US tax cut prospects: Later and smaller - Westpac

According to analysts at Westpac, smooth passage of a tax cut bill in the House will buoy hopes that the Republican party is united on taxes and meeting key self-imposed deadlines to pass legislation in quick time.

Key Quotes

“But of course only a single (identical) bill that passes through both chambers can ever become legislation, yet Republican leaders in the House and Senate are crafting very different tax cut bills. Why? Senate rules for passing tax cuts are much more stringent and House members are more beholden to special interests in their districts than Senators. The House is crafting a bill to pass the House but its not clear that could ever pass the Senate, and vice versa. It is less clear still that there is any real middle ground that will satisfy both camps.”

“Notable differences include: the Senate bill delays a corporate tax cut to 20% by a year whereas the House envisages implementation in 2018, the Senate’s plan retains seven individual tax brackets vs four in the House plan, while the Senate completely repeals all state and local income and property tax deductions while the House plan scales them back only partly. The latter is especially controversial and likely a major sticking point.”

“Taxpayers in areas where state and local income and property taxes are high benefit greatly from the ability to deduct these taxes from their Federal tax liability. These are notionally Democrat leaning areas like NY, NJ and California. But there are still 29 House Republicans whose districts are in these three states. House Republicans can only afford to lose 23 votes so their support is necessary and hinges on keeping these deductions in place, or at a minimum watering them down only slightly.”

“The Senate plan however removes these deductions completely. Senators are not as beholden to individual districts since they represent entire states and the rules for passing tax cuts are much more stringent – the net cost over 10 years cannot exceed $1.5trn and any tax cuts cannot add to the deficit beyond that period. That makes the elimination of these deductions among Senators very appealing – it saves the government $1.3trn over a decade. Moreover, since the Republican majority in the Senate is very skinny (52-48), the House will be likely be forced to adopt a Bill that looks more like the Senate’s plan – a bill that then loses critical support in the House.”

“The haggling is likely to result in delays to tax cuts into 2018 and result in a smaller package than is currently envisaged, probably with a 10-year sunset clause, an outcome that in all probability will leave markets wanting.”

“If Congress can overcome these challenges it begs the question whether tax cuts will make any real difference to the US economy. Proponents argue that tax cuts will boost the supply side of the US economy and raise growth. But, taxes alone are not what ail the US economy. The corporate sector is flush with cash and financing costs are at generational lows. As the slide above shows the effective corporate tax rate paid in the US has been falling for more than 30 years yet over that period business investment has been generally trending lower.”