5T allowed under the new budget resolution, which leaves the GOP little room to maneuver – but the legislation makes no apparent attempt to comply with the long-run deficit requirement.*  That’s it, game over, death by point of order.  The TCJA can’t be understood as a bill at all so much as an exercise in blame-shifting; this is Speaker Ryan’s opening bid to prod the Senate into putting together an actual bill.

Beyond that – the political economy of this bill doesn’t make a great deal of sense.  The basic structure is a swap of tax burden from corporations** and capital owners on to individuals, under the theory that the corporate rate cuts will increase the return to investment, increase investment and ultimately raise the level of growth.   That’s the policy justification – but you might have noticed something that sounds less-than-particularly popular about the prior sentence.  The TCJA will shift the tax burden on to individuals.

The TCJA will create large groups of winners and losers, in ways that I think are hugely problematic for the bill’s chance of survival.   There are two specific ways it does this – first, it doubles the standard deduction but eliminates the standard exemption.  For households taking the standard deduction this mostly works out to a wash, but it’s a straightforward increase to all households that itemize deductions rather than taking the standard deduction.  Secondly, it wipes out a large number of widely used deductions such as the medical expense deduction and the state and local tax deduction (SALT).  The net results mean that the bill is largely a wash for most of the population but will hit large swathes of the population with tax increases.

The fact that it creates these losers is bad – the specific people it harms are worse.  There are net tax increases both on the poor ($20K – $40K) but also on the merely-affluent ($200K – $500K).  The deduction repeal will particularly harm well-off voters in high-tax high-property-value jurisdictions…such as the suburbs of New York, New Jersey, and California.  That’s right, the Speaker is proposing a bill that would specifically target the most politically active swing voters in his most vulnerable members’ constituencies.  I do not think the SALT repeal survives.

Deduction-subsidized interest groups are gearing up to go to war.  By doubling the standard deduction as I mentioned above, the TCJA would substantially limit the number of households that itemize deductions, and in turn lessen the incentives to engage in behavior that would otherwise be deductible.  The homebuilders’ association is already gunning for this bill, and I do not think charities, universities, and churches are far behind.  This, coupled with the estate tax repeal (the estate tax motivates a lot of estate donations) would do real damage to Big Charity.  I expect the Catholic Church to come out, swinging hard, after they assess what this will do to their finances.

These interest groups could be paid off with one thing – money, of which there is none.  The existing bill bumps up exactly against the short-term deficit allowances and as I mentioned, runs wildly over on the long-run deficit.  You can’t get rid of the tax increases without getting rid of the tax cuts to corporations that are, essentially, the point.  And given that the bill is way over on the long-run deficit the changes required to make this bill Byrd-friendly would create more and bigger losers rather than buy off existing losers.

Finally, while overwhelming public support could overcome interest group resistance this bill is likely to end up somewhere on the spectrum between unpopular to neutral.  Democrats have decided to unify against it, which will put a natural ceiling on its public support.  The essential goals of this legislation – tax cuts for the wealthy and corporations – are quite unpopular.  It should be little surprise that the bill starts off somewhat underwater in popular opinion, and that’s before a lot of voters figure out this is going to raise their taxes.

Also, as a pure policy aside I think the bill’s authors underrate the time-consistency issues posed by the route they’re taking.  Tax cuts for big corporations and rich estates aren’t politically defensible – the next time Democrats take power they will do so on a platform of reimposing those taxes to pay for broadly popular spending programs.  In that context the hoped-for incentive effects will be muted, as people will not necessary expect that these tax incentives will stay in place.

To return to where I started – for both procedural and political reasons it is very difficult to see anything materially resembling the TCJA being signed into law.  While a lot of popular punditry on tax reform notes that “tax reform is hard”, I think the political obstacles here are actually substantially underrated.  I do think that the GOP will pass something – but the changes required to come up with something passable will require substantially altering the framework to create fewer losers and in turn giving up on some of the biggest giveaways to unpopular interest groups.  Something more like the Bush tax cuts with across-the-board time-limited cuts will be much more practical.  The existing policy framework appears flatly unworkable in the context of a partisan bill passed through reconciliation.

*: The link cited suggests sunsetting the corporate rate cuts after 10 years would solve this issue; I do not think the Congressional Budget Office would agree.  Large corporations have the ability to shift GAAP profits forward to claim the 20% rate, and claim large losses in the out years.

**: Particularly a massive pass-through cut that makes little sense to me, either on a policy or politics level, and might well have been written by the President’s tax lawyer.


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