US: Tax reform to have broad implications - BBH

US tax reform is the force with broad implications as the rise in the long-end of US curve last week, with the 10-year yield increasing 11 bp and the nine bp rise in the 30-year yield appear to have been driven expectations around US fiscal policy, explains the research team at BBH.

Key Quotes

“We succinctly summarize in nonpartisan terms where the process is and what to expect going forward.”

“The new development last week was that the Senate passed a 2018 budget.  It is different than the House version in that it anticipates a loss of revenue (tax cuts) that will increase the deficit by $1.5 trillion over the next 10 years.  Part of the reason is that unlike the House that offered a little more than $200 bln in spending cuts and other offsets.”

“To proceed to tax reform, both houses of Congress must approve the same budget.  The reconciliation process typically takes weeks.  This time could be different.  A parliamentary maneuver allows a shortcut.  As early as next week, the House may simply vote on the Senate's version.”  

“Once the budget is passed, Brady, the chair of the House Ways and Means Committee, will reportedly release a detailed tax reform bill.  His committee will vote on it, and with 2/3 Republicans, it is not much of a hurdle. The bill would then face a vote in the entire House.  The Republicans can afford to lose 22 of its member votes at the most.  Speaker of the House Ryan has suggested a floor vote could be held in early November.”  

“The Senate is working its own version.  The Republican majority on the Senate Finance Committee (chaired by Hatch) is a narrower 14-12.  The Republican majority in the Senate is 52-48.  Vice President Pence casts a vote in a tie, so in the Senate, the Republicans can loss two votes and still pass tax reform.”  

“It is on the floor votes that health care reform faltered in the House and Senate.  The recurring problem is not obstructionist tactics from the minority Democrats, but the inability of the Republican leadership is cross the divide within their party.  As all the House members face election next year, it may be easier to maintain party discipline than in the Senate, where only eight sitting Republican Senators will defend their seats, though one (Corker) has indicated intentions on stepping down.  These Senators immediate challenge stems from a potential primary challenge threatened by Steve Bannon.”  

“The gulf between those Republican Senators who want significant tax cuts even if it means greater deficits and those who have been critical of deficit spending throughout their careers may be too difficult to bridge.  While there are many components to the tax reform, part of the challenge is that there are few constituents that are concerned about more than one two components, which make larger compromises more difficult.”  

“Toward the end of last week, reports emerged suggesting that limits on tax-free retirement savings (e.g., 401k) were under consideration.  The problem is that because of the disparity of income and wealth, many people and households cannot benefit from the financial incentives to save.  These types of inducements, which Obama saw in the college saving programs (529B), contribute to the disparity.  However, Obama was forced to back off quickly as many middle-class families use pre-tax dollars to save for retirement.  There are more regressive taxes that can reconsider.”  

“That said, a shift from pre-tax to post-tax savings front loads tax receipts for the government.  All else being equal, it would make for a smaller deficit.  The change may initially squeeze household cash flow, and consumption, but the underlying rate of savings, adjusted for anticipated tax obligation may not be altered on the medium term.”  

“To conclude, the challenges that bedeviled the health care debate cast a cloud over tax reform.  Those lay ultimately in the narrow majorities that are majorities in party affiliation and little else.  Finishing the 2018 budget is the first step, and that is possible in the days ahead.  Then details of the House tax plan will be published.  The floor vote is where the challenge lies, but the Senate obstacles may be more formidable.  While some parts of the tax reforms seem stimulative, others (like removing the state and local tax deductions and/or further limiting tax incentives for retirement savings) seem to raise the effective tax burden on middle-class households that drive consumption.”