3-Month Bills Turmoil Ahead Of March Debt Ceiling Showdown: Bid To Cover Plunges To 8 Year Lows

Despite the GOP"s tax reform victory, over the past few weeks, Congress once again punted on a formal decision how to keep government funded and what to do with America"s debt ceiling and as a result US legislators simply kicked the can on the agreement of raising the nation’s borrowing limit for another few months. However, with the Treasury expected to breach the ceiling as soon as late March, today"s $45 billion 3-Month Bill auction was closely watched as it serves as a fresh gauge of investor anxiety about the ongoing impasse.

As a reminder, in the first week of December, the Treasury deployed a series of extraordinary measures to stay under the debt ceiling cap since it was reinstated on December 8. But T-bill investors, in both the primary and secondary market,  remain especially wary given questions over what’s known as the debt ceiling’s drop-dead date. Today"s Bills mature March 29, within the Congressional Budget Office’s late-March to early-April window for when Treasury will exhaust the extra capacity it’s using to keep below the $20.5 trillion limit.

Quoted by Bloomberg, Justin Mandeville of Inveso said that the late-December bill auctions “speak volumes to investors being cautious as to when the potential drop-dead date will be,” adding that “we saw it back in July when we had concerns about the October bills.”

And sure enough, having just concluded, the 3M bill was especially ugly, pricing at 1.445%, or a 3bps tail to the 1.415% When Issued, with Indirect Buyers fleeing, and taking down just 20.1% of the finally allotment, down from 30.8% in the last 6 auctions, while Primary Dealers had no choice but to step up aggressively from 61.9% in the 6MMA, to 74% as Direct interest also fizzled from 7.3% in the last 6 auctions to just 5.9%. But nowhere was the revulsion quite so visible as in the bid to cover, which plunged from 3.04 in the past 6 auctions to just 2.71 on Dec. 26: this was the lowest Bid to Cover since January 2009.

As Bloomberg reminds us, at the government’s July 24 auction, the US Treasury sold $39 billion of three-month bills at 1.18 percent, then the highest rate since 2008. The bid to cover for that particular sale also matched the lowest for the maturity since 2009. Congress wound up passing a three-month debt-ceiling suspension Sept. 8, weeks before Treasury Secretary Steven Mnuchin estimated the government would run out of cash.

However, revulsion to paper that could be impacted by the debt ceiling was not just in the primary market: it also hit the secondary Bill market, as the previously noted kink that has emerged in the bill curve between securities maturing in late March and those in early April, has gotten even more pronounced. For several days after the Dec. 18 auction of bills maturing March 22, the rate on these securities was higher than debt maturing a week later. Since then, the rate on securities expiring March 29 has climbed to 1.44%, exceeding those on bills due the following week by nearly 10 bps as shown in the chart below.

And so, looking at the debt ceiling fight that refuses to go away despite the can being kicked every few months, while there is still a chance the issue could be resolved without going down to the wire, it is unlikely: while lawmakers hammered out a spending bill this week to keep the government open through Jan. 19, they didn’t include a provision to lift or suspend the debt ceiling. The longer a resolution remains at the bottom of Congress’s to-do list, the larger the T-bill dislocations could grow. Sooner or later, the bond market - which has been crying wolf on a technical US default - will eventually be right.

Traub: "The US Has Reached The Last Stage Before Collapse"

Authored by James Traub via Foreign Policy,

The United States of America Is Decadent and Depraved

The problem isn’t Donald Trump – it’s the Donald Trump in all of us...

In The History of the Decline and Fall of The Roman Empire, Edward Gibbon luridly evokes the Rome of 408 A.D., when the armies of the Goths prepared to descend upon the city. The marks of imperial decadence appeared not only in grotesque displays of public opulence and waste, but also in the collapse of faith in reason and science. The people of Rome, Gibbon writes, fell prey to “a puerile superstition” promoted by astrologers and to soothsayers who claimed “to read in the entrails of victims the signs of future greatness and prosperity.”

Would a latter-day Gibbon describe today’s America as “decadent”? I recently heard a prominent, and pro-American, French thinker (who was speaking off the record) say just that. He was moved to use the word after watching endless news accounts of U.S. President Donald Trump’s tweets alternate with endless revelations of sexual harassment. I flinched, perhaps because a Frenchman accusing Americans of decadence seems contrary to the order of nature. And the reaction to Harvey Weinstein et al. is scarcely a sign of hysterical puritanism, as I suppose he was implying.

And yet, the shoe fit. The sensation of creeping rot evoked by that word seems terribly apt.

Perhaps in a democracy the distinctive feature of decadence is not debauchery but terminal self-absorption - the loss of the capacity for collective action, the belief in common purpose, even the acceptance of a common form of reasoning. We listen to necromancers who prophesy great things while they lead us into disaster. We sneer at the idea of a “public” and hold our fellow citizens in contempt. We think anyone who doesn’t pursue self-interest is a fool.

We cannot blame everything on Donald Trump, much though we might want to. In the decadent stage of the Roman Empire, or of Louis XVI’s France, or the dying days of the Habsburg Empire so brilliantly captured in Robert Musil’s The Man Without Qualities, decadence seeped downward from the rulers to the ruled. But in a democracy, the process operates reciprocally. A decadent elite licenses degraded behavior, and a debased public chooses its worst leaders. Then our Nero panders to our worst attributes — and we reward him for doing so.

“Decadence,” in short, describes a cultural, moral, and spiritual disorder — the Donald Trump in us. It is the right, of course, that first introduced the language of civilizational decay to American political discourse. A quarter of a century ago, Patrick Buchanan bellowed at the Republican National Convention that the two parties were fighting “a religious war … for the soul of America.” Former Speaker Newt Gingrich (R-Ga.) accused the Democrats of practicing “multicultural nihilistic hedonism,” of despising the values of ordinary Americans, of corruption, and of illegitimacy. That all-accusing voice became the voice of the Republican Party. Today it is not the nihilistic hedonism of imperial Rome that threatens American civilization but the furies unleashed by Gingrich and his kin.

The 2016 Republican primary was a bidding war in which the relatively calm voices — Jeb Bush and Marco Rubio — dropped out in the early rounds, while the consummately nasty Ted Cruz duked it out with the consummately cynical Donald Trump. A year’s worth of Trump’s cynicism, selfishness, and rage has only stoked the appetite of his supporters. The nation dodged a bullet last week when a colossal effort pushed Democratic nominee Doug Jones over the top in Alabama’s Senate special election. Nevertheless, the church-going folk of Alabama were perfectly prepared to choose a racist and a pedophile over a Democrat. Republican nominee Roy Moore almost became a senator by orchestrating a hatred of the other that was practically dehumanizing.

Trump functions as the impudent id of this culture of mass contempt.

Of course he has legitimized the language of xenophobia and racial hatred, but he has also legitimized the language of selfishness. During the campaign, Trump barely even made the effort that Mitt Romney did in 2012 to explain his money-making career in terms of public good. He boasted about the gimmicks he had deployed to avoid paying taxes. Yes, he had piled up debt and walked away from the wreckage he had made in Atlantic City. But it was a great deal for him! At the Democratic convention, then-Vice President Joe Biden recalled that the most terrifying words he heard growing up were, “You’re fired.” Biden may have thought he had struck a crushing blow. Then Americans elected the man who had uttered those words with demonic glee. Voters saw cruelty and naked self-aggrandizement as signs of steely determination.

Perhaps we can measure democratic decadence by the diminishing relevance of the word “we.” It is, after all, a premise of democratic politics that, while majorities choose, they do so in the name of collective good. Half a century ago, at the height of the civil rights era and Lyndon B. Johnson’s Great Society, democratic majorities even agreed to spend large sums not on themselves but on excluded minorities. The commitment sounds almost chivalric today. Do any of our leaders have the temerity even to suggest that a tax policy that might hurt one class — at least, one politically potent class — nevertheless benefits the nation?

There is, in fact, no purer example of the politics of decadence than the tax legislation that the president will soon sign. Of course the law favors the rich; Republican supply-side doctrine argues that tax cuts to the investor class promote economic growth. What distinguishes the current round of cuts from those of either Ronald Reagan or George W. Bush is, first, the way in which they blatantly benefit the president himself through the abolition of the alternative minimum tax and the special treatment of real estate income under new “pass-through” rules. We Americans are so numb by now that we hardly even take note of the mockery this implies of the public servant’s dedication to public good.

Second, and no less extraordinary, is the way the tax cuts have been targeted to help Republican voters and hurt Democrats, above all through the abolition or sharp reduction of the deductibility of state and local taxes. I certainly didn’t vote for Ronald Reagan, but I cannot imagine him using tax policy to reward supporters and punish opponents.

He would have thought that grossly unpatriotic. The new tax cuts constitute the economic equivalent of gerrymandering. All parties play that game, it’s true; yet today’s Republicans have carried electoral gerrymandering to such an extreme as to jeopardize the constitutionally protected principle of “one man, one vote.” Inside much of the party, no stigma attaches to the conscious disenfranchisement of Democratic voters. Democrats are not “us.”

Finally, the tax cut is an exercise in willful blindness. The same no doubt could be said for the 1981 Reagan tax cuts, which predictably led to unprecedented deficits when Republicans as well as Democrats balked at making offsetting budget cuts. Yet at the time a whole band of officials in the White House and the Congress clamored, in some cases desperately, for such reductions. They accepted a realm of objective reality that existed separately from their own wishes. But in 2017, when the Congressional Budget Office and other neutral arbiters concluded that the tax cuts would not begin to pay for themselves, the White House and congressional leaders simply dismissed the forecasts as too gloomy.

Here is something genuinely new about our era: We lack not only a sense of shared citizenry or collective good, but even a shared body of fact or a collective mode of reasoning toward the truth. A thing that we wish to be true is true; if we wish it not to be true, it isn’t. Global warming is a hoax. Barack Obama was born in Africa. Neutral predictions of the effects of tax cuts on the budget must be wrong, because the effects they foresee are bad ones.

It is, of course, our president who finds in smoking entrails the proof of future greatness and prosperity. The reduction of all disagreeable facts and narratives to “fake news” will stand as one of Donald Trump’s most lasting contributions to American culture, far outliving his own tenure. He has, in effect, pressed gerrymandering into the cognitive realm. Your story fights my story; if I can enlist more people on the side of my story, I own the truth. And yet Trump is as much symptom as cause of our national disorder. The Washington Post recently reported that officials at the Center for Disease Control were ordered not to use words like “science-based,” apparently now regarded as disablingly left-leaning. But further reporting in the New York Times appears to show that the order came not from White House flunkies but from officials worried that Congress would reject funding proposals marred by the offensive terms. One of our two national political parties — and its supporters — now regards “science” as a fighting word. Where is our Robert Musil, our pitiless satirist and moralist, when we need him (or her)?

A democratic society becomes decadent when its politics, which is to say its fundamental means of adjudication, becomes morally and intellectually corrupt. But the loss of all regard for common ground is hardly limited to the political right, or for that matter to politics. We need only think of the ever-unfolding narrative of Harvey Weinstein, which has introduced us not only to one monstrous individual but also to a whole world of well-educated, well-paid, highly regarded professionals who made a very comfortable living protecting that monster. “When you quickly settle, there is no need to get into all the facts,” as one of his lawyers delicately advised.

This is, of course, what lawyers do, just as accountants are paid to help companies move their profits into tax-free havens. What is new and distinctive, however, is the lack of apology or embarrassment, the sheer blitheness of the contempt for the public good. When Teddy Roosevelt called the monopolists of his day “malefactors of great wealth,” the epithet stung — and stuck. Now the bankers and brokers and private equity barons who helped drive the nation’s economy into a ditch in 2008 react with outrage when they’re singled out for blame. Being a “wealth creator” means never having to say you’re sorry. Enough voters accept this proposition that Donald Trump paid no political price for unapologetic greed.

The worship of the marketplace, and thus the elevation of selfishness to a public virtue, is a doctrine that we associate with the libertarian right. But it has coursed through the culture as a self-justifying ideology for rich people of all political persuasions — perhaps also for people who merely dream of becoming rich.

Decadence is usually understood as an irreversible condition — the last stage before collapse. The court of Muhammad Shah, last of the Mughals to control the entirety of their empire, lost itself in music and dance while the Persian army rode toward the Red Fort. But as American decadence is distinctive, perhaps America’s fate may be, too. Even if it is written in the stars that China will supplant the United States as the world’s greatest power, other empires, Britain being the most obvious example and the one democracy among them, have surrendered the role of global hegemon without sliding into terminal decadence.

Can the United States emulate the stoic example of the country it once surpassed? I wonder. The British have the gift of ironic realism. When the time came to exit the stage, they shuffled off with a slightly embarrassed shrug. That, of course, is not the American way. When the stage manager beckons us into the wings we look for someone to hit — each other, or immigrants or Muslims or any other kind of not-us. Finding the reality of our situation inadmissible, like the deluded courtiers of the Shah of Iran, we slide into a malignant fantasy.

But precisely because we are a democracy, because the values and the mental habits that define us move upward from the people as well as downward from their leaders, that process need not be inexorable. The prospect of sending Roy Moore to the Senate forced a good many conservative Republicans into what may have been painful acts of self-reflection. The revelations of widespread sexual abuse offer an opportunity for a cleansing moment of self-recognition — at least if we stop short of the hysterical overreaction that seems to govern almost everything in our lives.

Our political elite will continue to gratify our worst impulses so long as we continue to be governed by them. The only way back is to reclaim the common ground — political, moral, and even cognitive — that Donald Trump has lit on fire. Losing to China is hardly the worst thing that could happen to us. Losing ourselves is.

 

"Here"s What"s In It": Goldman Explains All You Need To Know About The Current State Of Tax Reform

To the delight of Donald Trump, just before 2am on Saturday morning the Senate passed the Republican Tax bill in a 51-49 vote, and with tax reform legislation now passing both chambers of Congress it looks very likely to become law by year-end, probably within the next two weeks according to Goldman Sachs which now ascribes a 90% probability of the legislation becomes law by year end.

In it latest assessment of the state of tax reform, Goldman analysts Alex Phillips and Jan Hatzius write that while largely a done deal, some differences between the two versions still need to be ironed out: "We expect the final structure of the bill to reflect more of the Senate bill than the House bill, including a 20% corporate tax rate effective in 2019, the Senate’s more restrictive limit on net interest deductibility, and the Senate’s treatment of pass-through income. Both proposals now include a $10k cap on state and local property tax deductibility, rather than full repeal, eliminating the most important political difference between the bills before the conference negotiations start."

Additionally, Goldman adds that while the corporate tax changes are likely to result in a net tax reduction in corporate tax liabilities, the size of the tax cut actually looks fairly small. Compared to current policy, the compromise legislation we expect to emerge from the conference committee would reduce the effective corporate tax rate by only a couple of percentage points.

Perhaps the most surprising take home from the Goldman analysis is that while the bank has increased its estimate of the growth impact from tax reform slightly, to around 0.3% in 2018 and 2019 - "reflecting the slightly larger amount of tax cuts in the Senate plan following revisions, and our expectations regarding the eventual compromise" - it still expects a relatively modest boost to overall economic growth.

That said, questions remains, most notably: "what"s in the actual bill?"

To answer, we publish the latest Goldman analysis for those still confused - which would be pretty much everyone - what is currently contained in the most sweeping tax overhaul in the US since the days of Ronald Reagan.

Tax Reform: The Home Stretch

Q: The Senate has passed the bill, now what?

A: Differences between the House and Senate bills are likely to be reconciled in a conference committee. A conference committee involves the appointment of conferees of both parties from the House and the Senate, with a majority of conferees needed to approve the final agreement. As a practical matter, House and Senate Republican leaders and a few other relevant Republican lawmakers are likely to negotiate the final agreement, as recent votes in the House and Senate demonstrate that Democratic support is unlikely to be needed to conclude the conference negotiation. Once the final conference report has been filed, the House and Senate must pass it once again before sending it to the President for signature. A simple majority would be required in both chambers, with no changes possible.

A possible alternative would be for the House to simply pass the Senate-passed bill, avoiding the conference process and expediting enactment. In light of the impending special Senate election in Alabama, upcoming fiscal deadlines, and general political uncertainty, congressional Republican leaders might consider this option if conference negotiations take longer than expected, though at this stage a conference committee looks much more likely.

We expect congressional Republican leaders to begin conference negotiations immediately, and believe they will target completion the week of December 11. If successful, this would produce final details around December 11-13, and final passage in the House and Senate December 14-15. One reason we expect this timing is because of the need to address expiring spending authority by December 8, which we expect to be extended temporarily through December 22, creating only a short period before year end when Congress is not addressing other fiscal deadlines.

Q: How likely is this to become law?

A: It is extremely likely that tax reform legislation becomes law, with a 90% chance it becomes law by year-end. Our view has been that once legislation has cleared the Senate, the odds of enactment would be quite high because the Senate has always represented the greatest obstacle to enactment. Reconciling differences in the conference committee represents a risk, but we do not believe congressional Republicans would allow tax reform to fail after having passed similar versions in both chambers. Even in the event that the conference negotiation bogs down, we expect that the House would simply adopt the Senate-passed version if there were no other alternative, though a compromise through a conference committee looks much more likely at this point.

Although the legislative process has been slower than we expected for the most of the year, over the last couple of months we have been consistently surprised at how quickly congressional Republicans have made progress on tax reform. The final step in the process, the House-Senate conference committee, often takes several weeks to complete; in 1986 it took conferees two months to reconcile differences between House and Senate versions of tax reform legislation, for example. However, it would not be unprecedented for a conference committee on major tax legislation to be completed in less time; the conference process for the 1981, 2001, and 2003 tax cuts took a week or less, for example. With the apparent motivation that congressional Republicans have to finish work on tax reform this year, we expect that a conference agreement between the House and Senate could be voted upon by mid-December. While it is possible that consideration of tax reform could spill over into January, at this point enactment in December looks far more likely.

Q: How does this compare to consensus?

A: Market pricing also reflects a view that tax reform is likely to become law. Over the last few weeks, high-tax stocks have outperformed low-tax stocks (Exhibit 2). This reflects, in our view, a growing expectation of tax reform, which should benefit companies with high effective tax rates more than companies with low effective tax rates. Prediction markets, which as recently as October ascribed only a 20% probability to tax reform being enacted this year, now imply a nearly 80% probability. The implied probability by the end of Q1 is around 95%. Our conversations with clients also suggest little remaining uncertainty regarding whether the bill becomes law. Instead, the focus has shifted to what changes might still be made, how differences between the House and Senate versions will be resolved, and what the effect will be across sectors.

Q: What changed in the Senate bill?

A: The pass-through, state and local tax (SALT), and capex expensing provisions became more generous, while alternative minimum tax (AMT) changes and profit repatriation rates became less generous. Among the major changes the Senate made prior to committee-passed version of the bill:

• Some property taxes would be deductible. The first $10k in state and local property taxes could be deducted under the Senate bill, bringing it into line with the House version. Previously no state and local taxes could be deducted from non-business income under the Senate version.


• The deduction for pass-through income has increased to 23%. The benefit would phase out for taxpayers with income above $500k, similar to the prior version. For taxpayers with total income near the limit who would otherwise be in the 35% bracket under this proposal, this would work out to tax rate on pass-through income of roughly 27%, rather than 29% under the prior version.


• Capex benefits would last slightly longer. Under the prior proposal, full expensing of equipment investment would have expired after 2022. With the recent revisions, the share of equipment that could be deducted in the year of investment would decline by 20pp after 2022, expiring fully in 2027.


• No AMT repeal, after all. The AMT imposes additional tax beyond the standard income tax on middle- and upper-income taxpayers with substantial deductions, among other circumstances. A separate AMT is applied to corporations. The House bill and original Senate bill would have eliminated the AMT; the revised Senate version increases the exemption amount for individuals but stops short of repeal; the corporate AMT appears to be left in place as well. Individual and corporate AMT repeal were estimated to reduce revenues by $770bn and $40bn respectively; this change is expected to offset the cost of some of the more generous provisions noted above.


• Higher tax rates on unrepatriated profits. The prior Senate n proposal would have taxed untaxed foreign profits at 10% if held in cash or liquid assets, or 5% if not. The current version steps up those tax rates to 14.5% and 7.5%.

Q: What happened to the “trigger” idea?

A: The trigger was dropped because it became politically unnecessary. Senator Corker (R-TN) and several other senators who were concerned about the deficit impact of the legislation had proposed a provision that would reverse some of the tax cuts several years from now if revenues had not grown more quickly than the official projections. As the revenue gain from the trigger would have been contingent on economic developments, the trigger was ruled noncompliant with the “Byrd Rule”, which stipulates that only provisions that have a fiscal effect can be included in budget reconciliation legislation. After this ruling, and other changes to the bill, all but one Republican senator had announced public support for the bill, meaning that it had sufficient support without the trigger. It is possible that the concept could be revisited if there is insufficient support for the final conference agreement without it, but at this point a trigger looks very unlikely.

Q: What are the remaining issues that need to be worked out?

A: The greatest policy differences between the House and Senate bills involve the AMT and top marginal rate, pass-through treatment, corporate provisions dealing with cross-border transactions, and net interest deductibility. Exhibit 3 summarizes the differences between the House-passed and Senate-passed versions, along with the estimated revenue effects over ten years estimated by the Joint Committee on Taxation (JCT). The right column of Exhibit 3 suggests what a potential compromise between the two versions might look like that would stay under the $1.5 trillion overall limit on revenue loss imposed by the recently passed budget resolution.

Q: Will the ACA mandate be repealed?

A: We expect the penalty on the uninsured to be set to $0, which would have the same practical effect as repeal. The Senate legislation sets the penalty on the uninsured to $0, which is estimated to generate over $300bn in budgetary savings over the next ten years. This is used to expand other tax cuts in the bill. House Republicans have been more supportive of repealing the individual mandate than Senate Republicans have, so Senate passage suggests that this change is likely to be included in the final version of the legislation, in our view.

Repealing the mandate would have two main effects. First, insurance coverage would decline. CBO has estimated that the level of uninsured would rise by 4 million in the first year after mandate repeal, and by 12 million in the third year.1 Given that the enrollment period for 2018 concludes in less than two weeks on December 15, around the same time that we expect tax reform legislation to become law, our expectation would be that the decline in coverage in 2018 would be somewhat smaller than the CBO estimate but that the effect in later years would be similar.

Second, premiums in the individual market would increase. CBO has estimated that average premiums would rise by about 10% without the mandate. Younger and healthier individuals are the most likely to drop coverage without the mandate. This would leave the remaining risk pool older and less healthy, leading to an increase in premiums. That said, since ACA subsidies are designed so that the government pays the portion of premium that exceeds a certain percentage of an individual’s income, subsidized enrollees would be responsible for only some or, in some cases, none of the additional premium cost. By contrast, unsubsidized enrollees would bear the full increase. CBO has estimated that the individual insurance market would continue to be stable without the individual mandate.

Q: How will corporate interest deductibility change?

A: The outlook here is murkier than in most other areas, but fiscal constraints could lead lawmakers to include the more restrictive Senate proposal in the final version. The House-passed legislation restricts net interest deductibility to 30% of an income definition that roughly translates to earnings before interest, taxes, depreciation amortization (EBITDA). By contrast, the Senate restricts interest deductibility to 30% of an income definition that roughly translates to earnings before interest and taxes (EBIT). The difference is substantial, and JCT estimates that the more restrictive Senate version would generate nearly twice as much revenue as the House provision.

Exhibit 4 shows the average interest deduction by industry as a share of each definition, using 2013 data from the IRS. We note that in the House and Senate bills, utilities are excluded from the limitation; the real estate sector is excluded in the House bill as well, and companies in that sector would have the ability to opt out of the limitation in the Senate bill but would lose the benefit of full expensing if they did.

The outcome for this provision is particularly hard to predict but we believe a provision closer to the Senate provision seems more likely to prevail. In light of the need to offset other changes to the bill, we would expect that negotiators will lean toward the version that generates greater savings if they are able to pass the Senate which has tended to be the higher political hurdle for the tax bill in general.

Q: How will the corporate international provisions be settled?

A: We expect the Senate’s “inbound” provisions to prevail, but the “outbound” provisions are hard to predict. The House and Senate both include “outbound” provisions intended to impose a minimum tax on some of the foreign operations of US companies, and “inbound” provisions intended to combat the erosion of the domestic corporate tax base through transactions with foreign affiliates. The general structure of the outbound and inbound proposals is similar in the House and Senate proposals.

The inbound proposals are conceptually similar but differ in the details. In both cases, they would effectively tax deductible payments that a US company makes to its foreign affiliates. In the House, this is structured as a 20% excise tax, though companies would have the option to elect to be taxed on the associated foreign income instead. In the Senate, the proposal would effectively impose a 10% tax on related-party payments. An important difference is that the Senate provision would appear to exclude payments to related foreign manufacturers for cost of goods sold, while the House proposal could tax some of those payments, with potentially greater effects on cross-border supply chains. That said, even the Senate version is likely to have consequences that are only understood after the legislation has been enacted and companies start to implement the new rules.

The outbound proposals are slightly more straightforward. These would impose a tax on any foreign intangible income exceeding a specified return (e.g., 10% in the Senate bill) on foreign tangible assets (e.g., depreciable assets like equipment and structures). Exhibit 5 shows the effective combined US and foreign tax rate under the House and Senate bills. While the House bill would tax half of this income at the 20% domestic corporate rate, for a 10% effective minimum tax, the Senate uses a more complicated structure that taxes all intangible income from foreign assets as US income at the 20% rate, but provides a 37.5% deduction of all intangible-related income related to foreign sales, whether from US assets or foreign assets. This could remove the incentive to move intellectual property and other intangibles to foreign subsidiaries since they would receive the same treatment on their foreign sales regardless of where the assets were held. However, previous US tax regimes that taxed income from US-based assets differently depending on whether the income was generated by sales in the US or in other markets were repealed after they were challenged successfully in the WTO by trading partners. In light of the risk of another successful challenge, we believe the conference committee is slightly more likely to settle on a policy closer to the House
proposal in this area.

Q: When will the changes take effect?

A: Apart from the potential delay in the corporate rate cut, almost all of the changes will take effect at the start of 2018. There are essentially no retroactive tax cuts or tax increases in the House or Senate proposals, with the notable exception of the tax on accumulated untaxed foreign profits. The only major provision that does not take effect at the start of 2018 is the Senate corporate rate reduction, which remains at 35% in 2018 and drops to 20% starting in 2019. We expect this will be included in the final version, since it reduces the ten-year cost of the bill by more than $100bn. Proponents of the delay argue this would also spur more capital investment in 2018, as it would incentivize companies to pull forward capex that would be fully deductible against the 35% rate in 2018 rather than the 20% rate in 2019. Exhibit 6 shows the overall change in tax receipts estimated by the Joint Committee on Taxation, shifted to a calendar year basis. We note corporate tax receipts are estimated to increase in 2018 under the Senate bill, which results from tax payments related to deemed repatriated profits, which would not be offset by a lower corporate tax rate until 2019.

Q: How will the bill affect corporate tax liabilities?

A: It will reduce effective corporate tax rates much less than the 15pp drop in the statutory rate implies. For context, the JCT estimates of the revenue effects of the tax bills are made against a baseline that assumes roughly $3.9 trillion in corporate tax receipts over the next ten years. This suggests that a corporate tax cut of around $300bn/10yrs should result in only a reduction in the effective tax rate across companies of less than 10%. This would result in less than a 2pp decline in the average effective corporate income tax rate, using for example the 19% average effective rate estimated by the Congressional Budget Office (CBO).

The eventual effect also depends on what assumption one makes regarding the extension of expiring provisions. Under current law, corporate taxes would rise by roughly $250bn over the next ten years due to the expiration of the current 50% bonus depreciation policy for equipment investment and a number of smaller expiring policies would add about $150bn more over the next ten years. Exhibit 7 shows the same estimates of the tax changes shown in Exhibit 6, but adds the effect of expiring policies that have not been addressed in the TCJA.

If Congress took no further action on taxes over the next ten years, corporate taxes would actually increase slightly versus current policy. However, most assume that some of these provisions will be extended when they are set to expire; under the Senate-passed bill, 100% immediate expensing of equipment investment is scheduled to phase down by 20% per year starting in 2023 but Congress could step in to prevent this phase-down.

Q: What does this mean for growth?

A: We expect the legislation to boost growth by around 0.3pp in 2018 and 2019. This is based mainly on the Senate version of the bill, which delays the corporate income tax cut to 2019 but includes a tax cut for individuals (including pass-through income) of around 0.6% of GDP in 2018, slightly greater than what we had previously penciled in. The effect is spread over two years in part because some of the provisions that reduce individual income taxes would show up primarily as lower tax settlements in 2019 rather than reduced withholding from paychecks in 2018.

On the corporate side, we disregard the temporary increase in tax payments in 2018 related to the tax on deemed repatriation; we do not estimate a growth effect from those repatriated profits, either. While the corporate tax cut looks likely to take effect with a one year delay, in 2019, we note that there is likely to be some pull-forward of capex from 2019 into 2018, as companies attempt to maximize their deductions against the higher corporate rate.

We note that the effect in 2020 and beyond looks minimal and could actually be slightly negative, as the JCT estimates suggest that the tax cut that year would actually be slightly smaller than in 2019. Exhibit 8 shows our revised estimate of the growth effects of fiscal policy, incorporating an assumption similar to the fiscal effects of the potential compromise shown in Exhibit 3.

Q: What are the political consequences of tax reform?

A: We do not expect it to help Republican prospects very much. Congressional Republicans have suggested that passing tax reform should help them maintain their majority after the 2018 midterm elections. While passing tax cuts ahead of an election should improve the majority party’s prospects, it is less clear that tax reform will provide the political tailwind Republicans are expecting. Certain provisions are controversial, and the bill overall is relatively unpopular among voters; an average of recent polling shows 32% of voters support the legislation, which compares unfavorably with other major tax cuts like the 1981 or 2001 tax bills, or even the roughly revenue-neutral tax reforms enacted in 1986. This is likely because one in three voters believes their taxes will increase because of tax reform, with more Democrats expecting an increase than average.

If these concerns persist, voters are likely to be ambivalent, or worse, regarding tax reform. That said, sentiment might improve if voters perceive over time that their taxes have declined. The Joint Committee on Taxation (JCT) predicts taxes will decrease or stay the same for about 90% of voters through 2021 (Exhibit 9). The most controversial aspects of the legislation also have mixed implications; while voters favor repealing the individual mandate by two to one, for example, repealing SALT deductions continues to be unpopular and could become a liability in the dozen or so competitive Republican-held House districts in New York, New Jersey and California.

In Major Victory For Trump, Senate Passes "Sweeping" Tax Bill Which Nobody Read: Here"s What"s In It

Shortly before 2am on Saturday, the Senate passed "the most sweeping rewrite of the U.S. tax code in three decades, slashing the corporate tax rate and providing temporary tax-rate cuts for most Americans" handing Republicans a badly needed legislative and political victory. Senators voted across party lines in a 51-49 vote, ending days of debate and "hand wringing" as leadership worked frantically behind the scenes to win over holdouts and get the proposal in line with the chamber’s rules.

Tennessee Senator Bob Corker, who had cited concerns over the bill’s effects on federal deficits, was the only Republican dissenter. Corker, who is retiring after 2018, said in a statement ahead of the vote that he "wanted to get to yes" on the tax plan. "But at the end of the day, I am not able to cast aside my fiscal concerns and vote for legislation that I believe, based on the information I currently have, could deepen the debt burden on future generations,” he said.

Corker"s dissent however was not enough to halt passage, and shortly thereafter Vice President Mike Pence presided over the final passage vote. GOP senators, who stayed on the Senate floor until the vote closed after midnight, broke out into applause after Pence announced the bill had passed.  

"This is a great day for the country," Majority Leader Mitch McConnell (R-Ky.) said during a 2 a.m. press conference after the vote.  "We have an opportunity now to make America more competitive, to keep jobs from being shipped off shore and to provide substantial relief for the middle class."

The bill would lower tax rates for individuals through 2025 and permanently cut the corporate tax rate from 35% to 20% (more details below). The bill’s tax cuts for individuals are temporary in order to comply with budget rules that the measure can’t add to the deficit after 10 years. The bill would also repeal ObamaCare’s individual mandate, a priority for President Trump and many Republicans.

* * *

The vote brings the GOP close to delivering a much-needed policy win for their party and President Donald Trump. After the vote, Trump said on Twitter that he looks forward to signing a final bill before Christmas. The president expressed gratitude to McConnell and Finance Committee Chairman Orrin Hatch for steering the measure through the Senate. “We are one step closer to delivering MASSIVE tax cuts for working families across America,” Trump wrote on Twitter.

We are one step closer to delivering MASSIVE tax cuts for working families across America. Special thanks to @SenateMajLdr Mitch McConnell and Chairman @SenOrrinHatch for shepherding our bill through the Senate. Look forward to signing a final bill before Christmas! pic.twitter.com/gmWTny3SfS

— Donald J. Trump (@realDonaldTrump) December 2, 2017

On Saturday morning, Trump followed up his praise to the Senate GOP, tweeting the "Biggest Tax Bill and Tax Cuts in history just passed in the Senate. Now these great Republicans will be going for final passage. Thank you to House and Senate Republicans for your hard work and commitment!"

Biggest Tax Bill and Tax Cuts in history just passed in the Senate. Now these great Republicans will be going for final passage. Thank you to House and Senate Republicans for your hard work and commitment!

— Donald J. Trump (@realDonaldTrump) December 2, 2017

* * *

Amid the republican jubilation over the passage of a bill which is heavily weighted to benefit corporations and pass-throughs, and will encourage all self-employed businesses to become LLCs, there was juist one problem: nobody actually read the 479-page bill.

As Montana Senator Jon Tester wrote late on Friday:

I was just handed a 479-page tax bill a few hours before the vote. One page literally has hand scribbled policy changes on it that can’t be read. This is Washington, D.C. at its worst. Montanans deserve so much better. pic.twitter.com/q6lTpXoXS0

— Senator Jon Tester (@SenatorTester) December 2, 2017

NY Governor Andrew Cuomo showed what the "handwritten notes on the page" looked like:

Senate Republicans are so desperate for a win they are going to pass a tax increase on New York with handwritten changes to the bill. pic.twitter.com/pT2Xvubiy2

— Andrew Cuomo (@NYGovCuomo) December 2, 2017

Commenting on this, Senate Democrat Charles Schumer noted that a set of last-minute revisions to the bill changed it in ways that had yet to be analyzed by the Joint Committee on Taxation, Congress’s official scorekeeper for the effects of tax legislation. “Is this really how Republicans are going to rewrite the tax code? Scrawled like something on the back of a napkin?” However, McConnell said the bill, the first text of which was introduced on Nov. 20, went “through the regular order.” He dismissed complaints like Schumer’s. “You complain about process when you’re losing,” McConnell said.

Bottom line: the chaotic process was similar to how Obamacare was passed on Christmas Eve in 2009: in fact maybe a slight improvement: at least this time Congress didn"t have to "pass the bill to find out what is in it." And it"s not like anyone reads these bills anyway.

So what happens next?

Before it goes to Trump, lawmakers will have to reconcile differences between the Senate bill and one the House passed last month, a process that will begin Monday. Although both versions share common topline elements, negotiations on individual provisions inserted to win votes, particularly in the Senate, may be protracted and difficult. The final product will end up being a central issue in the 2018 elections that will determine control of Congress.

“We’re going to take this message to the American people a year from now,” Senate Majority Leader Mitch McConnell said after the vote.

* * *

Among the major overhauls, both the House and Senate measures would cut the corporate tax rate to 20% from 35% - though the Senate version would set that lower rate in 2019, a year later than the House bill would. Also, the Senate bill, unlike the House version, would provide only temporary tax relief to individuals, ending tax cuts for them in 2026. Both bills are expected to add more than $1.4 trillion to the federal deficit over 10 years, before accounting for any economic growth. Bloomberg reported that last minute revisions to help shore up GOP support added about $32.5bn to the measure’s 10-year cost, according to a one-page analysis from the Congressional Budget Office.

The House and Senate bills also align on the contentious issue of individual deductions for state and local taxes: They’d eliminate all but a deduction for property taxes, which would be capped at $10,000. They differ on the home mortgage-interest deduction; the House bill would restrict that break to loans of $500,000 or less with regard to new purchases of homes. The Senate legislation would leave the current $1 million cap in place.

According to Bloomberg, the bills also differ on the tax rates they’d apply to multinational companies’ accumulated offshore earnings. The House bill would tax those profits at 14 percent for earnings held as cash and 7 percent for less-liquid assets. The revised Senate bill contains a lengthy section that has no direct mention of the rates, but a person familiar with the Senate plan said they’d be 14.5 percent for cash and 7.5 percent for less-liquid assets.

The Senate also approved a 23% tax deduction on business income earned from partnerships, limited liabilities and other so-called pass-through businesses. The House version would create a 25% tax rate for such business income, with restrictions on which businesses could qualify. Small businesses would get extra relief under the House legislation as well.

The House bill would also eliminate the estate tax, while the Senate version would limit the tax to fewer multimillion-dollar estates, but leave it in place. And after 2025, the limits would lift. Under current law, the estate tax applies a 40% levy to estates worth more than $5.49 million for individuals and $10.98 million for married couples. The Senate bill would temporarily double the exemption thresholds. The House bill would double the exemption thresholds, and then repeal the tax entirely in 2025.

As discussed previously, the House bill would consolidate the current seven individual tax brackets to four, leaving the top tax rate at 39.6%. The Senate bill would have seven brackets - with lower rates, and a top rate of 38.5 percent. As Bloomberg notes, "studies have shown that many of the tax bill’s benefits would go to the highest earners - and some middle-class taxpayers might actually pay more - a finding that could impact the House-Senate talks."

Most importantly, perhaps, the Senate bill includes a repeal of Obamacare’s mandate that most Americans have health insurance or pay a penalty. The House bill does not.

Here is a side-by-side comparison of the two plans thanks to the WSJ:

Also while we have yet to get confirmation, below is a list of last minute changes and revisions that made it into the final bill per Reuters:

• PASS-THROUGHS: Senators Ron Johnson and Steve Daines announced their support for the tax bill after securing agreement on a bigger tax break for the owners of pass-through enterprises, including small businesses, S-corporations, partnerships and sole-proprietorships. An original 17.4 percent deduction would rise to 23 percent.


• FULL EXPENSING: Senator Jeff Flake, who was a holdout over deficit concerns, agreed to vote "yes" after Republican leaders agreed to change a provision allowing the full expensing of business capital investments to sunset after five years. Flake worried that Congress would be unable to eliminate the benefit cold turkey, allowing it to bleed red ink for years to come. But the Arizona Republican says the change would instead phase out full expensing over three years beginning in year six.


• RETIREMENT SAVINGS: Senator Susan Collins said she persuaded Republican leaders to retain catch-up contributions to retirement accounts for church, charity, school and public employees.


• MEDICAL EXPENSES: Collins also said she was able to include language to reduce the threshold for deducting unreimbursed medical expenses for two years to 7.5 percent of household income from 10 percent.


• STATE AND LOCAL PROPERTY TAXES: Collins has proposed an amendment that would retain a federal deduction for up to $10,000 in state and local property taxes.


• INDIVIDUAL ALTERNATIVE MINIMUM TAX: Rescinding a proposed repeal of the AMT and instead increase exemption levels and phase-out thresholds is also on the table.


• CORPORATE ALTERNATIVE MINIMUM TAX: So is rescinding a proposed repeal of the corporate AMT.


• REPATRIATION: Another change could be to increase tax rates on U.S. corporate profits held overseas to 14 percent for liquid assets and 7 percent for illiquid holdings, up from 10 percent and 5 percent, respectively

Attention now shifts to a House-Senate conference committee - a specially appointed, temporary panel that will be charged with hashing out the differences in the bills and preparing a final version for both chambers to consider. Party leaders will select a small group of lawmakers, likely from the House and Senate tax-writing panels in each chamber, who would then be approved by each chamber. That work could start as early as Monday, with many high-stakes issues to be worked through. The deadline of Dec. 31 is an artificial one, though - aimed partly at securing a victory well in advance of the 2018 congressional elections. Republicans would have until the end of 2018 before they lose their ability to clear final passage in the Senate without a filibuster.

Trump Drafting Executive Order To Kill Obamacare"s Individual Mandate, Report

After having previously cut so-called "cost reduction subsidies" (see: Trump To Scrap Crucial Obamacare Insurer Subsidy) and the marketing budget for Obamacare, Trump is now reportedly ready to also repeal the legislation"s controversial "individual mandate" which taxes people who choose to forego health insurance.

According to the Washington Examiner an executive order has already been drafted to scrap the mandate but has not yet been executed only due to ongoing GOP debates over whether or not to include the repeal in the pending tax bill.

The Trump administration has prepared an executive order that would unravel Obamacare"s individual mandate, but has put it on hold to see whether it might be included in the Republican tax bill instead, a GOP senator told the Washington Examiner.

 

According to the senator, an executive order is sitting with the Office of Management and Budget waiting for approval. President Trump decided to delay the executive order after Sen. Tom Cotton, R-Ark., pushed for the inclusion of the individual mandate repeal in the tax bill, and has been supportive of its inclusion in statements he has made on Twitter.

Of course, including the individual mandate repeal in the tax legislation is intended create billions in budget savings and offset lower tax receipts but it could come with the unfortunate side effect of alienating potential mainstream GOP votes in the Senate who refused to support the Obamacare repeal efforts earlier this year.

Including repeal of the individual mandate in the tax bill instead of through executive order would create billions in budget savings that Republicans need to pay for tax cuts. According to a Congressional Budget Office report published in December 2016, repeal of the individual mandate would save $416 billion over a decade, since it would mean fewer subsidy payments to people who sign up. A new CBO report is expected Monday.

 

The repeal is not currently in the tax bill, known as the Tax Cuts and Jobs Act, but House Speaker Paul Ryan said this weekend that it was on the negotiation table among House Republicans.

 

"We have an active conversation with our members on a whole host of ideas on things to add to this bill and that"s one of the things being discussed," he said.

 

The senator who spoke to the Washington Examiner, who asked to remain anonymous, thinks colleagues could embrace repeal in the tax bill, because the revenue generated "pays for so many tax cuts."

According to the Washington Examiner, Trump cannot repeal the individual mandate through executive order, but he can broaden "hardship exemptions," which under Obamacare are left to the discretion of the administration. The exemptions allow customers to have ways to get out of paying the fine for not having coverage, which is $695 per adult or 2.5 percent of income, whichever is higher.

The Obama administration created hardship exemptions for a range of situations, including if someone filed for bankruptcy, experienced a flood, death of a family member, domestic violence or a shut-off notice from a utility company.

Of course, it"s only a matter of time until Nancy Pelosi and/or Chuck Schumer take a stage somewhere to tell us precisely how many people will die as a result of Republicans even talking about an "individual mandate" repeal.

"You May Be Hopping Mad When You Finish Reading This"

Submitted by John Mauldin of Mauldin Economics

Uncle Sam’s Unfunded Promises

Here’s a surprisingly profound question: What is a promise? Dictionaries offer various definitions. I like this one: “An express assurance on which expectation is to be based.”

That definition captures the two-sided nature of a promise. One party offers an assurance, which the other converts into an expectation. You deposit money in your checking account, and the bank assures you that you can have it back on demand. You expect that the bank will fulfill its promise when you visit an ATM.

Governments likewise make promises, but those are different. Government is the ultimate enforcer of promises, but we have no recourse if it chooses to break them – except at the ballot box. As we’ve seen in recent weeks regarding public pensions, that’s ineffective when the promises were made long ago by officials who are no longer in office.

The federal government’s keeping its promises is important for everyone in the US, because almost all of us are part of the largest public pension system: Social Security. We pay taxes our whole working lives and expect the government to give us retirement benefits. But what happens if it can’t?

Three weeks ago we visited the problems with local and state pensions. Last week we looked at European pensions. This week we are going to take a hard look at the unfunded liabilities and debt of the US government. And even though the federal unfunded pension liabilities dwarf those of state and local pensions, I want to make it clear that I believe the state and local problems will be far more intractable.

I have to warn you: You may be hopping mad when you finish reading this.

* * *

Doubled Debt

In the United States we have two national programs to care for the elderly. Social Security provides a small pension, and Medicare covers medical expenses. All workers pay taxes that supposedly fund the benefits we may someday receive. That’s actually not true, as we will see in a little bit.

Neither of these programs is comprehensive. Living on Social Security benefits alone is a pretty meager existence. Medicare has deductibles and copayments that can add up quickly. Both programs assume people have their own savings and other resources. Nevertheless, the programs are crucial to millions of retirees, many of whom work well past 65 just to keep up with their routine expenses. This chart from my friend John Burns shows the growing trend among generations to work past age 65. Having turned 68 a few days ago, I guess I’m contributing a bit to the trend:

Limited though Social Security and Medicare are, we attribute one huge benefit to them: They’re guaranteed. Uncle Sam will always pay them – he promised. And to his credit, Uncle Sam is trying hard to keep his end of the deal. In fact, he’s running up debt to do so. Actually, a massive amount of debt:

Federal debt as a percentage of GDP has almost doubled since the turn of the century. The big jump occurred during the 2007–2009 recession, but the debt has kept growing since then. That’s a consequence of both higher spending and lower GDP growth.

In theory, Social Security and Medicare don’t count here. Their funding goes into separate trust funds. But in reality, the Treasury borrows from the trust funds, so they simply hold more government debt.

The Treasury Department tracks all this, and you can read about it on their website, updated daily. Presently it looks like this:

• Debt held by the public: $14.4 trillion


• Intragovernmental holdings (the trust funds): $5.4 trillion


• Total public debt: $19.8 trillion

Total GDP is roughly $19.3 trillion, so the federal debt is about equal to one full year of the entire nation’s collective economic output. In fact, it’s even more when you consider that GDP counts government spending as “production,” even when Uncle Sam spends borrowed money. Of course, that total does not count the $3 trillion-plus of state and local debt, which in almost every other country of the world is included in their national debt numbers. Including state and local debt in US figures would take our debt-to-GDP above 115%. And rising.

You can quibble over the calculations, but there’s no doubt the numbers are astronomically huge and growing. And we haven’t even mentioned the huge and growing private debt.

Just wait. We’re only getting started.

Yes, Trillions

We in the business world put a lot of faith in accountants. We trust them to count the beans honestly and give us accurate reports. We may not like the numbers (I was certainly distraught with my final tax numbers this year!), but we mostly believe them. Nothing will make a company’s stock drop faster than accounting irregularities will.

Government accounting is, well, different. The government doesn’t need to make a profit, but we expect it to spend our tax money wisely and to deliver services efficiently. That’s not possible unless there is reliable accounting. But reliable accounting is the last thing most politicians want – it constrains them from promising things they can’t deliver. So we have to take all government numbers with many grains of salt.

However, there is one chink in the politicians’ armor. An old statute requires the Treasury to issue an annual financial statement, similar to a corporation’s annual report. The FY 2016 edition is 274 enlightening pages that the government hopes none of us will read.

Among the many tidbits, it contains a table on page 63 that reveals the net present value of the US government’s 75-year future liability for Social Security and Medicare. That amount exceeds the net present value of the tax revenue designated to pay those benefits by $46.7 trillion. Yes, trillions.

Where will this $46.7 trillion come from? We don’t know. Future Congresses will have to find it somewhere. This is the fabled “unfunded liability” you hear about from deficit hawks. Similar promises exist to military and civil service retirees and assorted smaller groups, too. Trying to add them up quickly becomes an exercise in absurdity. They are so huge that it’s hard to believe the government will pay them, promises or not.

Now, I know this is going to come as a shock, but that $46.7 trillion of unfunded liabilities is pretty much a lie. My friend Professor Larry Kotlikoff estimates the unfunded liabilities to be closer to $210 trillion. When presidential candidate Ben Carson last year quoted Kotlikoff’s numbers, the Washington Post, New York Times, and other mainstream media immediately attacked him. Of course, the journalists doing the attacking had agendas, and none of them were economists or accountants. None. Zero. Zip.

Larry responded in an article in Forbes, since Carson was using his data:

The fiscal gap is the present value of all projected future expenditures less the present value of all projected future taxes. The fiscal gap is calculated over the infinite horizon. But since future expenditures and taxes far off in the future are being discounted, their contribution to the fiscal gap is smaller the farther out one goes. The $210 trillion figure is based on the Congressional Budget Office’s July 2014 Alternative Fiscal Scenario projections, which I extended beyond their 75-year horizon.

The journalists used a very poorly researched analysis, which fit their political bias (shocking, I know). Apparently they take that fabricated analysis more seriously than they do the views of 17 Nobel Laureates in economics and over 1200 PhD economists from MIT, Harvard, Stanford, Chicago, Berkeley, Yale, Columbia, Penn, and lesser known universities and colleges around the country. Each of these economists has endorsed The Inform Act, a bi-partisan bill that requires the CBO, GAO, and OMB to do infinite horizon fiscal gap accounting on a routine and ongoing basis.

Now why would 17 Nobel Laureates and over 1200 US economists, all listed by name at www.theinformact.org, including many, like Jeff Sachs, who lean to the left, and others, like Glenn Hubbard, who lean to the right, endorse infinite horizon accounting. Because they understand something that I told Michelle repeatedly and have also told Bruce Barlett repeatedly. The fiscal gap is the only measure of our fiscal position that is mathematically well-defined.

Every other fiscal measure, including fiscal gaps calculated over any finite horizon, such as the CBO’s 25-year fiscal gap Michelle references, are not mathematically well defined. The infinite horizon is mathematically well defined because it is the same number no matter what choice of internally consistent fiscal words we use to label government receipts and payments. Moreover, the infinite horizon fiscal gap is the only measure of our fiscal policy’s sustainability that puts everything on the books. It is also the only measure of our fiscal policy’s sustainability that is invariant to the choice of words.

Congress’s choice of fiscal labels determines what gets put on and what gets kept off the books. I told Michelle that her grandparents’ Social Security benefits, for which she is now paying taxes, are not on the books because the government chose to call those payments “transfers” paid in exchange for “FICA contributions” not “return of principal plus interest” paid in exchange for “purchase of government bonds.”

Every mathematical model of the economy’s dynamic transition path incorporates the infinite horizon fiscal gap, which is called the government’s infinite horizon intertemporal budget constraint. This constraint has to hold, which means the infinite horizon fiscal gap must be zero. Our country’s infinite horizon fiscal gap is far from zero. It would take an immediate and permanent 59 percent increase in all federal taxes or an immediate and permanent 33 cut in all federal expenditures (including official debt service) to eliminate our fiscal gap. The longer we wait to fix our fiscal system, the larger the adjustment needs to be. This means that (the journalist), and others her age, will need to pay even more for all the “assets,” including my own Medicare and Social Security benefits that have been left off the books.

Yes, something will have to give.

The $210 Trillion Gap

I will admit that I’m not worried about the $210 trillion in unfunded liabilities. Long before we ever get to having to fund those liabilities, the country will be in a massive crisis.

Using the CBO’s own numbers, the projected total US debt will be $30 trillion within 10 years, but the CBO also makes the rosy assumptions that there will be no recessions and that GDP will grow at a 4% nominal rate. Now, that’s possible; but I’m inclined to haircut it a bit.

If you asked me to bet the “over/under” on the debt in 2027, I would bet the over at $35 trillion. After the next recession the deficit will be $30 trillion within 4–5 years and then grow from there at a rate of anywhere from $1.5 to $2 trillion per year. Note: That is not the CBO’s projected debt. It does not count the off-budget deficit that still ends up having to be borrowed. Last year the deficit was well over $1 trillion – but we were told it was in the neighborhood of $600 billion. If any normal company tried to use accounting like the US Congress does, the SEC would rightly declare it fraudulent and shut it down immediately. .

Here’s another chart from the Treasury’s annual financial report, projecting government receipts and spending:

Note that this chart expresses the various items as percentages of GDP, not dollars. So the relatively flat spending categories simply mean they are forecasted to grow in line with the economy, or just a little faster. But the space representing net interest grows much faster than GDP does – fast enough to make total federal spending add up to one-third of GDP by 2090.

Obviously, this chart is based on all kinds of assumptions, and reality will be far different. I doubt we will make it to 2090 (or even 2050) without at least one global depression or other calamity that radically resets all the assumptions. Beneficial changes are also possible – biotech breakthroughs that reduce healthcare expenditures, for instance.

Still, looking at the demographic reality of longer lifespans and lower birthrates, it’s hard to believe Social Security can survive over the long run in anything like its present form. But any major change will mean that the government is breaking its promise to workers and retirees.

Well, guess what: They backtracked on that promise decades ago. Few people noticed it at the time, and even fewer remember it now.

Tax, Not a Promise

There’s a big difference between that federal government financial statement and similar ones from private companies. “Liabilities” for a business represent contracts it has signed – the long-term lease on a building, for instance. The company agrees to pay so many dollars a month for the next 20 years. That obligation is enforceable in court. Even if the company enters bankruptcy, the court will award creditors damages from whatever assets it can recover.

The federal government doesn’t work that way. It signs contracts all the time – but often with escape clauses that private businesses could never get away with. Social Security is a good example.

Many Americans think of “their” Social Security like a contract, similar to insurance benefits or personal property. The money that comes out of our paychecks is labeled FICA, which stands for Federal Insurance Contributions Act. We paid in all those years, so it’s just our own money coming back to us.

That’s a perfectly understandable viewpoint. It’s also wrong.

A 1960 Supreme Court case, Flemming vs. Nestor, ruled that Social Security is not insurance or any other kind of property. The law obligates you to make FICA “contributions.” It does not obligate the government to give you anything back. FICA is simply a tax, like income tax or any other. The amount you pay in does figure into your benefit amount, but Congress can change that benefit any time it wishes.

Again, to make this clear: Your Social Security benefits are guaranteed under current law, but Congress reserves the right to change the law. They can give you more, or less, or nothing at all, and your only recourse is the ballot box. Medicare didn’t yet exist in 1960, but I think Flemming vs. Nestor would apply to it, too. None of us have a “right” to healthcare benefits just because we have paid Medicare taxes all our lives. We are at Washington’s mercy.

I’m not suggesting Congress is about to change anything. My point is about promises. As a moral or political matter, it’s true that Washington promised us all these things. As a legal matter, however, no such promise exists. You can’t sue the government to get what you’re owed because it doesn’t “owe” you anything.

This distinction doesn’t matter right now, but I bet it will someday. If we Baby Boomers figure out ways to stay alive longer, and younger generations don’t accelerate the production of new taxpayers, something will have to give.

If you are depending on Social Security to fund your retirement, recognize that your future is an unfunded liability – a promise that’s not really a promise because it can change at any time. 

How Will We Fund the Deficit?

And now we come to the really uncomfortable part. Notice that Larry Kotlikoff said we would need an immediate approximately 50% increase in taxes to fund our future deficits. That’s what we would need to create a true entitlements “lockbox” with the funds actually in it. But surely everybody knows by now that there is no lockbox with Social Security funds in it. That money was spent on other government programs and debts. And so when the CBO doesn’t count the trust funds as part of the national debt, they are not only being disingenuous, I think they are committing financial fraud. The money that will actually pay for Social Security and Medicare down the road is going to have to come out of future taxes, just as for any other debt of the US.

So at some point – even though Republicans are jawboning hard about cutting taxes now – we are going to have to raise taxes in order to fund Social Security and Medicare. I personally think it will have to be done with a value-added tax (VAT), because the necessary increase in income taxes would totally destroy the economy and potential growth.

(And yes, I know some of you will write back and say we had much higher tax rates in the 50s and we had good growth then, but our demographics and productivity levels were completely different in that era. Plus, nobody actually paid the highest tax levels. I remember that in the 80s, before Reagan cut the tax rate, I had so many deductions that my effective tax rate was about 15%. The irony is that after the Reagan tax cuts, my total tax payments went up, not down – I lost all of my cool deductions! Aaah, the good old days…)

But the simple fact of the matter is that no Congress is going to fund Social Security and Medicare through tax hikes. Before they ever go there, they will means-test Social Security and increase the retirement age – which they should.

Of course, Congress could always authorize the Treasury Department to authorize the Federal Reserve to monetize a certain amount of the Social Security and Medicare debt, which is essentially what Japan is doing (and seemingly getting away with it). I think we should all be grateful to the Japanese for being willing to undertake such a fascinating experiment in monetary and fiscal policy.

Let me close with a quick sidebar note. I think the Fed’s mad rush to raise rates and reduce its balance sheet at the same time is unwise. I mean, seriously, is the Federal Reserve balance sheet making that much of a difference to the US economy? Perhaps when that extraordinary balance was created, it did – but not today. This is one of those times when I think our policy makers should go slowly and tread carefully. Just saying…

Last Ditch Obamacare Repeal Bill Officially Dead After Collins Says No

Not only was the Republicans" third attempt to repeal Obamacare not lucky, but as of moments ago, said attempt has died a total of three times, the first when John McCain said he would vote no last Friday, then yesterday when Ted Cruz also said he would not support the Graham-Cassidy Obamacare repeal bill, and then the third and final time came late on Monday when Maine Senator Susan Collins confirmed she would oppose the latest GOP effort to repeal and replace ObamaCare, dooming the measure.

"Health care is a deeply personal, complex issue that affects every single one of us and one-sixth of the American economy. Sweeping reforms to our health care system and to Medicaid can’t be done well in a compressed time frame, especially when the actual bill is a moving target," she said in a statement.

Senator Collins opposes Graham-Cassidy health care bills https://t.co/nW6MFUvYVg pic.twitter.com/0DSxDJNMPp

— Sen. Susan Collins (@SenatorCollins) September 25, 2017

Her announcement is hardly a surprise: as we said last week, Collins was widely viewed as a "no" vote but talked with Pence over the weekend and said Sunday she wanted to see the preliminary analysis from the Congressional Budget Office. "It"s very difficult for me to envision a scenario where I would end up voting for this bill," she told CNN"s "State of the Union." Well, just prior to Collins" statement, the CBO projected that the last-ditch GOP ObamaCare repeal bill would result in "millions" of people losing coverage. The agency did not give a specific number given a lack of time to do the analysis before a vote, but said the "direction of the effect is clear." That was enough to seal Collins" "no" answer.

According to Bloomberg, Collins joins Republican Sens. Rand Paul and John McCain, who have already come out against bill, although technically on Sunday Ted Cruz said that “Right now, they don’t have my vote and I don"t think they have Mike Lee’s vote either,” which means that the third and final attempt to repeal Obamacare was not even down to the wire.

Collins"s announcement came as Graham, Cassidy and the White House engaged in a dash of last minute negotiations to try to keep their ObamaCare repeal push alive and win over holdouts, including Collins. “If there’s a billion more going to Maine ... that’s a heck of a lot,” Cassidy told The Washington Post. "It’s not for Susan, it’s for the Mainers. But she cares so passionately about those Mainers, I’m hoping those extra dollars going to her state ... would make a difference to her.”

According to The Hill, it isn"t immediately clear whether leadership will force a vote even though they are short of necessary support to pass a bill. "I"m in a fact-gathering mode," Sen. John Cornyn (R-Texas), the No. 2 Senate Republican, told reporters earlier Monday.

A spokesman for Majority Leader Mitch McConnell (R-Ky.) said last week that it was his "intention" to bring up Graham-Cassidy but he didn"t mention a potential vote in his opening remarks on Monday. Rank-and-file members have also expressed skepticism that they would ultimately have a vote.

And now onto Trump"s tax reform, which despite Wall Street"s recent spike in enthusiasm will likely suffer the same fate as Obamacare repeal.

Stockman Exposes America's Fiscal Doomsday Machine

Authored by David Stockman via DailyReckoning.com,

Maybe the Democrats did win the 2016 election. Or at least the the Deep State and its accomplices among the beltway political class, K-Street lobbies and the media did.

That’s because the media won a giant victory against something they deplore and despise more than anything else - the public debt ceiling. They sanctimoniously admonish that it’s a relic of the nation’s fiscally benighted past. They operate on a belief that this is an episodic tendency to threaten America’s credit and to offer Capitol Hill an opening to grandstand about the fiscal verities is a blight on orderly governance.

So the Donald’s latest burst of impetuosity — agreeing with Sen. Schumer to permanently abolish the public debt ceiling — has descended on the beltway like manna from heaven. Not Barack Obama, Bill Clinton, Jimmy Carter or even the Great Texas Porker, Lyndon Johnson, dared to utter the thought of it — at least not in polite company.

Suddenly, and notwithstanding all the good he has done disrupting the status quo, the Donald has become the foremost enemy of America’s very financial survival.

The Federal budget is a Fiscal Doomsday Machine. The depository of American wars and entitlements have run rampant. Under the pile drivers of a global empire and the retiring baby boom, it is rapidly propelling the nation toward fiscal catastrophe. That grim outcome is virtually guaranteed if the only remaining safety brake — the debt ceiling — is summarily abolished.

Due to entitlements, debt service and the slow pipeline of appropriated spending there is no such thing as an annual Federal budget or accountability for how much Uncle Sam spends and borrows. Instead, the $4.1 trillion that Congressional Budget Office (CBO) projects the Federal government will spend in FY 2018, and the $563 billion it will borrow, reflects the dead hand of the past.

Entitlements and other mandatory spending alone is projected to reach $2.566 trillion or 63% of total FY 2018 outlays.

Another $307 billion will be required for interest on the nation’s $20 trillion public debt, while upwards of half the $1.22 trillion for so-called “discretionary” or appropriated programs also reflects funds appropriated years ago.

Altogether, $3.5 trillion, or 85% of outlays, will be essentially baked into the cake before a single Congressional vote is taken on anything regarding the FY 2018 budget.

The Federal spending machine is almost entirely on autopilot and heading for disaster owing to ballooning populations and debt. Ten years from now the combined cost of mandatory programs and debt service will reach $5.12 trillion compared to just $2.87 trillion during FY 2018.

Entitlement spending will be nearly double — even if Congress took a 10-year recess!

As shown below, that means the Federal spending share of GDP is now inexorably climbing toward 30% owing to baby boom retirements, even as revenue under current law is stuck at about 18% of GDP. The CBO’s latest projection of the widening fiscal gap — soon more than 10% of GDP annually — leaves nothing to the imagination.

America really does have in place a Fiscal Doomsday Machine.

The Fiscal Doomsday Gap Is Uncloseable — The Crisis Is Permanent

In the chart above, it is easy to see why the beltway argument — that we’ve already spent the money and must liquidate by borrowing whatever it takes — is so thoroughly wrong. The tidal forces driving the budget are so enormous and dangerous that some kind of automatic, institutionalized braking force is absolutely necessary.

The fiscal exigencies of empire, demographics and debt have now become insuperable.

In the case of demographics, it is all right here. The baby boom is retiring at a rate of 10,000 per day, and the wave will not crest until there are nearly 100 million Americans over 65 years of age — double today’s 50 million.

Needless to say, at an average cost of $35,000 per year for retirement pensions and medical care alone, the fiscal math becomes prohibitive.

The voting and political math is downright impossible, and has been that way for the last 34 years.

The last time any significant chunk was taken out of social security or medicare benefits was back in 1983 when the Congress did agree to the Greenspan Commission’s proposal to delay the payment date of the Social Security cost of living allowance (COLA) by the grand sum of 90 days on a one-time basis!

There was one other change, that I was personally involved in, that seals the case. Working with Greenspan we had narrowed the benefit cut options down to a binary choice and presented it to the swing vote on the commission. The latter happened to be 88 year-old Claude Pepper — a left-over from the New Deal era and champion of America’s elderly lobby.

Did he want a reduction in early retirement benefits immediately or an increase in the retirement age starting 30 years hence? Apparently, Senator Pepper concluded he would not live to be 118, and choose the second option!

All of that happened when the over 65 population was about 28 million, not 100 million.

There is no plausible scenario in which Congress will proactively and voluntarily address reform for the ballooning population of elderly Americans. It will only happen when action is forced by the debt ceiling mechanism — the equivalent of a credit card cancellation on a national level.

The recent utter failure to do anything at all about ObamaCare and the underlying health care system that is already consuming 18% of GDP only reinforces the case for a fiscal dues ex machina. As seen below, the cost of the medical entitlements alone relative to national income will double from 5% to 10% over the next three decades.

Where that leads, of course, is to fiscal catastrophe.

Without a fiscal braking mechanism that is external to voluntary legislative action, the day of reckoning will be catastrophic.

Even by the CBOs own Rosy Scenario based long-term projections, the nation’s public debt ratio is heading for a Greek-style 150% within the next 25 years, and by our own more sober view of the economic future far worse than that.

When Washington descends into complete fiscal disarray, the meltdown will be on and the grim reaper of recession will be just around the corner.