Tax Reform Update – September 2017

AALU - Leadership for Advanced Life Underwriting

September 2017


AALU Tax Reform Update – September 2017

September Legislative Agenda

Congress returned to Washington last week with a number of legislative priorities to address by September 30th. Two of the biggest were raising the federal debt limit and passing a bill to keep the federal government funded.

In a surprising turn of events, last Wednesday President Trump struck a deal with Democrats on a legislative package to punt the debt ceiling and government funding votes for at least three months, in addition to providing supplemental funding for hurricane relief for the Gulf Coast.

The deal occurred during a scheduled meeting in the Oval Office with President Trump and Congressional leaders of both parties. Senate Minority Leader Chuck Schumer (D-NY) and House Minority Leader Nancy Pelosi (D-CA) floated a similar package on Wednesday morning, and it was widely panned by Republican leaders, with House Speaker Paul Ryan (R-WI) initially calling the idea “ridiculous and disgraceful.”

Yet during the meeting, President Trump announced that he supported the deal floated by Schumer and Pelosi. Senior Administration officials had previously agreed to support the Republican proposal with longer extensions for the debt ceiling.

Despite discomfort with the deal, both the House and Senate quickly passed the three month extensions in addition to providing $15.3 billion for hurricane relief efforts. The extensions for the CR will expire on December 8th, as will the debt ceiling—though Treasury may have some wiggle room to push a vote into 2018. However, the conservative caucuses in the House (The Republican Study Committee and the Freedom Caucus) opposed the deal and ninety House Republicans voted against the package. We will address the broader implications for tax reform in more detail below.

The deal cleared a significant portion of the must-pass legislation off the September agenda, yet Congress still needs to reauthorize children’s health insurance (SCHIP), the FAA, and the National Flood Insurance Program by September 30th. Additionally, the National Defense Authorization Act will likely go through regular order this month—requiring significant floor time.

The most significant incomplete prerequisite to tax reform remains the lack of a Budget Resolution for fiscal year 2018. A Budget Resolution agreed to by both chambers is necessary for filibuster protection in the Senate.

Health care reform also remains unfinished. Despite repeated efforts, Senate Republicans were unable to repeal and replace the Affordable Care Act before heading into the August recess. President Trump continues to urge Congress to complete health care reform, a sentiment shared by a number of Republican Congressmen and Senators. Given the political and practical imperatives around health care reform, the issue will continue to linger.


Tax Reform

Congressional Environment

Despite the formidable list of challenges, Republicans will be squarely focused on tax reform this Fall. While the Trump Administration and Congressional leaders are still in agreement that tax reform will be completed by the end of 2017, Republicans acknowledge it’s an ambitious timeline, and AALU believes that the first or second quarter of 2018 is a more realistic timeframe for passing tax reform. Even with the longer timeline, Republicans face a difficult political and Congressional environment, with a variety of challenges that could distract from tax reform.

Republicans planned to use the August recess to begin making their case to the American people about the benefits of major tax reform, but a variety of factors (WH staff changes; controversy and tragedy in Charlottesville; Hurricanes Harvey and Irma) prevented a sustained message from getting across.

One key dynamic that will influence tax reform this Fall is the relationship between President Trump and Republican House and Senate leaders in Congress. A complicating factor is the strained relationship between President Trump and Leader McConnell, with multiple reports indicating that tensions boiled over as the recess progressed. President Trump has continued his attacks on Congressional Republicans into September. The deal he struck with Senator Schumer and Leader Pelosi on government funding and the debt limit further exacerbated these tensions.

The deal also feeds another narrative the media loves to play up: The Pivot. After the election it was widely speculated that the President, with no previous affiliation with the Republican Party, could turn on his party and focus on working with Democrats to craft bipartisan legislation. President Trump, some say, seems more comfortable with his fellow New Yorker Senator Schumer than with Leader McConnell or Speaker Ryan.

Yet it is important not to read too much into this deal in terms of a longer-term pivot. President Trump is kryptonite to a wide swath of the Democratic Party, and the idea that Trump is about to pivot to a much more progressive agenda is highly questionable. Republicans remain in control of Congress and whether or not they like each other, they need each other to accomplish their shared goals, including tax reform.

In addition, Republicans and Democrats have seemingly mutually exclusive goals for tax reform. Republicans want tax reform (or tax cuts) to grow the economy by letting you keep more of the money you earn (or at most taking no more of it). Democrats want tax reform to raise more revenue for the federal government. To date, there has not been any real effort to craft a serious bipartisan tax reform package.

Most importantly, Republicans are under significant political pressure to produce a win. Apart from the confirmation of Supreme Court Justice Gorsuch and an improved regulatory philosophy they have yet to notch many major legislative achievements. The failure to repeal and replace the Affordable Care Act absolutely enhances that pressure.

The legislative process can seem dormant for a long period of time, then quickly get going—speeding a bill though committees and both chambers of Congress. This potential is heightened for large pieces of legislation that could draw some level of opposition from a breadth of stakeholders.

As we discuss below, Republicans still need to make fundamental decisions about tax reform. The extensions give Republicans more breathing room. How Republicans use this three month period will be critical to tax reform.

FY 18 Budget Resolution

Some Republicans continue to discuss their desire for bipartisan tax reform, but AALU agrees with most observers that securing eight Democratic votes in the Senate is a bridge too far given current differences—despite some bipartisan overtures from President Trump. For example, Ways and Means Chairman Kevin Brady (R-TX) recently reached out to Democrats on tax reform, but he rejected one of their core requirements: no tax cuts for the top 1%.

Without Democratic support, Republicans must use reconciliation, a special procedure that provides protection from the filibuster. While reconciliation involves innumerable arcane hurdles, it provides the opportunity to pass tax reform with only 51 votes in the Senate. To activate this procedure, Republicans must include reconciliation instructions in the FY 18 budget resolution (“Budget”).

However, the Budget foments its own intraparty disagreements. To date the House Republicans have not resolved the differences between their moderates and their fiscal hawks over entitlement spending. Budget Committee Chairman Diane Black (R-TN) included $200 billion in mandatory spending cuts in the current version of the budget resolution. Meanwhile, the Freedom Caucus is demanding $500 billion in entitlement cuts, while the moderate Tuesday Group is reticent to vote for big budget cuts that have no chance of passing the Senate. Bottom line, they have yet to craft a package that secures the necessary votes.

The continuing struggles to pass a budget resolution in the House indicate the seriousness of their internal divisions, and with no plan to break the impasse there is plenty of work to be done. But, given the budget is their ticket to tax reform, it is widely expected that Republicans will find agreement eventually.

Tax Reform: The Details

As we reported in late July, “the Big Six”—Paul Ryan (R-WI), Mitch McConnell (R-KY), Kevin Brady (R-TX), Orrin Hatch (R-UT), Treasury Secretary Steven Mnuchin, and NEC Chairman Gary Cohn—released a one-page framework for tax reform. The big takeaway was the acknowledgement that border adjustability, estimated to raise $1 trillion-$1.2 trillion in revenue to pay for dramatic rate reduction, would not be a part of tax reform—making fundamental change to our system of taxation more challenging. Instead, the scope of tax reform could become constrained without the convenience of a major revenue source. It is worth remembering that the press has to fill a vacuum to meet the demand for information, parsing every utterance for meaning whether intended or not. Big questions remain at this stage. The likely next step will be the long promised release of another four to five page framework for tax reform followed by the development of legislative text in the Ways and Means Committee.

Among the key tax questions yet to be decided:

  • Corporate and Individual Tax Rates
  • Revenue Neutrality (baseline considerations, dynamic scoring)
  • Retirement Savings Provisions
  • Interest Deductibility
  • Expensing (Asset Valuations)
  • Camp Draft Provisions Impacting Life Insurance Products and Companies
  • Permanence

Republicans have yet to make key threshold decisions about 1) overall spending and revenue targets in the budget resolution and 2) dynamic scoring/baseline considerations. They will use dynamic scoring, but haven’t formalized the baseline or scored a legislative draft, so the magnitude of potential changes is still unknown.

It has been reported that most of the Big Six believes the Corporate rate will end up between 20% and 25%. President Trump continues to aggressively promote a 15% rate, but that is almost impossible to achieve. Speaker Ryan said last week that he is aiming for a C rate in the mid-to-low 20s—near or below the 22.5% average of industrial-world corporate tax rates.

Closely tied to the Corporate rate is the tax treatment for pass-throughs. Reducing the tax rate for small businesses is even more expensive than it is for corporations, which makes getting the pass-through rate below 25% almost impossible in the current environment. As an organization representing advisors that serve a wide variety of businesses and their employees, AALU supports the Main Street Fairness Act, legislation introduced by Senators Collins (R-ME) and Nelson (D-FL). The bill seeks to ensure small businesses never pay a higher tax rate than large corporations—achieving a level of equity in rates regardless of business structure.

There have been no specific proposals in terms of retirement savings provisions and interest deductibility. There has been some recent discussion about limiting pre-tax benefits for retirement plans like 401(k)’s, switching to an after-tax Roth contribution regime—sometimes referred to as “Rothification.” Republicans are looking for significant revenues to offset the cost of tax reform, and such a switch is estimated to bring in roughly $400 billion in revenue. To be clear, there has been plenty of pushback on this idea from a number of stakeholders in the retirement savings community, and we will continue to monitor this aspect closely.

In addition, there are few specifics on deductibility and expensing, outside of repeated assertions from Republican leaders that the mortgage interest deduction and charitable deduction are off the table. The House Blueprint recommended immediate 100% expensing, but Chairman Brady has come off of that stance somewhat, and seems open to phasing-in such a benefit.

The C rate that’s finally settled on will be impacted by how far Republicans are comfortable with pushing on such items as rolling back deductions and limiting expensing. For example, the more you allow for items such as immediate expensing, the likelier the C rate is closer to 25%. The more you limit deductions, the closer you can get to 20%.

The pressure to obtain enough revenue to get business rates down to desired levels is compounded by repeal of the estate tax. Full estate tax repeal was part of the House Blueprint, and it has consistently been mentioned by House Republicans and the Trump Administration as a desired provision in a tax reform package. Yet repeal carries a $275 billion price tag (over 10 years), adding to the revenue challenges Republicans face in lowering rates.

Given those revenue challenges and a dearth of alternatives, the Camp Draft is once again being mentioned in the halls of Congress. AALU Ambassadors and internal staff continue our work educating tax writers and key members of Congress about the consequences of the Camp Draft on our clients and our industry—including the value of business uses of life insurance and non-qualified deferred compensation plans for financial security and retirement planning, as well as the importance of permanence and sustainability in long-term planning. As of this update, there are no specific proposals to revive the life insurance provisions of the Camp Draft, but given the Congressional tendency to return to previous legislative text without viable options, it is important to remain vigilant.

Summary

As Republicans develop the details of tax reform this Fall, they face a number of challenges and many questions remain unanswered. Yet despite the hurdles, Republicans have significant motivation to pass major tax reform from both a policy and political perspective, and the next few months should add clarity to the contours of the ultimate tax reform package.

AALU is following the long-term strategic plan on tax reform that was developed after the election, and we are continually monitoring changes in the environment as we execute our strategy. Given all the uncertainty, it is critical to remain alert, and AALU continues to closely watch for any provisions negatively impacting life insurance. We will update members on tax reform developments as warranted, and continue to engage each of you directly as this process unfolds in the coming weeks.

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