Still Confused About Trump's 1-Page Tax Plan Goldman Explains It All
by Tyler Durden
Since at its core, yesterday's 1-page "tax plan" was a Goldman creation - and was presented
to the world by two former Goldman employees - who better to explain what Trump had in
mind than Goldman Sachs itself, which it did overnight in a far lengthier note from its
chief Washington analyst Alec Phillips.
Here is Goldman with an elaboration of the handful of bullet points contained on the
much anticipated one page, extending it by nearly 600% to some 6 pages of details.
Perhaps it would be prudent to just have Alec Phillips present the next iteration of Trump's
tax plan: after all he , together with Jan Hatzius, appears to be the man behind it.
From Goldman
Q&A on the President�s Tax Reform Plan
The White House announced a slightly revised set of principles for tax reform, which appear
to incrementally reduce the size of the proposed tax cut compared with the President�s campaign
proposal, and eliminate a few of the differences between the campaign plan and the House Republican
blueprint on tax reform.
That said, the White House proposal is still likely to reduce tax receipts by substantially
more than the House proposal would.
While the White House appears likely to rely on optimistic growth assumptions to offset
most of the fiscal effects of the proposed tax cut, Congress will not be able to do so
and must decide whether to pursue revenue-neutral tax reform or an explicit tax cut.
While no decision is imminent, today�s announcement and indications of openness to a tax cut among
congressional Republicans suggest that a tax cut is more likely than revenue-neutral reform.
We expect a long road ahead for tax legislation.
While we believe there is a good chance that tax legislation becomes law�in fact, market
participants might be underrating the odds of tax cuts, a change from earlier this year�there
may be few concrete legislative actions on tax legislation over the next couple of months
for markets to react to.
Q: What did the White House announce?
Treasury Secretary Steven Mnuchin and White House National Economic Council Director Gary
Cohn briefed the press today (April 26) on the direction that the President will take
on tax reform this year.
They provided little detail, and what detail was provided was mostly similar to President
Trump�s campaign proposal.
That said, there were some policy changes compared with the campaign proposal that provide
clues about the direction the White House might take the debate.
In addition, the Administration�s thinking on the fiscal impact of the tax cut is at
least slightly clearer.
Q: What has changed compared with the last tax proposal?
The proposal appears to have changed in four areas compared with the campaign proposal:
A smaller tax cut for top income earners: The White House proposal would lower the top
marginal tax rate for individuals from 39.6% to 35%, rather than the 33% proposed in the
campaign.
A smaller tax cut for middle-income individuals: The proposal now calls for a standard deduction
of $24k for couples rather than $30k.
This is still roughly twice as much as the current standard deduction and is identical
to the House Republican proposal.
Repeal of the state and local tax deduction: The Trump campaign proposal was unclear about
which, if any, individual tax deductions might be eliminated, but the current White House
proposal is more specific; the deduction for state and local taxes would be eliminated,
while the deductions for mortgage interest, charitable contributions, and retirement savings
would be maintained.
A territorial tax system for business income: The campaign proposal would have repealed
the deferral of tax on income earned by foreign subsidiaries of US companies, and would have
instead taxed those earnings at 15% minus foreign tax credits, amounting to what would
effectively be a 15% minimum tax on foreign earnings.
Instead, the revised White House plan would adopt a territorial tax system, which exempts
foreign earnings from US tax.
In addition to the explicit changes compared to the campaign proposal, today�s announcement
was also noteworthy for two conspicuous omissions.
No border adjustment: The plan does not endorse the border adjusted tax (BAT) that makes up
part of the destination-based cash flow tax (DBCFT) system in the House Republican blueprint.
In comments earlier in the day, Treasury Secretary Mnuchin indicated that the White House did
not support the BAT in its current form, though he suggested that revisions might be considered.
In light of substantial opposition to the BAT in the Senate, it would have been very
surprising to see the White House endorse the proposal.
That said, today�s announcement did not include an outright rejection of the proposal
either.
No mention of interest deductibility or capex expensing: The Trump campaign proposal would
have allowed businesses the option of full expensing of capital investment in return
for non-deductibility of interest expense.
However, today�s outline is silent on this question.
This is notable since many observers assume that the White House does not support the
mandatory shift to full expensing of capex and non-deductibility of interest included
in the House Republican blueprint.
Exhibit 1: The latest White House plan includes some new elements
Q: What effect would these revisions have on the size of the proposed tax cut?
Overall, we figure that the changes the White House has announced would shrink the size
of the proposed tax cut by more than $1 trillion over ten years compared with the prior version:
A standard deduction of $24k for couples costs about $300bn less over ten years than the
$30k standard deduction proposed in the campaign; A 35% instead of 33% top marginal rate for
individuals probably reduces the cost of the proposal by around $400bn over 10 years;
Repeal of the state and local tax deduction would raise around $800bn in tax revenue;
and The shift to a territorial tax system would
reduce corporate tax receipts by $200bn to $300bn more over ten years than the prior
proposal.
With these changes, we expect that the overall cost of the tax plan would decline from the
roughly $6 trillion cost over ten years previously estimated by the Tax Policy Center (TPC) to
just under $5 trillion.
As noted above, it is unclear how the proposal would treat capital investment and interest
expense, but if the proposal omitted any changes in this area, it would shrink the cost of
the proposal over the next ten years by another $1.3 trillion to around $3.7 trillion, based
on TPC estimates.
Q: Where does this put the proposal in comparison with the House and Senate?
It brings the White House proposal closer to where Congress is likely to be on most
issues, but the rate cuts on corporate and business income are still greater than we
think Congress will support.
On the individual side, we believe that a 35% top marginal rate is more likely than
the 33% rate that House Republicans have proposed, given fiscal constraints and the fact that
a 35% rate would be a natural place to settle, as it was also the top rate prior to 2013.
The White House�s proposed $24k standard deduction and elimination of the state and
local deduction bring it into line with the House Republican blueprint.
While we are skeptical that the state and local tax deduction will be repealed entirely,
we note that the House, Senate, and White House now all appear to be focused on limiting
this benefit, suggesting that at least a limitation is becoming more likely.
On the corporate side, the inclusion of the territorial system for corporate income in
the White House plan brings it in line with the House proposal as well as the position
that we expect the Senate to take.
However, the 15% rate that the White House proposes on corporate and pass-through business
income is lower than the 20% and 25% rates, respectively, that the House proposes or that
the Senate is likely to agree to.
Ultimately, we expect that Congress will cut the corporate rate to perhaps 25%, and we
would expect the tax rate on small business to be higher�quite possibly still aligned
with the top individual tax rate.
Q: What have we learned about how the tax cut might be paid for?
Secretary Mnuchin has stated that the tax proposal would be offset through a combination
of growth and various base broadening measures.
We expect this to be outlined in more detail by May, when the President submits a formal
budget to Congress for fiscal year 2018, including projections of revenues and deficits over
the next ten years.
Our preliminary expectation is that the White House will assume that the majority of the
fiscal effect of the tax cut would be offset through a projection of faster GDP growth.
For example, if the White House assumes a 3% growth rate over the next ten years, rather
than the 1.8% average rate that CBO assumes, this would increase revenues by roughly $3.7
trillion over the ten- year period.
We note that the fiscal benefits of a higher trend growth forecast are very backloaded;
over half of the total revenue gain over the ten-year period would come in the final three
years, so the projected deficit over the next several years would expand as a result of
the tax cut, regardless of what growth assumptions one makes.
White House growth projections would have little direct effect on the legislative process
in Congress, whereas the Joint Committee on Taxation (JCT) will use growth projections
provided by the CBO as a starting point for analysis and is likely to make much more conservative
estimates of the effect that tax legislation is likely to have on growth.
That said, optimistic White House growth assumptions might help build political support in Congress
for the eventual legislation.
With apparent support for an explicit tax cut from key Republicans like Senate Finance
Committee Chairman Orrin Hatch (R-UT), momentum for a tax cut rather than revenue-neutral
reform appears to be growing.
Q: Won�t Senate rules make it difficult to pass a tax cut that is not paid for?
Rules regarding the �reconciliation� process make it more difficult to pass a tax cut than
to pass revenue-neutral tax reform, but we expect lawmakers to get around these obstacles.
Republican leaders have made clear their intent to use the reconciliation process to pass
tax legislation, since this allows the Republican majority to circumvent likely Democratic opposition
in the Senate.
However, the �Byrd Rule� in the Senate prohibits reconciliation legislation from
increasing the deficit after the period covered by the budget resolution that governs the
process, which traditionally lasts for ten years.
The most obvious way that congressional Republicans might get around this constraint is simply
to allow the tax cuts to expire after ten years (i.e., by 2027).
This was done in 2001 when the Bush Administration passed a large individual tax cut.
However, two reasonable objections to this have been raised.
First, structural reforms to the tax code could do more harm than good if they were
made temporary.
That said, a simple tax cut (for example, dropping the corporate rate from 35% to 25%)
would not be as difficult to implement on a temporary basis, particularly since we expect
that there would be a widespread belief that such a tax cut would be extended or made permanent
before it expires, just as the 2001 tax cuts were for the most part.
A second, more technical, objection has also received some attention recently.
The JCT has indicated that the revenue loss associated with a temporary tax cut would
continue several years after it expired, because companies might postpone their use of certain
tax benefits until after rates have risen and might pull forward income that would otherwise
be recognized later.
The JCT estimates imply that allowing a 20% corporate tax cut to expire after nine years
would result roughly a $90bn revenue loss in the second decade, which would violate
the Byrd Rule.
However, this would become a much less important consideration if a corporate tax cut were
considered as part of a larger package that also included some permanent provisions that
raised revenue, considering that the House and White House proposals would already raise
hundreds of billions of revenue through base broadening in the second decade, even excluding
the effects of controversial proposals like border adjustment.
Q: Now that the White House has made its proposal, what happens next?
There are four important milestones coming up over the next few months:
The President�s Budget: The White House is expected to submit its budget proposal
to Congress in mid-May.
We would expect this to include some additional detail regarding tax legislation�at a minimum,
it is likely to include more specifics regarding the potential effect on revenues and the deficit�as
well as an a general indication of the scale of its infrastructure plan.
The final disposition of the health bill: House Republicans look likely to make another
attempt at passing the American Health Care Act (AHCA), after announcing modifications
intended to satisfy the conservative and centrist Republicans who signaled they would oppose
the prior version.
However, the announced revisions appear likely to increase support among conservative Republican
lawmakers but they do not appear to have shifted the views of centrist Republicans nearly as
much.
As of this writing, consideration of the revised health bill within the next week or so appears
possible but not likely unless it becomes clear there will be adequate support.
Even if health legislation passes in the House, we do not expect a majority of the Senate
to support the House version, and developing a bill that can pass the Senate is likely
to take several weeks, at least.
The upshot is that Republican leaders will soon need to decide whether they can pass
a health bill in the House, or officially postpone consideration and move on to other
issues, since the budget and tax process cannot move forward until they do.
The congressional budget resolution for FY2018: At the start of the year, Congress passed
a budget resolution for FY2017, which served the sole purpose of providing instructions
to the committees with jurisdiction over the Affordable Care Act (ACA) to pass health legislation
using the reconciliation process.
It was expected that a second resolution for FY2018 would then be passed once health legislation
had been enacted, in order to provide instructions for passage of tax reform legislation.
With health legislation in legislative limbo, it is unclear whether Republican leaders will
pass a second budget resolution this year.
However, since the instructions under the FY2017 resolution called for legislation that
was roughly budget-neutral, the only way Congress can pass a meaningful tax cut would be to
win bipartisan support, which seems unlikely at the moment, or to pass a new budget resolution
that explicitly instructs the tax-writing committees to cut taxes.
Draft tax legislation released: It is difficult to predict when tax legislation might be made
public in the House or the Senate, but our expectation is no earlier than June and possibly
not until July.
In the near term, we expect the tax-writing committees, particularly the House Ways and
Means Committee, to hold hearings examining some of the key issues in its proposal, like
the border-adjusted tax.
Once the procedural groundwork for a committee vote has been laid, by passing a new budget
resolution or re-using the instructions intended for the health bill, the committee is likely
to release its proposal to the public and pass it quickly.
In the Senate, the timing is even more fluid; we expect more detail from the Senate Finance
Committee over the next couple of months regarding its likely approach for tax reform legislation,
but a formal proposal appears to be a ways off.
The extended timeline for even releasing a draft proposal suggests that while the House
could vote on tax legislation in committee before August, a vote on the House floor is
less certain, and Senate passage before August looks very unlikely.
This suggests that tax legislation is unlikely to become law before Q4 2017.
While enactment shortly before year-end is a clear possibility, we believe it is more
likely to become law in Q1 2018.
We continue to believe that tax legislation is fairly likely to become law.
In fact, market sentiment regarding fiscal policy might have become too negative.
This is a substantial shift from the start of the year, when sentiment among market participants
took a much more positive view regarding the potential for major policy changes.
However, we expect the process to continue slowly over the next couple of months, and
without any clear signs of progress financial markets are apt to take a wait and see attitude
toward tax reform.
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