Tax Reform – Maybe Not

I have a friend here who is an ardent Republican, It has been fun watching as he adapts to the reality of Trump, and is now a partisan cheerleader for someone who, a few months back, was anathema to him. Such is the power of tribal politics.

In any case, not to depress him, I ought to note quickly that the much vaunted tax reform proposed by Paul Ryan is almost certainly dead. This is not to argue that tax reform won’t happen. I think it might. It just won’t bear much resemblance to what Paul Ryan was looking for.

This failure, coming so soon after his abject defeat over health care might be the death knell of Ryan’s short leadership of the House Republican caucus.

Yes, I know that the media is full of hushed talk about the re-vitalization of health care reform. But that looks more aspirational than fact. The essential problem that scuppered the Ryan/Trump plan still remains: there are a large number of Republicans in the House that object to all and every government involvement in health care insurance. They see it as a massive invasion of individual freedoms — how Friedman-like of them — and would prefer to rely on the magic of private markets to do the dirty work. In other words they see health care as just another commodity up for sale and not anything deserving of special status. If you aren’t covered by health care insurance then that’s your choice. If you can’t afford coverage, they argue, then stop buying other stuff, like food for instance. In this stance they are fully supported by mainstream economics in which everything is a commodity and consumers always optimize their purchases. According to economic theory if you aren’t covered by insurance its because you chose not to be. Don’t forget this is the same crowd that tells you that if you are unemployed its because you want to be. Employment is, after all, a choice like everything else.

The problem for the House freedom fighters is that they represent only a small part of the overall Republican party. The rest have, begrudgingly, taken on board the reality that Obamacare has re-shaped the discussion on health care. Getting rid of it would be an enormous political risk. So the party is deeply divided and can only legislate on health care with Democratic cooperation. Since that would come at a price — as in keeping Obamacare and fixing it rather than abolishing it and starting over — Ryan led reform is dead.

Now: about tax reform.

The Republicans are deeply divided over this too. Who could have guessed it? And, once again, Ryan seems to be out on a limb.

The core of his much talked about plan is the adoption of a Destination Based Cash Flow Tax [DBCFT]. Such a tax is designed to turn the US into a massive tax shelter. Companies based in the US could export products and deduct the value of the cost of those products for tax purposes. Conversely, companies importing goods would be unable to deduct the cost of those goods for tax purposes. The whole idea being to protect and encourage exports and penalize imports.

The issue is that an enormous amount of American end-sales are sourced from abroad. Most retailers are huge importers and would face extraordinary increases in their tax bills. They would be forced to pass that increase in cost on to customers causing a huge rise in retail prices. Unsurprisingly, companies like Walmart and Target have come out strongly against such a tax.

The fun fact here is that the tax is a liberal idea developed by academic economists who argue that the radical rise in retail prices would be precisely offset by a change in the value of the dollar. This is because of the shift in the US trade balance brought about, presumably, by the tax. So Ryan is pushing something that has its origins in a leftish academic setting.

Funnier still is that plenty of Republican opposition to the tax centers on the entirely academic idea that the exchange rate will, indeed, adjust enough to offset the enormous profit hit taken by the likes of Walmart, which is, lest we forget, the largest employer in the country. The academics, naturally, think this cleverness based on their theories is nothing to worry about.

What’s not to like?

Well, a lot.

It seems as if several Republicans have cottoned onto the fact that academic economics is sufficiently disconnected from reality that it cannot be trusted when we are thinking of tampering with hundreds of thousands of jobs. And, yes, I am aware of my pun: some of the loudest opposition is coming from Senator Cotton of Arkansas, a state which, just coincidentally I am sure, is home base for Walmart. Apparently many politicians are as skeptical of academic economics as I am. They ought to be. Who knew I would have something in common with Senator Cotton?

The problem for Ryan is that he was relying on a DBCFT to finance the rest of his tax reform. It was projected to generate about $1 trillion over its first ten years, which was sufficient to allow a major reduction in the corporate tax rate, from 35% to 20%, and since its cost effects were supposed to be offset by that rise in the dollar he had hoped its effects would be invisible to the general public. He had, he thought, found a perfect tax reduction technique for his corporate sponsors. Unfortunately the realities both of politics and the weakness of academic economics unmasked his scheme. Without that $1 trillion his entire tax reform plan unravels and he is left with nothing.

Hence the current inaction and evasion in the House.

Meanwhile Trump has promised us a big and beautiful tax reform of his own and keeps promising that it is being worked on. Any day now we will learn its wonderful details. Any day now.

Having flubbed his opening lines on health care — he had no plan so he relied on Ryan which turned out to be a political disaster — Trump is under pressure to introduce his own policy. Up until now we have no idea of what a Trump plan might look like. Other than, that is, its undoubted wondrousness. He has hinted he likes a Value Added tax [VAT], but traditional Republicans hate VAT because they see it a as stealth method for paying for social programs like health care. Reagan said as much.

Given that he hasn’t staffed up the Treasury Department it seems unlikely that his Treasury Secretary will be of much use. So he is relying on Gary Cohn, his economic advisor, as architect. No one knows what will arrive, or when. The Trump administration is in its infancy and seems chaotic. It is yet to settle into anything resembling governance. So something like tax reform, which needs careful construction and lots of political selling in Congress looks like a long shot. At least for now. Maybe later? Any day now …

The Republican jubilation at their surprise victory last November and their total control of Congress led them to announce a massive and rapid legislative revolution. Health care and tax reform were the centerpieces of this program, along with, if you believe Trump,  an infrastructure plan. So far nothing has turned up, time is going by, and muddle along with defeat is the order of the day.

What this means for Ryan is anyone’s guess, but even his most ardent supporters must be getting tired of him by now. And he must be, surely, getting tired of his extremist freedom fighting colleagues. Maybe he’ll quit?