Battles Brewing Over US Budget and Taxes
The new priorities of the US Congress and the Trump administration are designed to make US fiscal policy more pro-growth and pro-business. What these legislators will actually accomplish, however, is anyone’s guess – particularly once political posturing and special-interest lobbying kicks in. On top of that, the federal budget process has many twists and turns that will ultimately dictate the timing, scale and scope of changes.
Complicating matters further, the Republican-controlled Congress and President Donald Trump have work to do before they can even get to next year’s budget: They must approve new short-term spending bills that fund the government through September, the end of the fiscal year, and they will need to raise the debt ceiling to avoid a government shutdown. At every step along the way, they will be met by resistance from Democrats and many within their own party.
Significant changes to government spending
Mr Trump’s fiscal-year 2018 budget proposal, sent to Capitol Hill on 16 March, sets in motion formal Congressional processes that will determine the funding levels for federal agencies, programs and operations – and most of them have little chance of being approved. The proposal calls for unprecedented cuts in civilian non-defense discretionary spending and the elimination of 19 federal agencies to fund increased spending on national defense, veterans affairs and homeland security. As proposed, the budget would confine civilian non-defense spending to slightly more than 3 per cent of gross domestic product in fiscal-year 2018, a 56-year low.
Initial indications suggest that not only do congressional Democrats dislike the proposal, but much of the Republican base in both houses of Congress disagrees with the president’s plan as well – with one prominent senator calling it “dead on arrival”. Republicans on the political right already contend that the proposal, if enacted, would magnify the federal budget deficit; more moderate Republicans complain that severe cuts to programs important to their respective states or districts cannot be supported.
Major tax reform in Republicans’ sights
Even as they prepare for a fierce budget fight, Congress and Mr Trump have begun serious consideration of tax reform for businesses and individuals. These proposals could turn into the most comprehensive new tax legislation since 1986 and are expected to spark a new round of political battles.
By most accounts, Republican leaders in Congress will seek to enact reform legislation by no later than late summer, so the pressure will build quickly. Tax reform will focus not only on businesses: Plans call for reduced burdens on middle- and lower-middle-income households, and a broader tax base for higher-income tax filers, designed to eliminate net reductions in their effective rates. Legislation along these lines will put many moderate Democrats in a tricky situation: Positioning against the tax bill could look like a rejection of benefits for low- and moderate-income taxpayers, while voting for the bill could seem like capitulation to the Republican leadership in Congress.
Regardless of the timetable, passage of business and personal tax-reform packages seems inevitable this year, even if they fall short of the original goals of the administration and House Speaker Paul Ryan. Compromise will be needed because several components of the comprehensive package - such as the border adjustability tax – are highly controversial. Nevertheless, proponents of radical reform will push hard for changes to taxes, spending, health insurance and regulation, considering them overlapping parts of a comprehensive program that works only if all of the key provisions remain intact. Think of it as a stack of Jenga blocks.
Change is coming
In the end, the overall tax-reform package as proposed by the administration and congressional leaders will likely raise the federal budget deficit over the next decade. Yet the increase can be offset partially if the package stimulates economic growth sufficiently to boost tax revenue and shrink government spending. Either way, meaningful changes in spending priorities and major tax reforms can be expected well before the end of 2017. The markets should respond well if Mr Trump’s pro-growth and pro-business policies become reality and the economy strengthens.