Tax Reform?

Author: David R. Kotok, Post Date: November 13, 2017

“The only difference between death and taxes is that death doesn’t get worse every time Congress meets.” – Will Rogers (source:

The “Chairman’s Mark” is a 247-page document that outlines the items for consideration by the Senate Committee on Finance Markup.  They convene this week. Here is a PDF of the document:’s%20Mark.pdf. According to a press release, this committee “has the largest committee jurisdiction in either chamber of Congress, oversees more than 50 percent of the federal budget and has jurisdiction over tax, trade, and healthcare policy.” It is chaired by Senator Orrin Hatch (R-Utah).

Readers who are following the tax reform debate closely know that the target for passage of any tax bill is to get the changes in the tax code to “score” at less than a $1.5 trillion additional deficit when applying the 10-year forward rules. These complex rules are a product of our political system. Like it or not, this is how we function.

Here is a PDF of the scorecard for the current tax bill: JCT.pdf. Set aside your political leanings, if you can, and examine the spreadsheet. On these pages are the details wherein lies the “devil.” Notice that the final number is -$1,495.7 billion. In other words, if this list were to be enacted as it reads, the bill would fall just barely within the $1.5 trillion limit that allows passage by the Senate with a simple majority vote. Passage by the Senate would then allow a simple majority vote of the House to agree.

An alternative would be passage in each chamber and then a conference committee report that would require negotiation, followed by a return of the bill to each chamber for a straight up or down vote. Again, a simple majority in each chamber would be enough if the additional deficit stays under the $1.5 trillion 10-year score.

Here is one example of 10-year scoring. Look under section II, Business Tax Reform, H.2. On that line, entitled “Repeal of advance refunding bonds,” the estimated budget impact is listed for each year of the 10-year period. The 10-year total appears at the far right. According to this estimate, a repeal of refunding in the municipal bond arena will reduce the federal deficit by $16.8 billion over the 10-year test period.

Here is another example. Look at section I, Tax Reform for Individuals, F. That line is entitled “Repeal of the Alternative Minimum Tax on Individuals.” According to the scorecard that repeal would lower federal tax revenues, which is why the score is a negative number of $706.7 billion over 10 years. The negative number means that passage of this item increases the deficit.

I will leave the rest of these details to readers who wish to dig deeply.

We have some takeaways.

First, the tax code will not be made simpler by this bill, and the implementing of a postcard tax form is a political gesture that means nothing. In the details of the scorecard one can detect the work of the many lobbyists who are trying to influence the item they are focused on for the special interest group they represent.

There is a debate about whether a political deal can be reached on a tax reform bill. There is additional debate over which versions will prevail and how the process will ultimately be resolved among the forces in the House, the Senate, and the White House. All this is our system at work.

Here is our guess.

We think the recent elections demonstrated how weak the Republican Party is and how much damage has been done by the President’s belligerent style. Republicans were trounced by Democrats.

The Republican leadership fears a tidal wave of Democratic victories in next year’s midterm elections, so they are desperate to pass a tax reform bill, no matter how the details affect policy decisions. But to get that victory, they have to find enough to agree upon. And those Republicans who have decided to retire next year have no motivation to be party loyalists. They can vote as they see fit. We believe they will.

In addition to those who have been prominent in their disputes with Trump, there are others who are quietly voting their conscience and owe nothing to this president. An example is Frank LoBiondo (R-NJ), who has announced his retirement. Disclosure is needed. I know Frank personally and have for many years, including a long period before he ran for Congress. I encouraged him to run and have supported him. It will be our loss when he retires. He was willing to run in 2016 without endorsing Trump. That was a tough thing to do, but he applied his conscience, as he has over the years. There are others like him. Some are retiring from Congress in 2018, and while they may not make national headlines, their votes will count for the next year.

My conclusion is that there will be a tax reform bill. The Republican leadership must have one and will compromise to get it, no matter what they have to exchange for the necessary votes. I also believe that Trump will sign any tax reform bill that makes its way to his desk. He is desperate for a victory. He will claim all sorts of wonderful political gains. Such is the nature of political hyperbole.

What that final bill will look like is still not clear. A thousand elements are being haggled over, one by one.

We also believe that the deficit will grow. And we expect that the out years are going to see a deficit measured in trillions, not billions. What that means for interest rates is harder, since interest payments on the federal debt suppress the ability to spend in other sections of the budget. In the past 10 years (during Bush’s final years, Obama’s full term, and the first year of Trump’s), the federal government increased its total outstanding debt by over $10 trillion. Meanwhile, the interest bill for the federal budget remained about flat, at or near $400 billion a year, held in check by the decline in interest rates to near zero and the sustaining of that very low level for nearly a decade. That meant the government got to refinance its higher cost debt as well as issue new debt at very low rates.

That’s right. We borrowed an additional $10 trillion from ourselves and the rest of the world. Yet we did NOT add to the cost of debt service, because of the interest rate policy applied by the Federal Reserve.

Now that party is coming to an end. The Fed is slowly raising interest rates. The government is increasing its deficit (read: borrowing). And the Fed is also shrinking its balance sheet, which means a gradual transfer of federal debt back to market agents around the world.

Add to that mix a so-called tax reform bill. These are a lot of moving parts.

We are cautious. We think policy outcomes are highly uncertain. For us at Cumberland, this is an extremely challenging time to manage portfolios. The key is to preserve capital and to reposition rapidly when circumstances change.

Let’s end with two historical judicial references about taxation.

“The power to tax involves the power to destroy.” John Marshall (1819) McCulloch v. Maryland

“The power to tax is not the power to destroy while this court sits.” Oliver Wendell Holmes, Jr. (1928) Panhandle Oil Co. v. Knox

David R Kotok
Chairman and Chief Investment Officer
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