Tax Reform

Senate Republicans Just Took a Big Step Toward Permanently Overhauling the Tax Code

The bill advances lowers corporate and individual tax rates while setting the stage for large increases in the deficit.

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Ron Sachs/SIPA/Newscom

Senate Republicans just passed a major rewrite of the tax code on a party line vote, with only one GOP dissent. The vote puts Republicans significantly closer to permanently altering the shape of the U.S. tax code, which has long been a priority for party leadership.

If the legislation becomes law, it would be the first major rewrite of the tax code since the Reagan administration. The bill would substantially cut the corporate tax rate, which analysts say would help spur economic growth and make America more competitive internationally. At the same time, passage of the bill also represents a significant abdication of the GOP's promises to legislate transparently and not increase the deficit.

A separate version of the bill has already passed in the House last month. The two pieces of legislation are now expected to advance to a conference committee where House and Senate negotiators will attempt to work out the differences, after which the two chambers will have to vote again. Alternatively, the House could simply pass the Senate bill unchanged.

The bill was in flux until the last minute, with significant objections coming from a group of senators who said they were concerned about the bill's effect on the deficit. Under President Obama, Republicans frequently criticized Democrats for failing to read or provide sufficient time to debate major legislation.

But as of late Friday afternoon, after Republicans secured commitments to vote for the bill, final legislative text had not been published. When the final text of the legislation did appear late in the evening, it was covered in handwritten notes and alterations.

The Senate version is projected to increase the deficit by a little more than $1.4 trillion over the next decade. Republicans backing the bill have insisted that the plan will make up the revenue by spurring additional economic growth, but they have not produced official analysis reaching the same conclusion. Although Treasury Secretary Steve Mnuchin repeatedly promised that the administration would provide a dynamic analysis, no such report has been released.

Independent analyses have found that some of that decline in revenue would be made up by increased economic growth. A Joint Committee on Taxation Report released yesterday estimated that even with dynamic effects the bill would still increase the deficit by about $1 trillion; more favorable estimates have put the effect on the deficit closer to $400 billion.

Throughout the week, there were reports that the bill would address worries about the deficit with the inclusion of a "trigger" mechanism that would automatically raise taxes if yearly economic growth projections fell short. But that plan fell through last night after the Senate parliamentarian told GOP leadership that it wouldn't be allowed under the reconciliation process that Republicans relied on to pass the bill with a simple majority.

One of the senators who objected to the bill on fiscal responsibility grounds was Jeff Flake (R-Ariz.). But on Friday he announced his support for the bill after securing the elimination of an expensing provision and a promise from party leadership to enact permanent protections to recipients of the DACA immigration program that started under President Obama.

The Senate bill makes major changes to both individual and corporate taxation. It permanently slashes the corporate tax rate from 35 percent down to 20 percent, alters the way that businesses can expense new equipment, and reduces taxes on income earned by pass-through businesses, a tax structure in which corporate profits are taxed as individual income. Those changes could create an incentive for many businesses to restructure as pass-throughs as a form of tax arbitrage, which is what happened when the state of Kansas attempted a similar change. An analysis by the Tax Foundation found that the Kansas provision encourage tax avoidance but not economic growth.

The bill also cuts individual tax rates, nearly doubles the standard deduction, gets rid of the personal exemption, expands the child tax credit, and eliminates or caps several major tax code deductions, including the state and local tax deduction. It modifies, but unlike the House plan does not repeal, the alternative minimum tax, which disallows some deductions by high earners. Over the next decade, filers at all income levels would see a tax cut.

However, unlike the corporate tax reduction, which is permanent, the individual rate reductions are phased out by 2026, creating a major policy cliff, and nearly guaranteeing high-stakes legislative showdowns. The sunset was designed largely to ensure that the bill conformed with Senate budget rules, which require that legislation passed via the reconciliation process not increase the deficit after a decade. Republican leaders have argued that Congress is not likely to let those tax cuts expire. That, in turn, would result in a significant long-term deficit increase.

Among the biggest changes in the Senate bill is the elimination of the tax penalty associated with Obamacare's individual mandate, which could have significant effects on the stability of the exchanges, which have already seen high premiums and insurer drop outs, and thus on the number of people in the country with health insurance. The House bill did not eliminate the mandate, but repeal is likely to remain a part of whatever the two chambers negotiate in conference.

Eliminating the mandate lowers the deficit by about $340 billion, according to the Congressional Budget Office, as a result of about 13 million fewer people signing up for Medicaid and subsidized coverage in the exchanges. The savings help offset the budgetary effects of the bill's tax reductions. Some Republicans, however, have argued that the CBO's estimate attributes too much coverage to the mandate, which would mean that the deficit reduction is also too high as well.

Under the Obama administration, Republicans frequently criticized the president for high deficits and allowing the national debt to increase. Throughout the year, GOP leadership promised that the bill's budgetary effects would be fully offset by eliminating loopholes and deductions. That didn't happen.

The bill could still change in conference, but between the effects of repealing the mandate and the expiration of the individual tax cuts, it is probable that the final legislation will end up increasing the deficit far more than most estimates suggest.

So while it represents a significant legislative victory for the GOP, and the advancement of several longtime policy goals, it is also one that confirms that for the Republican party, fiscal responsibility was never more than a politically convenient pretense.