Goldman Reveals The Biggest Risks To Tax Reform As Trump, Corker Feud Escalates

Well, needless to say, yesterday wasn’t a great day for anyone who is basing their bull thesis on tax reform “hope.”

Trump woke up before dawn and immediately got to work on Twitter. By 8:50 a.m., he was back on the Bob Corker thing, accusing The New York Times of setting the Tennessee Senator up to “sound a fool.” The icing on the cake was Trump branding the GOP lawmaker “Liddle Bob” before concluding with this: “and that’s what I am dealing with!”

Of course that was a lie, and The New York Times proved it a couple of hours later, by publishing the actual recorded moment when Bob Corker says “I hope you’re recording this,” thus proving, beyond a shadow of a doubt, that he was not in fact “set up” and that his express purpose in granting the Sunday interview was to let the American people know that the President probably isn’t fit to serve.

So the thing is, this matters for tax reform. A lot. Here’s an excerpt from something I wrote for DealBreaker:

If you’re Gary Cohn, your job just got a lot harder. Trump has potentially torpedoed tax reform in the interest of defending his honor (a while back, Corker became the first Senator to openly question the President’s competence and last week, Bob mused that the only thing separating America from “chaos” is the trio of John Kelly, Jim Mattis, and Rex Tillerson).

Although most analysts have been mum on this so far (presumably because they’re still trying to determine if what happened on Sunday is real), Cowen’s Chris Krueger offered this on Monday morning:

  • Either Trump realizes that Corker can sink the remainder of the Trump/GOP legislative effort and is upset by that reality, or he didn’t/doesn’t know and just made it a reality. Either way, we see ZERO upside for the budget process/tax reform in this Twitter tantrum with the policy downside limit-down.

Yes, as it turns out, there is “ZERO” (and the all-caps are in the original note) upside to the President instigating a Twitter battle with a Senator from his own party by calling said Senator a gutless beggar on a Sunday morning.

Fast forward to Wednesday and Goldman is now weighing in. Here’s Hatzius:

We recently estimated that a tax cut of $1 trillion over ten years split evenly between individual and corporate taxes and distributed evenly over the next ten years could boost growth in 2018 and 2019 by 0.1-0.2pp and raise the level of GDP over ten years by 0.5%. However, as we recently noted, we believe the risk is to the downside of these estimates.

The most obvious risk is simply that Congress fails to pass meaningful tax legislation at all. This risk has increased slightly in recent days, in light of statements from Sen. Corker (R-Tenn.) including that he would not support tax reform legislation unless it decreased the deficit. While it is too early to say what the legislation will ultimately look like, we do not expect the bill the Senate eventually votes on to reduce the budget deficit over the next ten years. Senator McCain (R-AZ) has also indicated that he might oppose legislation that is not considered under “regular order” with bipartisan support, and thus seems unlikely to support the upcoming tax legislation which congressional Republicans have signaled they plan to pass through the reconciliation process. If this pair votes against tax reform, it would leave Senate Republicans with only 50 votes, the bare minimum needed to pass legislation through the reconciliation process. While there are a few Senate Democrats who might ultimately vote for the tax bill, there are a few additional Senate Republicans who might oppose it. We still see enactment of a tax cut by 2018 as the base case, but recent developments highlight the legislative obstacles that will need to be overcome.

So there’s the problem. This may be dead in the water (as we wrote on Monday).

But assuming it isn’t (D.O.A. that is), Goldman thinks there’s a possibility that it could ultimately be phased in in order to avoid legislative pitfalls. Here’s more on that:

The other downside risk to the potential near-term growth effects from tax reform, is the likelihood that tax legislation will be phased in over multiple years. We believe whether or not this occurs will depend on how congressional Republicans balance two competing priorities as they write tax legislation.

First, congressional Republican leaders and the Trump Administration are likely to seek to reduce statutory tax rates as much as possible. The framework recently released by the “Big Six” would reduce the corporate tax rate to 20% and establish a new pass-through rate to 25% and individual rates of 12%, 25%, and 35%. However, these rate reductions would reduce projected tax receipts by trillions of dollars over the next ten years, while Congress looks likely to allow for a much smaller net tax reduction of only around $1 trillion, in our view. Base broadening is likely to be used to offset some of the cost, but political obstacles will limit how much base broadening can be achieved.

One way tax-writers might fit a bigger tax cut into a smaller placeholder is to allow some of it to phase in over several years. For example, the 20% corporate rate proposed in the Big Six framework would reduce tax receipts by around $1.8 trillion over ten years; this alone would exceed the $1.5 trillion revenue reduction targeted in the Senate budget resolution, and would crowd out individual tax cuts and other priorities. Phasing the reduction down in equal increments over ten years would cut the cost roughly in half while still technically allowing the Administration to achieve its goal. While we are skeptical that a 20% corporate rate will be achieved even after a long phase-in, the option to phase in a tax cut over several years increases the probability that a rate in the mid-20s could be achieved, for example.

However, there might be a second potential goal that would push in the other direction. Republican lawmakers, who are likely regarding their midterm election prospects with some concern, might seek to provide some temporary stimulus to the economy in 2018 ahead of the election in November. We would expect this to be a consideration particularly with regard to individual tax cuts.

There are also more technical arguments against phasing in a tax cut, particularly related to congressional budget rules. The “Byrd Rule” in the Senate prohibits tax or spending legislation considered under the “reconciliation” process from increasing the deficit after ten years (or whatever period is covered by the budget resolution). Applied to a phased-in tax cut, this would lead to a gradual phase-down in various rates, followed by a sharp increase in rates in 2028 to comply with the rule. This is something that Republican leaders have said they would like to avoid. Nevertheless, this is exactly what Congress did in 2001 and 2003, when it enacted tax cuts set to expire in 2010, eventually leading to the “fiscal cliff.”

The 2001 tax cut, as well as the tax cut in 1981 and the tax reform act of 1986, are in fact the most obvious analogies to the current experience. Only a small share of the 1981 and 2001 tax cuts took effect in the year of enactment (less than 1% of the estimated 5-year cost in 1981, and around 3% of the ten year cost in 2001). In the second year, the figure rises but is still well below the 10-year average cost. Following the 1981 tax cut it took until 1984 for the tax cut to hit its “run rate” (i.e., to equal the average amount over the period estimated) and the 2001 tax cut was projected to take until 2006 to hit that rate (Exhibit 1). This suggests that if Congress cuts taxes by $1 trillion over ten years, the net tax cut in 2018 could be well under $100 billion.

Phases

Right. And again, that’s assuming Trump doesn’t do, say, or tweet anything in the interim that stymies things even further.

KBW was out on Tuesday suggesting that because Corker is “a serious player on policy who won’t tank tax legislation because of a spat with the president,” and therefore investors “shouldn’t panic about the prospects for tax reform as President Trump and Senator Bob Corker feud.”

Duly noted, but as Corker clearly suggested in his interview with the Times, there’s more at stake here than a Twitter feud. Corker said – and I quote – “he concerns me [and] he would have to concern anyone who cares about our nation.”

This is about more than tax reform. So if Trump goes off on another Twitter tangent or otherwise does anything rash, there’s a non-zero chance that even GOP lawmakers may start to undermine him by deliberately tanking his agenda.

Finally, KBW conceded this:

Corker has a good relationship with Sen. Majority Leader Mitch McConnell and fellow Republican senators, and probably won’t inflict political pain on them to settle scores with the White House [but] at the same time, he’s also a budget hawk, will probably use any leverage he has to constrain size of tax cuts.

Curb. Your. Enthusiasm.

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