Expectations for Tax Reform

The Takeaway

Wall Street is keenly focused on the potential for tax reform across multiple fronts in Washington as we look ahead to 2017 and the Trump Administration. As of this writing, we are most optimistic on the prospects of an international-focused tax reform package, the revenue from which would be used to offset the cost of a domestic infrastructure and transportation spending package. However, it is possible (perhaps even likely) that Speaker Ryan will push Trump to consider broader corporate tax reform and potentially even individual tax reform now that Republicans control the executive branch and have majorities in both legislative chambers in Washington. Fast-track budget reconciliation authority will most likely emerge as a vehicle for either corporate or individual comprehensive tax reform, but the maneuver may not be necessary for an international-focused tax reform bill, making it an easier lift in our view. For those and other reasons outlined in this report, we are increasingly bullish on the prospects of some measure of tax reform in the near future.


House Speaker Paul Ryan (R-WI) congratulated Donald Trump on his win Tuesday and reveled in the newfound dominance of the Republican Party in Washington’s lawmaking chambers. The Speaker has always championed corporate tax reform and includes a fairly detailed proposal for reform in his Better Way agenda.

There is a perennial disagreement in Washington, usually between Democrats and Republicans but now potentially between two wings of the Republican Party, about how to use the highly coveted and oftdiscussed revenue that would be raised by imposing a “deemed” tax on accrued foreign derived earnings. For illustration, Trump’s plan would impose a 10% tax on the estimated $2.6 trillion in overseas earnings “trapped” offshore primarily among the technology and pharmaceutical industries. Such a tax would generate roughly $170 billion in revenue. He proposed using that revenue as a down payment on a national infrastructure program, which in recent weeks Trump suggested should total $1 trillion.

Republicans more broadly, however, have historically preferred to use that same foreign revenue to offset the cost of reducing the corporate tax rate. There is disagreement between Trump and the Better Way platform on what top-line rates for the corporate tax should be (15% in Trump’s plan, 25% in the Better Way plan), but all Republicans support a reduction in the corporate tax rate and agree that repatriating foreign derived earnings is a germane and attractive source of money to get that ball rolling.

Key Obstacles

Unfortunately for the Republican Party, while they hold majorities in the House and Senate, they do not hold a supermajority in the Senate. As such, any partisan comprehensive corporate tax reform bill will fail in the Senate unless it is passed via reconciliation instructions. This is a complex and time-consuming process, which will suck most of the oxygen out of Washington. Therefore, it may not immediately appeal to Trump, who is by most accounts seeks to make great strides from day one of his presidency. Furthermore, it requires full buy-in from the White House and will need to supersede other efforts, such as comprehensive immigration reform or repeal of the Affordable Care Act – two issues that occupied greater prominence in Trump’s campaign and are more important to his supporters as evidenced by the exit polls of the recent election.

About Reconciliation

Reconciliation instructions come to fruition as follows: first, the President releases his FY18 Budget (likely in early March), which includes directions to pass X legislation through this fast-track authority. Second, the House and Senate Budget Committees consider the President’s budget and put forward their own budgets, which in theory should take the President’s proposals into account. Finally, the two chambers agree verbatim to a unified budget and pass a formal Budget Resolution with both agreeing that reconciliation instructions should be applied to the same legislative agenda item. There are a number of issues competing for this coveted fast-track authority: immigration reform, energy reform, tax reform, healthcare reform, etc. It is not permissible to pass more than one reconciliation bill in a given year and, while some of these subjects could theoretically be rolled into one larger bill (as was the case with the Affordable Care Act and student loan payments in 2010), it is very difficult to combine different measures without 60 votes in the Senate due to the inherent restrictions placed on reconciliation authority. Republicans would risk seeing portions of their comprehensive legislation stripped out, for example, if they did not include direct revenue or deficit impacts, were considered non-germane by the Senate parliamentarian, or if they increase the deficit in the future.

For those reasons – and the basic reality that comprehensive reform of anything takes time, resources and the attention of numerous committees – only one of those key agenda items can be realistically expected to pass via reconciliation in any given year. Tax reform will have to compete with those other issues, including immigration reform, healthcare reform, and financial regulatory reform, for top billing in the first year(s) of the Trump Administration.

Trump has Time on His Side

Given the bipartisan support for infrastructure investment, the path of least resistance politically and in terms of expediency would be to move forward with a bipartisan, international-only tax reform package coupled with infrastructure spending as opposed to a more robust and time consuming corporate or individual tax reform package. It is also worth noting that while the Republicans do not have 60 votes in the Senate in 2017, they may well enjoy such a margin in 2019 after the mid-term elections. Running the table in Washington with a promising 2018 mid-term creates breathing room for Trump that would not have existed for ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES BEGIN ON PAGE 2 Clinton given the 25 Democrats up for reelection in 2018, many of whom are in red or purple states versus the 8 Republicans who are up for reelection. As stated at the outset, we believe the potential for some manner of tax reform in 2017 is greater than it has been in many years. At a minimum, Speaker Ryan will push aggressively for such reform in the coming weeks. In our view, the most likely legislation is the international-focused, but corporate and individual reform will certainly be a topic of discussion and could pass in future years of Trump’s presidency.


RISKS

The legislative and regulatory agendas are subject to change at the discretion of leadership. Unprecedented economic conditions could instigate unanticipated and/or sweeping shifts in policy. Predicting the future is a hazardous endeavor and economic / market forecasting is an imprecise science. Actual outcomes may differ substantially from our forecasts. The predictions and opinions expressed herein are subject to change at any time.

ANALYST CERTIFICATION

I, Henrietta Treyz, certify that (i) the recommendations and opinions expressed in this research commentary accurately reflect the research analyst’s personal views about any and all of the subject securities or issuers discussed herein and (ii) no part of the research analyst’s compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the research analyst in the research commentary.

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