For Republicans to win on tax reform, something's got to give

With control of the White House and Congress, Republicans are closer than they've ever been to achieving a long-sought goal: reforming the U.S. tax code. After several months of behind-the-scenes work, House and Senate leaders, the tax writing committees of both chambers and the Trump administration agree on what reform should look like. The shared goal is a simpler tax system that encourages economic growth, allows U.S.-based businesses to compete abroad, provides middle-class tax relief and is done in a way that as much of it is permanent as possible without adding to the deficit.

This is a big to-do list. And to achieve it, something's got to give. That something should be the deficit. This is both a policy prescription and a political one. Revenue neutrality, which is the euphemism used to describe some people's taxes going up to finance other taxes going down, is a noble goal that does not meet current economic or political realities in the United States.

Politically, the deficit is not a pressing political concern in either party. Debt politics have changed from five years ago. Middle class tax relief will give the Republican Party something to run on in the 2018 midterm elections, and a pro-growth tax reform will provide the incumbent party economic tailwinds in the 2020 presidential election. Democrats have enough ammunition to fire in next year's elections that a mild expansion of the debt isn't likely to be the thing that costs any Republican member his or her seat, but failing to accomplish anything legislatively might be.
 

Economically, the current deficit path of the U.S. is not good. The Congressional Budget Office's projected deficit this year is 3.6 percent, down from a high of 9.8 percent in 2009, but set to rise throughout the congressional budget window to 5.2 percent in 2027. But a modest annual deficit increase of half a percentage point of gross domestic product could finance a sizable, pro-growth tax cut. Such a tax cut could be easily absorbed by financial markets in a time of historically low interest rates where, thanks in part to the Federal Reserve, there is ample financing for U.S. government debt.

The positive reaction from markets in the wake of Donald Trump's election was largely driven by expectations of fiscal stimulus and only modestly higher inflation as a result. In the Obama era, many liberal commentators were calling for a deficit-financed infrastructure plan to take advantage of low interest rates. Reducing the corporate tax rate is a similarly important economic policy for preserving the U.S. corporate tax base and allowing U.S. firms to compete internationally. Allowing corporations to take their foreign income and invest in jobs and growth here in the U.S. by shifting to a territorial tax system with a mandatory repatriation tax will help boost growth and make the U.S. an even greater hub for foreign investment.

Paying for a tax cut is going to present an enormous political challenge that can't be solved. Many in corporate America are eager to see the punitively high U.S. corporate rate drop to internationally competitive levels, but few are raising their hands to offer an increase in their own net tax burden to finance that general rate cut. Getting bogged down fighting over how to pay for tax cuts would squander the opportunity currently in front of the party.

Paying for a tax cut is going to present an enormous political challenge that can't be solved.

And it isn't necessary. The Senate's complicated reconciliation rules require that a bill be deficit neutral only outside Congress's 10-year budget window. Inside the window, there is room to be much more creative. Other constraints exist, such as the chamber's pay-as-you-go rules and the statutory law that was signed by President Obama, but those constraints can be navigated around if there is political will. A deficit financed bill would allow for much deeper and much broader tax cuts than a fully-financed bill. And new taxes could be implemented in the final years of the budget window to solve the deficit problems outside it.

This is not a new formulation. The Affordable Care Act, passed in 2010, was largely financed by tax increases that came online several years after its passage so that no one felt an immediate tax increase. Several of those taxes have been delayed by subsequent acts of Congress, perhaps indefinitely. Any revenues raised in later years should be put towards making the corporate changes permanent to provide certainty for businesses making investments. Expiring individual taxes can always be extended, even under a Democratic president, as the expiring 2001 and 2003 tax relief was in 2010 and 2012 under President Obama.

The artificial constraint of revenue neutrality, which is neither politically nor economically binding, is far too limiting. The success of tax reform won't be measured by the Congressional Budget Office's estimate of its deficit impact, but on its long-run effects on growth, investment and jobs. And a deficit-financed tax cut is the likeliest path towards achieving something meaningful in this Congress.

Jonathan Lieber is director of the U.S. practice at the Eurasia Group, a global political risk consulting firm. He served as deputy director of the White House National Economic Council during the George W. Bush administration and later as principal advisor to Senate Majority Leader Mitch McConnell on economic and trade policy.

This piece was originally published in The Hill.