Tax reform in the Senate

Tax reform in the Senate

Senator Schumer recently said the Senate Democratic majority will pass a budget resolution, in part so it can create a reconciliation instruction to pass tax reform with a simple Senate majority. This is important.

I don’t begrudge the majority for creating that hardball procedural option – we Republicans did it in 2001 and 2003 to enact two rounds of tax cuts. In 2001 we used a reconciliation bill to pass a center-right bipartisan bill 58-33 (Democratic now-Chairman Baucus supported it). in 2003 we used it to pass a Republican-only bill 51-50.

Having a reconciliation vehicle creates the opportunity to pass a bill with a simple majority, but it does not require the bill to be partisan. If Senate Democrats follow this procedural path, they will have to choose between a bipartisan bill (likely Baucus-Hatch) or a partisan Democrat-only bill. The former would be easier to conference with a tax reform bill passed by a Republican House, while the latter would more closely hew to the policy goals of most Senate Democrats and our newly-avowed liberal/progressive President.

The way to tell which they’re going to do is to look at what the upcoming Democratic budget resolution requires tax reform do on total tax levels. If, as Senator Schumer suggests, the budget resolution requires that tax reform increase total taxes by hundreds of billions of dollars (or even a trillion+!) over the next decade, then reconciliation isn’t just an option, it’s their chosen path. Senate tax reform that massively raises taxes will be a partisan positioning exercise that will not lead to a law, and Senate Democrats will need to use reconciliation to block a Republican filibuster. If the President and Senate Democrats want to try to enact bipartisan tax reform, they’ll have to make it revenue-neutral or nearly so.

This didn’t have to be the case.

To my tremendous dismay, in 2011 and 2012 Congressional Republicans repeatedly signaled that they would agree to higher total revenues if they could get tax reform that they liked on microeconomic grounds (i.e., that lowers marginal effective rates on labor and capital). This created the risk that Republicans would agree to higher taxes once in exchange for tax reform, and a second time to get structural entitlement reforms. That’s a lot of potential tax increases, and it scared me tremendously.

While key Congressional Republicans insisted they would only agree to higher revenues resulting from dynamic economic growth effects, I was skeptical about the numbers. In the failed Grand Bargain negotiations of Summer 2011, Speaker Boehner was willing to agree to +$800B in taxes over ten years, as long as those increased revenues were the result of higher economic growth resulting from tax reform that lowered marginal rates. He, and later Republicans on the Super Committee, said they would not agree to “static” revenue increases but they floated the $800B number.

I think you can get maybe $100-150B in higher revenues over ten years from the pro-growth effects of a great tax reform bill. +$800B means you’re agreeing to static tax increases through reform as well. I think that’s terrible policy. You get the benefits of lower marginal rates and a somewhat more efficient economy, but you give them up by having government take more resources from the private sector. In my view that’s almost certainly not worth it, especially when you move from an imagined ideal tax reform to that likely to result from a real-world legislative process in which the efficiency benefits would be tremendously diluted.

The Grand Bargain fell apart in the summer of 2011 because President Obama wanted even higher taxes: +$1.2T over ten years. This discussion repeated itself last month, with the President even more aggressive in his demands for higher taxes. He got about half that amount with his New Year’s tax hike law.

Now the President is signaling that he wants the rest of his tax increases through tax reform, and there’s no way he’s going to get it. Senator Schumer’s comments suggest that Senate Democrats’ priority for tax reform is not making the code more efficient or increasing economic growth, it is raising total tax revenues to finance bigger government.

Agreement on the total level of taxation is a prerequisite for enacting tax reform. In 2011 or most of 2012 Democrats could have gotten some key Republicans to agree to +$800B, if it had been raised the right (pro-growth) way. Now they can’t get that. If Senate Democrats insist that tax reform raises total revenues by hundreds of billions of dollars, tax reform will go nowhere, for five reasons.

First, taxes were just increased by more than $600B. Those Republicans who were willing to support Speaker Boehner’s +$800B will count that +$600ish B against that amount. A few Republicans might in theory still be willing to agree to net revenue increases equal to the dynamic benefits of increased growth, but that’s at most +$100-150B. There is clearly no Republican appetite for net increases measured in hundreds of billions of dollars (this pleases me). Senate Republicans would block such a bill if they could, necessitating the reconciliation bill which could not be filibustered. But even if Senate Democrats pass it on a party-line vote, House Republicans will not agree to further tax increases beyond maybe +$100-150B, and then only if they really like the pro-growth incentives in a reform bill. They probably won’t even go above revenue-neutral because of reason #2.

Second, the President’s end zone dance and partisan taunting during and after the New Year’s tax increase law should convince even the most bipartisan and cooperative of Congressional Republicans that the political risk/reward tradeoff of working with the President on tax reform is poor. Bipartisan tax reform only has a chance if members of both parties can see both a potential policy win and a shared political win at the end of a long and winding road. President Obama has demonstrated repeatedly that he views fiscal politics as partisan and zero sum. For a Camp-Baucus-Hatch tax reform bill to come together, which is the only feasible path to enacting a new law, you need a legislative environment conducive to bipartisan cooperation. Thanks to the President’s framing of the last tax law we have exactly the opposite.

Third, a partisan path for Senate Democrats makes Finance Chairman Baucus’ job much harder. He will not have the bipartisan cover essential to repealing or reforming the popular broad-based tax preferences like the mortgage interest subsidy, the health tax exclusion, the deductibility of charitable contributions, and deductions for state and local taxes. If you want to move the policy needle you need to tackle these big items, and you can’t do that and succeed without bipartisanship to protect you from the political blowback of taking on such popular preferences.

Fourth, a partisan path means Mr. Baucus has a smaller universe of potential votes to work from. Sure he’d only need 50 (+ the VP), but corralling 50 of 55 votes on tax reform is hard and may be impossible. It’s much easier to try to find 50 votes out of 100, even if 20 conservatives of those 100 are practically ungettable. In committee any one of his 11 Democrats could hold a bill hostage if Republicans are unified in opposition.

Finally, tax reform that raises taxes creates far more losers than winners. That increases citizen and interest group opposition and makes it even harder to get the votes needed to pass a bill. Democrats may like the prospect of spending an extra trillion dollars but I’ll bet they can’t find the votes for the specific tax increases to raise that much, especially if they’re simultaneously trying to sell tax reform as helping taxpayers.

Senator Baucus knows all of this. Whatever his personal policy preferences, he has to know that a budget resolution that instructs him to enact tax reform that raises hundreds of billions in higher taxes will not lead to a law, but instead at best to a partisan stalemate in which he is the face of a liberal bill that represents the views of a quite liberal Senate Democratic caucus. It’s almost impossible for him to pass such a bill out of the Senate. If he does it’s almost impossible to conference with the House.  And either way it won’t help his reelection prospects in low-tax Montana this election cycle.

If you are interested in the prospects for tax reform, watch the public postures of the key Senate Democratic players on total tax levels in the budget resolution. The people to watch are Finance Chairman Baucus, Budget Chairman Murray, and Leader Reid. Also watch Senators Durbin and Schumer and incoming Treasury Secretary Jack Lew if he is confirmed.

If in their budget resolution Senate Democrats require that tax reform raise total taxes by hundreds of billions of dollars or more, then tax reform will at best be an interesting contrast in partisan approaches between Senate Democrats and House Republicans, and at worst a partisan flame-out in which the Senate fails to pass a bill or doesn’t even try.

If instead the moderates (and Chairman Baucus?) force the budget resolution to create a reconciliation instruction for revenue-neutral tax reform, or tax reform that only raises revenues by $100-$150B over ten years from dynamic growth effects, then the prospects for significant and bipartisan tax reform in the next two years increase from “hopeless” to “extremely unlikely.”

Sorry to be so pessimistic.

(photo credit: Office of Senator Baucus)

 

6 responses

  1. Keith, won’t the budget produced by the Senate have tax cuts and revenues (to be “balanced”), and won’t Boehner pass it with a majority of Democrats? Do you seriously beleive that at the end of the day, Boehner and McConnell won’t end up giving President Obama pretty much everything he wants? I fail to sae any reason for optimism given the history of the last two years. Do you really beleive otherwise?

  2. The Gop Wanted a Budget & You’ll get it! Boehner promised to balance budget in 10 yrs SO he’ll have to cut Govt by 1/3. What’s NONPARTISAN about that??? Nothing! You’ll Get Balanced Approach that President Ran ON. Ryan Budget helped him win. It was rejected by the Majority 51% to 47%

  3. Cat,

    “You’ll Get Balanced Approach that President Ran ON” O’s idea of “balance” is to balance $600 MM of tax increases (that he just got) with $800MM of tax increases through closing so-called loopholes. What’s balanced about that?

  4. Keith, is it still permitted under the Byrd Rule for a revenue-neutral tax bill to be processed under reconciliation? Does Schumer have the upper hand under the Byrd Rule in seeking to raise revenue? If a tax bill raises zero revenue, does that not show the bill’s purpose is more to change policy and than it is to affect the budget?

    • Frank, I don’t think the precedent has changed but I’m not sure. But I think this is trumped by a point I missed in the above post and have corrected in a new post. Senate Ds can’t create a reconciliation bill without a budget resolution conference report, and it’s hard to imagine House Rs allowing them to do that (or agreeing to any budget resolution conference report for that matter).

Follow

Get every new post delivered to your Inbox.

Join 6,386 other followers