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This week, focus will be on the extension of the appropriations bill and on the (very low) risk of a federal government shutdown. .....

 

- On 2 December, the Senate approved its version of the Tax Cuts and Jobs Act (TCJA). According to the dynamic estimates drawn up by the Joint Committee on Taxation, the Senate version of the TCJA would increase the deficit by around one trillion dollars, and would have an average expansionary effect on GDP of 0.8% in 2018-27. The effects on growth diminish over time due to the transitory nature of many measures (full expensing of machinery investment, personal income tax rate cuts). The Senate’s version, like the one voted by the House, is essentially regressive in terms of its impact on the income of households. The static impact of the measures on the cumulated 2018-27 deficit is similar for the two versions, at around 1.4 trillion dollars.  

- The next step towards the final tax reform is the reconciliation of the bills approved by the House and the Senate. The two versions share a widening of the taxable base, and sweeping changes to the core of corporate taxation (territorial system of taxation, one-off rates on the repatriation of foreign-held earnings, even if at different levels, reduction of the corporate tax rate to 20%, tax cuts for pass-through businesses, limit on interest deductions). 

- The two bills though differ on many points. The Senate’s version is constrained to have no effects on the deficit over the post-budget horizon, to meet the requirements of the rule imposed for the use of the reconciliation procedure. The House’s version does not meet these requirements and should be adjusted on this front as well. For households, the House has left the maximum tax rate at 39.6%, the number of tax rates drops to four, child tax credit is moved up to 1,600 dollars, deductions for health care expenses and student loans are repealed, as also the Alternative Minimum Tax and the estate tax (starting after 2024). For businesses, the House bill sets the corporate tax rate at 20% starting in 2018, and a maximum tax rate on pass-through businesses at 25%. The Senate’s TCJA cuts the maximum tax rate on households to 38.5%, maintains seven tax rates (lowered only until 2025), changes the deduction for dependent children to 2,000 dollars, keeps the AMT, the inheritance tax (with a higher tax-free threshold), and deductions for health care expenses and interest on student loans. For businesses, the Senate bill cuts the tax rate on earnings starting in 2019, and simple partnerships are allowed to deduct capital gains rather than being imposed a maximum rate. These differences can be reconciled, if the political will is there, but the price to pay will be a number compromises.

- The Republican leadership is aiming for a bill by mid-December, to be voted in Congress and brought before the President to be signed off before the end of the year. The deep willingness to approve the reform by end-2017, leads us to forecast that the two versions will be reconciled rather swiftly. The easiest way is for the House to accept most of the features of the Senate TCJA, although the final bill is likely to differ from both the original versions. 

- To assess the macroeconomic impact of a potential reform, it is important to note that the Senate’s version pushes back to 2019 the corporate rate tax, includes higher child tax credits, and reduces personal income tax cuts only through 2025. Therefore, stimulus to the business sector would be delayed, and the transitory and regressive nature of the household stimulus could reduce the effects on growth. For now, on a very preliminary base, we estimate that reform may have expansionary effects averaging around 0.3pp per annum in 2018-19.

- This week, focus will shift to the extension of the appropriations bill expiring on 8 December. The Republicans aim to pass an immediate extension until 22 December, and to then negotiate a spending bill for 2018-19. Democratic votes are needed to approve the spending bill, and compromises will be required to avoid a federal government shutdown. 


Appendix
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