How Tax Reform Can Still Blow Up: A Side-By-Side Comparison Of The House And Senate Tax Plans

To much fanfare, mostly out of president Trump, on Thursday the House passed their version of the tax bill 227-205 along party lines, with 13 Republicans opposing. The passage of the House bill was met with muted market reaction. The Senate version of the tax reform is currently going through the Senate Finance Committee for additional amendments and should be ready for a full floor debate in a few weeks. While some, like Goldman, give corporate tax cuts (if not broad tax reform), an 80% chance of eventually becoming law in the first quarter of 2018, others like UBS and various prominent skeptics, do not see the House and Senate plans coherently merging into a survivable proposal. 

Indeed, while momentum seemingly is building for the tax plan, some prominent analysts believe there are several issues down the road that could trip up or even stall a comprehensive tax plan from passing the Congress, the chief of which is how to combine the House and Senate plans into one viable bill.

How are the two plans different? 

Below we present a side by side comparison of the two plans from Bank of America, which notes that the House and the Senate are likely to pass different tax plans with areas of disagreement (see table below). This means that the two chambers will need to form a conference committee to hash out the differences. There are three major friction points:

1. the repeal of the state and local tax deductions (SALT),


2. capping mortgage interest deductions and


3. the delay in the corporate tax cut.

The House seems strongly opposed to fully repealing SALT and delaying the corporate tax cuts and the Senate could push back on changing the mortgage interest deductions. Finding compromise on these issues without disturbing other parts of the plan while keeping the price tag under the $1.5tn over 10 years could be challenging.

Here are the key sticking points per BofA:

• Skinny ACA repeal: The repeal of the individual mandate is back on the table. It would free up approximately $300bn in revenue to pay for the tax plan. But this likely means no Democratic Senator will support the bill. This could prove costly as the Republicans can only afford to lose 2 votes and several Republican Senators are already on the fence on the tax plan.


• Byrd Rule means tax plan might not hatch: Reconciliation directives allow the tax plan to add $1.5tn to the deficit in the first 10 years (See appendix for breakdown of the cost of each plan). However, rules in the Senate state that any bill passed under reconciliation has to be revenue neutral beyond the 10 year budget window. Given that the Republicans are hoping to make the corporate tax cuts permanent, it would mean that they would need to find additional revenue in the out years while sunsetting all other tax cut provisions (e.g. personal tax cuts). This will mean the personal tax code at best will revert back to current law or at worst roll back the cuts and preserve the repeal of the deduction which would amount to a tax increase on households after ten years. Currently, the Senate plan would let reduction in the personal tax rates, expansions of the standard deduction and child tax credit and other provisions expire after 2025. The court of public opinion could threaten the tax plan.

And while it remains to be seen if tax reform will pass the Senate, or like Obamacare repeal, it will get shot down by the like of McCain (and perhaps Corker), another key question, is whether the US even needs tax reform at this point - the Fed certainly could do without the added inflationary pressure - and whereas former Goldman COO and Trump"s econ advisor, Gary Cohn certainly thinks so, his former boss, Lloyd Blankfein disagrees. So does Bank of America, which maintains that at this stage of the business cycle, tax cuts are not needed to sustain the current expansion. Nevertheless, BofA concedes the passage of a comprehensive tax plan would likely lead to a short term boost to growth which would translate to further declines in the unemployment rate and higher inflation.

Then, as the economy begins to heat up, the Fed will likely lean against the economy by implementing a faster hiking cycle than currently projected, which will ultimately spark the next market crash, recession and financial crisis. Ironically, the seed of Trump"s own destruction would be planted by his biggest political victory yet (assuming tax reform passes, of course).

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As a bonus, here is a simulation BofA ran using the Fed"s FRB/US model to calculate the potential costs of the tax plans. BofA ran its simulations assuming model consistent expectations for all sectors of the economy and using the inertial Taylor rule to set the path of the federal funds rate: "o simulate the impact of the fiscal stimulus brought on by the tax cuts, we make the fiscal setting exogenous during the first 10 year period and adjust the path for corporate and personal income taxes to take into account the government revenue effects from the tax plan."

Costs aside, to get a sense of the economic impact from the two tax plans, BofA similarly models the two plans" outcomes using the FRB/US macroeconomic model. The simulation results suggest under the House plan, the US would see a boost to aggregate demand as growth would be approximately 0.4pp higher relative to baseline in 2018 and 0.3pp higher in 2019. Better aggregate demand would reduce the unemployment rate by 0.3pp by 2019 and put upward pressure on inflation. These growth and price dynamics would lead the FOMC to raise rates an additional 1 to 2 hikes over the next two years. The economic impact from the Senate plan would be slightly more modest but in the same ballpark as the House plan. Under the Senate plan, the model predicts growth to be approximately 0.3pp higher in both 2018 and 2019 and similar dynamics for the unemployment rate and inflation as seen in the House plan, leading the FOMC to tighten quicker than the current baseline path.

There is also an "alternative" scenario where we a watered down version of the tax plan passes (i.e. modest tax cuts for middle-income households and a corporate tax cut near 25-28% that is deficit increasing by $600bn-$800bn on a static basis). Under the "alternative" scenario, we would see approximately half the economic impact that is seen under the House plan. Given that such a plan would likely only generate modest inflationary pressures, the Fed"s response likely would be relatively muted and it would likely stay on its baseline path.

Goldman On Tax Reform: "Now Comes The Hard Part"

The ink wasn"t even dry yet on the just published Republican Tax Cut And Jobs Act, and within the hour UBS was already confident that it has virtually no chance of passing: As UBS chief economist Seth Carpenter wrote shortly after the publication, "to our read, the release confirms our view that tax reform is far from being a done deal. The bill contains several specifics that we believe will prove sticking points, which increase the difficulty of finding the votes to support the plan in both the House and the Senate." Fast forwarding to Carpenter"s conclusion: "We maintain our view that tax reform is unlikely this year or next."

To be sure, banks have a right to be skeptical: after all with the economy already growing above 3%, the last thing financial institutions want is for another burst of output courtesy of fiscal stimulus. Last week, Lloyd Blankfein said as much when the Goldman CEO warned "now’s not the best time for tax cuts", a view diametrically opposite that of his former "right hand man", Gary Cohn, currently Trump"s chief economic advisor, who said this is precisely the right time for more tax cuts.

“I can’t say this is the moment where you want the most fiscal stimulus in the market, when we’re mostly at full employment, when GDP last registered at 3 percent,” Blankfein said Thursday in a Bloomberg Television interview. “I don’t know that this is the moment that you provide the biggest stimulus.”

Goldman CEO"s skepticism was obvious in a report released this afternoon by economic Alec Phillips, who looked at the tax plan released on Friday, and said that while Goldman still assigns a two-thirds chance of tax reform passing, it conceded that "now comes the hard part."

First, here are the big picture details:

Tax Reform: Now Comes the Hard Part

• The recent release of the House tax reform bill marks the start of the second, harder, stage of tax reform. The plan cuts the corporate tax rate to 20% and reduces taxes on individual and “personal business” income while  staying within the $1.5 trillion (over 10 years) cost limit recently agreed to in the House and Senate. Achieving all three goals had appeared quite difficult in our view but the proposal does it, according to the official estimates.


• The House proposal includes substantial reforms. However, this greater-than-expected base broadening has already generated some political opposition, which is likely to lead to changes to the House bill as it moves forward.  The Senate is likely to release its own version with even greater differences within the next week or so, in our view.


• The proposed tax cut is more front-loaded than we have expected; official estimates suggest a tax cut of 0.75% of GDP in 2018. However, we expect the final version to have a smaller near-term effect as competing priorities lead tax-writers to phase in some cuts—particularly corporate rate cuts—over time. Senate Republican centrists have already expressed concerns about the cost and might balk at tax cuts that expire after five years, since the true ten- year fiscal cost would rise if they were extended.


• The net tax cut appears to be weighted more heavily toward individual and “pass-through” income than to the corporate sector. This is surprising considering the proposed immediate and permanent 20% corporate tax rate, but appears to be the result of substantial base-broadening, new restrictions on cross-border corporate activity, and the fact that several existing tax incentives are set to expire, which offsets a portion of the net tax cut under the legislation.


• We continue to believe that tax legislation has around a two-thirds chance of becoming law by early 2018. The release of the House legislation is a positive step in that it moves the process forward. It also demonstrates that  meaningful base-broadening might be more achievable than we have believed. However, it does not alter our outlook for the odds of enactment, since the Senate is likely to release its own bill shortly and the vote in that chamber represents the greater obstacle to passing tax reform.

Hatzius lays out the key underlying details for his current outlook:

There are good reasons to believe that tax legislation will become law in the next few months and we believe there is a 65% chance of enactment by Q1 2018. First, tax reform—and a net tax cut—is an area where the President and most congressional Republicans generally agree. This is notable, since there are substantial differences within the Republican Party on a number of other issues, including immigration, infrastructure, international trade and health reform.

 

Second, congressional Republicans face a difficult midterm election in 2018 and many lawmakers believe Republican prospects would be improved by a major legislative achievement before voters head to the polls. As Exhibit 1 shows, Republicans tend to be more supportive of most of the general aspects of tax reform than Democratic voters, though some tax changes are more popular than others; middle-class tax cuts and small-business relief enjoys broad support, while corporate tax cuts do not.

 

Third, tax legislation can pass in the Senate with only 51 votes, instead of the customary 60 votes, through the budget reconciliation process. Now that a majority of the House and Senate have passed a budget resolution calling for a tax cut of up to $1.5 trillion over ten years, the odds would seem low that they would fail to follow through in passing the tax legislation itself.

 

Nevertheless, there are still a number of ways that the effort could run off the rails. First, tax reform is much harder than tax cuts. The recently introduced House proposal is a case in point. While the proposal achieves meaningful reductions in individual and corporate tax rates, it also targets a number of specific tax benefits and several important constituencies have come out against the bill. This is the main risk to passing tax reform with only Republican votes, in light of the slim Republican majorities in both chambers.

 

Second, although House and Senate majorities voted in favor of a budget resolution including an instruction to cut taxes by up to $1.5 trillion over ten years, a few of these lawmakers have expressed some hesitation regarding the tax legislation itself. Senator McCain (R-AZ), for example, has called for the legislation to be considered under “regular order” and might not support a tax bill passed via the reconciliation process. Senator Corker (R-TN) supported the budget resolution but has left open the possibility that he would oppose the tax bill itself if he feels it would add to the deficit beyond the estimated revenue gain from economic growth effects and the cost of extending expiring provisions.

 

Third, while few argue against the concept of revenue neutral reform that lowers statutory tax rates and broadens the tax base, there are good arguments against a large net tax cut at the moment, including a high debt-to-GDP ratio, growing fiscal imbalances projected over the coming decade, and an economy with little remaining slack. This stands in contrast to the 1981 and 2001 tax cuts, when the federal budget was projected to run surpluses, the debt-to-GDP ratio stood at less than half of its current level, and the economy was in recession.

 

That said, the tax cut is not that large; nearly $500 billion in expiring tax provisions were likely to be extended regardless of tax reform, so the net revenue loss over ten years compared to our and most other realistic projections is only around $1 trillion (0.4% of GDP). The increase in GDP that would result from a tax cut would reduce the net cost slightly further.

Next, Phillips breaks down the key components of the Tax Cut And Jobs Act, whose core principles are summarized as follows:

On November 2, the House Ways and Means Committee released its Tax Cuts and Jobs Act (TCJA). The proposal makes more substantial changes than are implied by its estimated cost. The House plan achieves a 20% corporate tax rate and tax relief for individuals and “personal business income” while staying within the $1.5 trillion (over 10 years) limitation on cost recently agreed to in the House and Senate. Achieving all three goals had appeared quite difficult but the proposal managed to do this, according to estimates from the Joint Committee on Taxation (JCT); the most recent estimate puts the total revenue loss at just over $1.4 trillion over ten years.

Here, instead of repeating Goldman"s take on all the core aspects of the TCJA, we summarize the progression of tax reform courtesy of the following summary chart:

Which the brings us to Goldman"s critical discussion on "the way forward", or what happens next. Exhibit 8 below summarizes Goldman"s expectations regarding the timeline for consideration of tax reform over the next few months.

The House Ways and Means Committee is scheduled to begin its “mark up” of the TCJA on Monday, November 6. This is likely to take several days, and will involve the consideration of dozens (potentially over 100) amendments to the proposal, followed by a vote on the package as amended. House Republican leaders hope to pass the bill on the House floor the week of November 13, but might have to postpone the vote until after the Thanksgiving recess (the week of November 20) if there is insufficient support and further changes become necessary. In our view, there is little risk that the committee will fail to pass the bill, but a good chance that objections from some Republicans could delay passage by the full House until after Thanksgiving. That said, we believe there is a high probability of House passage by December.

How about the Senate?

The Senate Finance Committee might release its own proposal late in the week of November 6, though it is also quite possible this could be delayed. Although Senate Republican leaders have expressed hope that the Senate might be able to pass tax reform legislation by the end of November, this seems unlikely to us. Passage in December is certainly possible, however, in our view. We assume that a conference committee between the House and Senate will be necessary to resolve differences between the two bodies, which would probably delay final enactment until early 2018. That said, it is conceivable that the House could instead simply pass the Senate’s version of tax reform, which might allow for enactment before year-end. We continue to see enactment in early 2018 as the base case, though we note that market perceptions could shift substantially before then. For example, a successful Senate vote in December could lead market participants to place a high probability on eventual enactment, since the Senate vote is widely seen as the greatest risk to passage.

In summary, Goldman continues to believe there is a 65% chance that Congress will approve a tax bill by Q1 that results in a net tax cut of about $1 trillion (0.4% of GDP) over ten years (an amount similar to the tax cut under the TCJA, adjusting for scheduled expiration of tax incentives under current law) by Q1 2018. By comparison, prices in the online prediction market PredictIt imply a 60% probability that a corporate tax cut will be enacted by the end of Q1 2018, and around a 30% chance it would be enacted prior to year-end, down from over 80% early in the year.

What about the market?

The relative performance of our equity strategists’ basket of high tax stocks vs. the S&P 500 suggests that expectations have come down further. Even after adjusting for dollar depreciation—low tax stocks tend to have more foreign exposure so the relative performance might also be driven by the value of the dollar— the basket suggests that market expectations for tax reform that benefits high tax companies more than low-tax companies are not much greater now than they were prior to the election.

What may be taking place, according to Phillips, is that In light of the House proposal’s 20% rate combined with substantial base broadening and base-erosion protections, the market might soon assign a higher probability that the high tax rates faced by some companies— particularly those with a largely domestic focus— might converge with the low effective tax rates that some US-based multinationals pay. As a reminder, while the statutory US tax rate is 39%, the effective US tax rate of 27% has never been lower. In this light, the Trump tax cuts, contrary to Steven Mnuchin"s observations, will soon be seen as a non-event, especially if Goldman is correct, and the agreed upon corporate tax rate end up being 25%...

Futures Slide On Report Corporate Tax Cuts To Be Temporary, Phase Out After A Decade

When the NAR won the battle over keeping State and Local Tax deductions "as is", in the process denying the proposed GOP tax reform more than a trillion in revenue over the next ten years, it effectively doomed the most important provision of the republican tax bill set to be unveiled tomorrow: the reduction in the corporate tax rate from 35% to 20%. Or rather the permanent reduction in the corporate tax rate. Because according to House Ways and Means Chairman, Kevin Brady, what will be revealed on Thursday is a tax proposal with a temporary corporate cut, one which reverts back to the original 35% tax rate after a decade.

Brady says tax bill will only have TEMPORARY cut in the corp rate from 35% to 20%. Couldn"t not make permanent cut comply with Senate rules

— Damian Paletta (@damianpaletta) November 1, 2017

As Bloomberg confirms there have been conflicting reports about when the rate cut would take effect, or how long it would last, and according to a Republican lawmaker, House tax writers will phase out the proposed corporate rate of 20% after a decade. While cutting the corporate tax rate to 20% from 35% is a key provision of the Republican tax legislation that set to be unveiled tomorrow, no matter how hard they tried, GOP legislators could not get over a key hurdle: lack of revenue.

According to Bloomberg, "Congressional tax writers are struggling to find enough revenue to help the tax package adhere to the 2018 budget Congress adopted last month. That budget would allow the legislation to add no more than $1.5 trillion to the federal deficit -- before accounting for any economic growth that might result."

The problem is that the corporate tax cut is estimated to cost just over that, or $1.6 trillion over the next decade according to the Tax Foundation. One solution to the dilemma, is the notion of phasing in the corporate rate cut.  Furthermore, the congressional Joint Committee on Taxation said in an April letter to House Speaker Paul Ryan that a corporate tax rate of 20 percent would create deficits in the long run even if it remained in effect for just three years, adding further complication to the current revenue-less predicament.

Another problem: making the rate-cut temporary would limit its ability to spur economic growth, a key selling point cited by President Donald Trump and others. It is also a key factor in explaining the recent market surge, especially since Trump"s "Biggest tax cut ever" would have a 10 year shelf life, at which point things would revert back to the way they were.

And while stocks have been slow to grasp the significance of this major disruption to the GOP tax bill, the USDJPY is - gradually - waking up, or rather down, and so are futures...

An Army Of Lobbyists Is Coming To Kill Tax Reform

Having sworn themselves to secrecy, Republicans on the House Ways and Means committee are scrambling to put together a tax bill by next week. But not knowing anything about the details of the plan, as it stands right now, hasn’t stopped an army of lobbyists from mobbing Capitol Hill with one overweening mission: To threaten, cajole or otherwise coax lawmakers into preserving loopholes that benefit their clients.

Here"s Bloomberg:

The stage was set with the House’s adoption Thursday of a budget resolution designed to speed the course of tax legislation and kick off a three-week sprint toward a House bill. Now, lobbyists representing every corner of the economy are poised to first devour, then attack what may be hundreds of pages of legislation that Brady says he’ll release Nov. 1.

 

Special interests from realtors to dairy farmers will be trying to save their industry-specific tax breaks, said Tim Phillips, president of Americans for Prosperity. His group, which is backed by billionaire industrialists Charles and David Koch, supports ending such breaks.

 

“It’s pretty fierce,” Phillips said. “We met with Brady on Tuesday and he was saying their offices are swamped with all the special interest groups swarming in asking to be protected.”

The immense pressure to find a source of revenue to compensate for the sweeping cuts to corporate and individual rates has already nearly derailed the tax reform process. Yesterday, House Republicans narrowly approved the Senate version of a $4 trillion federal budget over the objections of 20 blue-state Republicans who oppose the elimination of the state and local tax deduction, which they say would disproportionately raise taxes on middle-class taxpayers in blue states, which tend to have higher taxes. Yet, Ways and Means Chairman Kevin Brady has said the elimination of the SALT deduction will stay in the bill - for now, at least.

Kevin Brady

On a static basis, the nine-page outline introduced by the White House and GOP Congressional leaders last month will cost $2.4 trillion over the first decade and $3.2 trillion over the second decade, according to an analysis by the nonpartisan Tax Policy Center. The TPC also found that 80% of the benefits from tax reform would accrue to the top 1% of earners. Republicans who are writing the bill must somehow reduce the impact on the deficit to $1.5 trillion, while adhering to President Donald Trump’s promise that middle-class Americans would be the biggest beneficiaries of the tax overhaul.

Still, it remains to be seen which groups will lose their benefits. According to Bloomberg, even Republican members of Ways and Means don’t know what will be preserved and what will be eliminated.

That could make releasing the bill by the Wednesday deadline difficult.

“The problem is that Ways and Means has somewhat been kept out of the loop with details,” Representative Jim Renacci of Ohio, a member of the House tax-writing panel, said in an interview. “There are still a lot of hurdles to get it done.”

As Bloomberg points out, the elimination of the SALT deduction has become one of the most divisive issues surrounding tax reform. Trump and congressional leaders have proposed abolishing that break, which benefits high-tax states that tend to vote Democratic. But several Republican House members from such states want to preserve the break in some form.

“Can you get people to put their party loyalty above home-grown constituents’ concerns?” said Hollier, a former chief of staff and legislative director for Senator Mike Crapo, an Idaho Republican. “How they deal with that will show that people can be broken.”

And unsurprisingly, corporate lobbyists, who are used to their clients’ interests being given priority in Congress, are upset with the Republicans’ decision to keep other details of the bill under wraps.

Will Hollier, whose clients include Microsoft Corp. and Visa Inc., told Bloomberg that secrecy is a double-edged sword: The secrecy has allowed for some efficiency, but it’s also prevented GOP leaders from winning broad support.

Which could create problems for the bill as it moves forward because, as Sen. Bob Corker told Bloomberg: “I don’t think that people realize that 80 percent plus of this effort is eliminating things in the code,” referring to special interest loopholes. Meaning that, once the bill’s details are made public, Republicans will need to guide it to the president’s desk over lobbyists’ objections.  

“I mean, over the next two weeks, especially when the Senate tax-writing committee puts their stuff out, they’re going to realize that this the biggest tax code rewrite since 1986 and it’s going to affect everyone,” Corker said.

Lobbyists have already started pushing back against details in the nine-page outline that would raise taxes on corporate America. Those measures include the elimination of corporate deductions for interest payments – which could raise as much as $1 trillion over a decade – as well as a new foreign minimum tax that would affect corporations who shift profits to offshore tax havens

One of the ways to make up the revenue gap is by limiting the deductions corporations take on the interest they pay on their loans -- a major consideration for industries such as private equity and real estate. A prior House Republican proposal called for completely eliminating the corporate break, which could have raised more than $1 trillion over a decade.

 

“They’re totally undecided,” about how to restrict corporate interest deductions, said Marc Gerson, the chair of law firm Miller & Chevalier. Gerson said proposals include setting limits based on a company’s earnings before interest, tax, depreciation and amortization, or Ebitda, a key measure of profitability. Existing debt might be grandfathered in, he said.

 

Another piece of the framework is aimed at preventing U.S. companies from shifting their earnings to offshore tax havens -- by imposing a minimum foreign tax. The idea -- described briefly and obliquely in the framework language -- was called “appalling” several weeks ago by Ken Kies, a lobbyist whose clients include Microsoft and General Electric Co. The rate and formula for such a tax haven’t been specified, but the proposal carries multibillion-dollar implications for multinationals.

 

On the individual side, the treatment of state and local deductions remains in question. At least 12 Republicans from high-tax states, whose constituents stand to lose if the tax break is repealed, voted no on the House budget Thursday. The most vocal among them have demanded a compromise on the issue.

Given the number of parties involved, there are many obstacles to passing tax reform by the Republicans’ hoped-for deadline of year’s end, including the other issues on the Congressional agenda. Congress must fund the government to avoid a shutdown by Dec. 8. That could turn ugly as the White House has signaled it’ll demand funding for a border wall, and Democrats say they want a solution to protect young undocumented immigrants.

To be sure, there is one powerful political imperative that might force Republicans to swallow their objections: The fear that another legislative failure - especially one with the potential to tank financial markets - could cost Republicans one, or both, of their Congressional majorities.

House and Senate leaders hope to pass bills through their chambers by Thanksgiving, said Speaker Paul Ryan and Senate Majority Whip John Cornyn. The different bills would then have to be reconciled with another round of votes in December. Only then can Congress send the final bill to the president’s desk.
 

House Passes Budget, Jumps First (Smallest) Hurdle Towards Tax Reform

The House passed its 2018 budget resolution Thursday (with 18 Reps voting against) crossing the first threshold toward its goal of sending tax reform legislation to President Trump.

As WaPo reports, the House budget resolution includes major spending cuts demanded by the party"s conservative wing, but the party"s focus is now on passing a tax bill that could add as much as $1.5 trillion to the budget deficit. Special procedures set out in the legislation would ultimately allow Republicans to pass the bill over a potential Democratic filibuster in the Senate.

"Our budget specifically paves the way for pro-growth tax reform that will reduce taxes for middle class Americans and free up American businesses to grow and hire," House Budget Committee Chairman Diane Black (R-Tenn.) said during floor debate.

In a 219-206 vote, The Hill reports lawmakers approved a budget resolution for 2018 that sets up a process for shielding the GOP tax bill from a filibuster in the Senate.

A total of 18 Republicans voted against the resolution, along with all the Democrats, but GOP lawmakers hailed the vote as meaningful because of the tax measure.

“We haven’t reformed this tax system since 1986. We need to pass this budget so we can help bring more jobs, fairer taxes, and bigger paychecks for people across this country,” Speaker Paul Ryan (R-Wis.) said during House floor debate.

Ironically, Democrats lambasted it for the same reason.

“This budget isn’t about conservative policy or reducing the size of our debt and deficits. It’s not even about American families. This budget is about one thing – using budget reconciliation to ram through giant tax giveaways to the wealthy and big corporations - and to do it without bipartisan support,” said Rep. John Yarmuth (D-Ky.), the ranking member of the House Budget Committee.

The Senate is proceeding on a separate track toward passing its own budget, which will have to be reconciled with the House version in the coming weeks.

Yet, as The Hill notes, there are already signs of trouble, with some Republicans questioning whether the tax proposal would add too much to the deficit, and others balking at plans to eliminate a deduction for state and local taxes. The tax plan is now estimated to add $1.5 trillion to the deficit over a decade, but that figure would grow if the state and local tax deduction is not eliminated.

Trump Tax Plan Leaked, Includes Tax Cuts For Wealthiest Americans; Morgan Stanley Skeptical

Ahead of the Trump administration"s official disclosure of what its latest tax proposal would look like, overnight Axios leaked some of the more salient highlights, the first being that the tax rate for the wealthiest Americans would be cut to 35% and second, taxes on on big and small businesses would be reduced substantially, with plans to cut the top tax rate for “pass through" businesses from 39.6% to 25% - a move which would impact LLCs and sole-proprietorships. As Axios explains, this change would have a material impact on most small businesses in America, which do not pay the corporate tax and instead have their profits “passed through” to owners and taxed at the individual income rate. Bloomberg also adds that at the same time Republican negotiators are targeting a corporate tax rate of 20 percent, according to two people familiar with the matter. That would be higher than the 15% President Donald Trump wants, setting up a key decision for the president on a top legislative priority.

The plan was conceived by the "Big Six" Republicans, a group which includes House Speaker Paul Ryan, Senate Majority Leader Mitch McConnell, Treasury secretary Steven Mnuchin, White House economic adviser Gary Cohn, and the chairmen of the two tax-writing committees — Senate Finance Committee chairman Orrin Hatch and House Ways and Means chairman Kevin Brady.

Some further details, per Axios" sources:

• Top individual tax rate cut from 39.6 to 35. The current seven income tax brackets collapsed to three, as part of simplification. (Axios hasn"t obtained the other two rates.)


• Axios can confirm that the Big Six agreed to cut the corporate tax rate from 35 percent to 20 percent. That key detail leaked last night to the Washington Post. (Trump has said he wants the corporate rate to be 15 percent.)


• The Big Six framework is also expected to include guardrails to prevent wealthy people from artificially lowering their income taxes by rearranging their affairs to get taxed at the small business rate.


• We can confirm, too, WashPo"s reporting that under the Big Six framework there"ll only be three individual income tax brackets rather than the current seven, and that Republicans plan to double the standard deduction — a boost for the middle class and a key component of simplification.

As Axios adds, this "Big Six" tax framework "named because it"s been hashed out behind closed doors between six top Republicans and administration officials" will set up a clash with Democrats over the tax breaks that apply to large corporations and upper income Americans, as Democrats have already drawn a red line on tax reform and 45 out of 48 Democratic senators signed a letter saying they wouldn"t support any tax bill that adds to the deficit or offers new tax breaks to the wealthiest Americans.

At the same time, "republicans are desperate for a win and appear on course to fund tax cuts with a blend of deficit spending and the closing of loopholes. They will dare Democrats, especially the 10 senators up for re-election in states Trump won, to vote against tax breaks for their constituents."

Trump and Treasury Secretary Steven Mnuchin have said previously that they didn’t want the tax plan to offer any tax cut to the highest earners and that they’d balance a rate cut by eliminating deductions that the wealthy use to reduce their tax bills. Mnuchin said in November, weeks after Trump’s election, that “there will be no absolute tax cut for the upper class.”

Reminded of that on Sunday, Mnuchin said he never made a "pledge" that there would be no absolute tax cut for the upper class in the administration"s tax plan. During an interview on CNN"s "State of the Union," Mnuchin was asked about previous comments, in which he said there would be no absolute tax cut for the upper class.

"Can you reaffirm that pledge that there will be "no absolute tax cut for the upper class?" CNN"s Jake Tapper asked Mnuchin.

"It was never a promise. It was never a pledge...It was what the president"s objective was," Mnuchin said. Mnuchin said the administration has been working with the bipartisan leadership.

"We look forward to releasing the plan this week," Mnuchin said. "I think what"s important about this plan is it creates a middle-income tax cut. It makes businesses competitive and it creates jobs. That"s what this is all about." Mnuchin also said there are "lots of changes" as it relates to the "high end."

"We"re getting rid of lots of deductions," he said. "And yes, I can tell you, the current plan for many, many people, it will not reduce taxes on the high end." He also said the plan will provide a middle-income tax cut and said it will create jobs. Mnuchin also said that there was a meeting on tax reform on Tuesday at the White House with congressional Republicans and Democrats,

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Despite the growing movement on Trump"s tax reform, in a note released earlier this week, Morgan Stanley"s Michael Zezas said that he is skeptical of bipartisanship and Q4 is a logjam, "but tax reform should make slow progress toward 2018 passage even as failure risks remain. Deficit expansion is part of the deal, but limited in scope & stimulus."

Below are Zezas" observations on what happens next:

We expect the tax reform process to temporarily take a backseat to some legislative "must do"s" in 4Q. The latest continuing resolution and debt ceiling suspension expire on December 8. A fix to the former is complicated by the need to raise expiring budget caps. On the latter, while cash-management measures should extend the "drop dead date" on the debt ceiling until April (or, with a little luck, June), we believe Republicans will address this "early", in 4Q, and include the debt ceiling increase in the end-of-year deal to avoid voting on it next year closer to the midterms while they are finalizing tax reform. December is further complicated by the Democrats" declaration that they will include a DACA fix to all "must-pass" legislation. We expect a face-saving resolution to emerge (potentially after a series of one-week extensions), but similar events have been volatility-inducing, historically.

Tax reform should survive, but advance more slowly than the current proposed timeline (1H18 passage est.). With data from historical tax cuts as our guide, we continue to expect a modest deficit expansion that delivers little near-term stimulus: We expect the tax reform effort to survive the pitched policy battles about immigration and near-term government funding. Republicans" conceptual policy agreement on the issue, and desire to avoid squandering one-party control, likely supersede any lingering divisions and help the party continue its progress. However, some management of expectations regarding the timing and content of tax reform is in order, and outcome risks are skewed toward our bear case.

• Base case – a complex simplification: In our view, reconciliation limits the ambition of tax plans, and waters down even the less aggressive proposal we expect next week. Corporate reforms are phased in, with a terminal rate of 25% paid for by repatriation, haircuts to interest deduction, and dynamic scoring. Personal tax code changes include permanent "simplification" and temporary, but modest, rate cuts paid for through dynamic effects and an income-based limitation of itemized deductions. First-year deficits would be projected to rise by a modest 0.5% of GDP, similar to the year 1 scores of the Bush tax cuts, given that currently proposed rate cuts score as similar deficit expansions.


• Bull case – all dessert, no vegetables: Holdout fiscal hawks abandon caution and fully embrace supply-side faith that tax cuts pay for themselves as special interest groups push back on initially proposed limitations to deductions. Corporate tax changes remain similar to the base case, but deficit-funded, temporary personal cuts are accommodated by either extending the budget window or replacing the JCT as the official legislative scorer. First-year deficits would be projected to expand by about 1% of GDP, the high end of the impact from recent, similarly sized, unfunded tax cuts.


• Bear case – party foul: No legislative action before the midterm elections as Republicans fail to clear any of a number of hurdles: key policy disagreements; delayed response to existing legislative needs  like DACA or the debt ceiling; and an unforeseen crisis requiring Congressional attention.

Morgan Stanley concludes with the following five takeaways for Investors:

1. Stimulus may disappoint, but progress is enough for risk markets near term;


2. US dollar flow from repatriation may disappoint;


3. Relative fundamental equity sector winners include retail, telecom, energy, & utilities;


4. Tbills issuance may grow by $200B in 1Q18;


5. Be prepared for Q4 volatility, opportunity.

In any case, President Trump plans to give a speech unveiling the Big Six framework in Indiana on Wednesday. The framework is the starting point for the tax reform process. It reflects the shared view of the Big Six, but it will inevitably change substantially as it goes through the normal legislative processes in the House and Senate.

Finally, going back to Axios, here are five things which it believes can trip the process.

• The National Federation of Independent Business (NFIB,) the leading small business association, wants to equalize the small business rate and the corporate rate. Under the current plan, that"s not happening. The corporate rate will be 20 percent and the small business rate 25 percent. "That"s going to be controversial, but it"s not a deal-breaker I don"t think," said a source close to the process.


• House conservatives — especially the Freedom Caucus — haven"t been involved in the Big Six discussions and they want the corporate rate to be much lower, at 16 percent. Republican leaders say there"s no way that"s going to happen, and Treasury Secretary Mnuchin agrees.
  The Trump tax plan will likely add to deficits, at least in the short term, which will bother some deficit hawks. But tax reform advocates were heartened when, just this week, Senate Republicans on the


• Budget Committee cut a deal that would reduce government revenue by as much as $1.5 trillion over 10 years. Republicans argue that, with economic growth spurred by the tax reform, there"ll be substantially less lost revenue than $1.5 trillion.


• Realtors and home builders won"t be happy with the doubling of the standard deduction. That"s because lots more people will take the standard deduction and many fewer will itemize their tax returns. A prevailing belief in the real estate world is that under those conditions, fewer people will take the mortgage interest deduction, which could mean fewer homes being purchased.


• Whichever groups are hit up for the "pay-fors" — the loopholes being closed — will inevitably form lobby groups and oppose those elements of the plan.

Illinois House Approves Historic 32% Tax Increase, Governor Vows Veto

With Illinois, which on Saturday morning entered its third fiscal year without a budget, facing a catastrophic downgrade, late on Sunday evening the Illinois House approved the most controversial element of a budget package, a tax hike which will increase the income tax rate by 32% from 3.75% to 4.95%, and the corporate income tax rate from 5.25% to 7%, to try and end a historic budget impasse. The bill passed 72-45. The House also approved a $36 billion spending plan minutes later on a 81-34 vote. According to the Sun Times, it cleared an initial hurdle on Friday with 23 Republicans voting “yes.”

“While no one could say this was an easy decision, it was the right decision,” House Speaker Mike Madigan said after the spending bill vote. “There is more work to be done.” Dems said they would work with Republicans on other resolution of other issues on table.

The proposed tax increase will now head back to the Illinois Senate, which approved a revenue bill on May 23 with all Democratic votes as part of its “grand bargain” package. But Governor Bruce Rauner has said he’ll only support an income tax hike if it’s limited to four years and paired with a four-year property tax freeze. He’s also still seeking changes in workers’ compensation and pensions.

Commenting on the just passed House bill, Rauner said he’ll veto the revenue bill.

“I will veto Mike Madigan’s permanent 32% tax hike. Illinois families don’t deserve to have more of the hard-earned money taken from them when the legislature has done little to restore confidence in government or grow jobs,” Rauner said.

“Illinois families deserve more jobs, property tax relief and term limits. But tonight they got more of the same." He also said in an emailed statement that “if the legislature is willing to pass the largest tax hike in state history with no reforms, then we must engage citizens and redouble our efforts to change the state."

Some commentators promptly countered that Rauner"s veto will likely be overriden.

The tax bill passed with some essential Republican support: it needed 71 votes. But Illinois House Republican Leader Jim Durkin questioned how it will address the state’s $14 billion backlog. Durkin is seeking to get Rauner the “balanced budget package,” he wants, which includes spending reductions and “meaningful reforms.”

“I am disappointed that we’re taking this up at this moment when there has been significant, significant progress to address the priorities of the governor and also the priorities of this caucus,” Durkin said.

There are, of course, political ramifications to supporting a tax hike, on both sides of the aisle. Some House Democrats were expected to vote no to try to shield themselves from Illinois Republican Party attacks in next year’s election. But some House Republicans, knowing they’d too be targeted for supporting it. said there’s no other choice.

Others were even more fatalistic: “If I lose my seat so be it,” state Rep. Michael Unes, R-Pekin said, adding the state shouldn’t have gotten so close to a financial collapse. “Without this, we will lose thousands of lives and thousands of jobs and the alternative is so much worse. I don’t like this. This is not easy. This is really, really difficult,” Unes said. “But the alternative is much worse than this. The alternative is literally taking our state off the cliff.”

David Harris was among the Republicans who supported the bill, while also urging the governor to sign the revenue and spending bills if passed: “Have the courage to do what is right and bring this madness to an end.” 

“I was not elected as a state legislator to help preside over the financial destruction of this great state,” Harris said. “I respect my colleagues who are voting no. But to me, enough is enough.”

Meanwhile, changes made by House Democrats from the original Senate bill include the removal of streaming and satellite fees. It also closed corporate tax loopholes, increased the earned income tax credit, and restored the research and development and manufacturers’ tax credit to attract more businesses.

House Democrats filed amendments to both the tax and spending measures on Sunday, which included nearly $400 million more in cuts. Although some House Republicans voiced frustrations over changes, House Democrats said they were reflective of topics discussed during negotiations.

It is unclear if the passed tax increase will be sufficient to placate S&P. Recall July 1 was the date when the credit agencies said they would drop the state to “junk” status without a budget. Ultimately, the fate of Illinois" credit rating is now in the hands of Rauner, and whether and how fast his imminent veto is overriden.

Ultimately, Illinois faces a lose-lose dilemma: get junked and see its funding costs soar, or save its lowest possible investment grade rating, and watch as what is already the worst metropolitan exodus (recently the population of Chicago shrank the most of any US city), go into overdrive as tens of thousands more scramble to escape the state"s soaring tax rates.