29 09 2015

Jeb or Hillary, tax reform wins in 2016

Comprehensive tax reform is a once-in-a-generation accomplishment, the sort of legislative achievement that every politician wants but few will get. Republicans and Democrats began this year with ambitious talk of reaching a bipartisan agreement on tax reform, but it has now become clear to most that it will require the investment of more time and political capital than President Obama has remaining.

That does not mean, however, that investors should ignore the conversation until the next White House occupant arrives in 2017. The building blocks for comprehensive tax reform are already being set into place in Congress and on the campaign trail.

Key power players from each party are ascending to pivotal roles in Congress. In the House, former vice presidential candidate Paul Ryan (R-WI) took the gavel on the Ways and Means Committee at the start of this year, beginning a six-year term as its chairman. Ryan has spent years studying tax issues, and passed up opportunities in House leadership for this chairmanship. He is using his first two years in the position to create favorable conditions for reform, pushing legislation to permanently extend some perennial tax breaks to create a more favorable budgeting calculus later on and leading efforts to use a narrow international tax-reform deal to cover the cost of a long-term highway funding bill.
In the upper chamber, Minority Leader Harry Reid (D-NV) will be retiring at the end of 2016, clearing the path for Senator Chuck Schumer (D-NY) to take the lead of the Senate Democratic caucus in 2017. Schumer has long been a major player in the tax discussion as a senior member of the Finance Committee. This past summer, he partnered with Senator Rob Portman (R-OH) to develop the committee's bipartisan framework for international tax reform.
Of course, the most important player in any large-scale tax-reform negotiations will be the next president at 1600 Pennsylvania Avenue. While it is not yet clear who will win the respective party nominations, much less the presidency, the fact that so many top presidential candidates have begun releasing plans demonstrates that tax reform will be a top priority for whoever next sits in the Oval Office. Despite the passionate anti-establishment sentiment currently gripping voters, I still believe that the two plans that are most likely to see action are those from Hillary Clinton and Jeb Bush.
Clinton's tax proposals, like many Democratic plans, emphasize relief for the middle class. But she also stresses creating the environment for long-term economic growth, which is why a significant increase to the capital-gains tax for investments less than six years in duration is at the center of her plan.
If Clinton wins the election, it is possible that Senate Democrats ride her coattails and regain control of the upper chamber. However, even under the best-case scenario for Democrats, they will not flip enough seats to reach the 60-vote super-majority necessary to pass legislation under long-standing Senate rules. Thus, Clinton will need to work with Schumer and Ryan to hammer out a compromise tax-reform package.
Bush's proposals, in turn, are much broader than Clinton's and his options if he wins the presidency may also be broader. His plan emphasizes job growth, with most of his rate deductions framed as opportunities to increase employment and simplify the filing process. The plan would collapse the seven current individual tax brackets into just three, and would lower the capital-gains rate for all investments, regardless of duration. To encourage people to seek out jobs, Bush calls for expanding the earned income tax credit for childless workers, allowing secondary earners to file taxes separately, and eliminating the payroll tax for seniors eligible for Social Security. On the corporate side, Bush's plan sets a 20 percent top rate and removes many deductions for simplification purposes. However, Bush's entire plan is predicated on an ambitious projected growth rate of 4 percent, which many economists pan as unrealistic.
If Bush wins, Republicans would face the same 60-vote hurdle in the Senate as Clinton, but they will have an ace up their sleeves – the reconciliation process. Under this legislative maneuver, Congress is able to pass one piece of legislation each year with only a simple majority of each chamber, and in this scenario, the Republicans would control both the House and the Senate. In fact, in both 2001 and 2003, the Republican Congress used this exact process to pass President George W. Bush's tax cuts for ten years, the longest period applicable when using the reconciliation process.
There are limits, though, on how far the reconciliation process can be used. Among the current requirements, any bill passed using reconciliation cannot add to the deficit, which would be a problem for Bush's plan as proposed. Republicans could always relax these requirements, as they did when they passed the 2001 and 2003 tax cuts. But as that occurred before the advent of the Tea Party, which was sparked in large part out of concern over the government's profligate spending, such an effort this time around would likely run into greater resistance, particularly from rank-and-file conservative House Republicans.
It is common for investors to treat most of what comes out of politicians' mouths as empty promises, particularly during campaign season. However, in this instance, they should pay attention as the building blocks of comprehensive tax reform are subtly being laid.