The GOP-led Senate late Thursday approved a budget resolution that sets aside room for a net $1.5 trillion tax cut over the coming decade.
The 51-49 vote is important because it will allow the GOP to pass tax cuts with just 50 votes, plus Vice President Pence. With the exception of Kentucy Sen. Rand Paul, the Republican holdouts who derailed ObamaCare repeal were on board.
Yet, even assuming that the House will agree to the Senate's deficit-hiking budget, all of the hard work remains because Republicans are starting with unrealistic expectations for what President Trump is still calling "the largest tax cuts in U.S. history."
Wall Street expects that Trump will sign tax cuts into law in the first half of 2018, but that the package will be a whole lot smaller by then. Analysts at Morgan Stanley and Goldman Sachs have indicated that they see a 25% corporate tax rate as much more likely than the 20% that the White House says is nonnegotiable.
Even a 25% corporate rate would be good news for the stock market, raising S&P 500 earnings by 8% and potentially pushing the S&P 500 index to 2650 by year end, says Goldman chief equity strategist David Kostin.
The big challenge will be to squeeze individual tax cuts and corporate tax cuts through a $1.5 trillion hole.
While Republicans are counting on dynamic scoring to show that the tax legislation will pay for itself to a significant extent, they are likely to be sorely disappointed by official scores from the Joint Committee on Taxation for two key reasons.
The first problem is that there appears to be very little chance Republicans will find the budget offsets to make corporate tax cuts permanent. Yet even the conservative Tax Foundation has said that temporary corporate tax cuts would initially boost growth, but then the effects of a corporate tax cut would substantially reverse.
The second problem is that the official budget scorekeepers use dynamic scoring models that will penalize the GOP for adding more than $1 trillion in debt over the first decade, because the extra debt is seen as likely to push up interest rates and raise the cost of capital.
To utilize the Senate's filibuster-proof reconciliation process, the GOP plan can't add to deficits beyond the first decade, yet cutting the corporate rate to 20% will alone cost $3 trillion in the second decade, according to an analysis by the Tax Policy Center. As of now, the GOP has only spelled out about $300 billion in savings from repealing business tax breaks.
The tax framework jointly released by the White House and GOP leaders in the House and Senate last month included $2.6 trillion in net business tax cuts in the first decade, the Tax Policy Center said. While the cost could be lowered by phasing in the tax cuts, that won't be nearly sufficient to shrink the cost enough to make room for deficit-increasing individual tax cuts.
The effort to find offsetting savings to pay for business tax cuts is off to a rough start. The GOP dropped House Speaker Paul Ryan's plan to impose a border-adjustment tax after a fierce lobbying campaign from retailers like Wal-Mart (WMT). The border adjustment tax would have raised an additional $1.1 trillion by applying a 20% tax on imports.
IBD'S TAKE: The Dow Jones industrial average ended above 23,000 for the first time on Wednesday, up nearly 1,250 points since IBD changed its market trend indicator on Aug. 22 to "confirmed uptrend" from "uptrend under pressure," the equivalent of a yellow light turning green. Make sure to read The Big Picture column each day to stay on top of the market direction, a key indicator that lets you know when you can be aggressive and when you should move to the sidelines.
The next fight is likely to be over phasing out the deduction of interest payments on new corporate borrowing. That interest deduction is an especially big one for utilities and telecommunications firms like Verizon (VZ), which has more than $100 billion in debt.
While the unified framework put together by the Trump administration and GOP leaders in Congress does state that the deduction will be "partially limited" for corporate borrowers, Goldman Sachs is skeptical, predicting "no substantial changes" to the deduction.
Republicans plan a modest tax on tech companies like Alphabet (GOOGL) and Apple (AAPL) and drugmakers like Pfizer (PFE) that have amassed piles of cash to avoid paying high domestic tax rates on profits earned overseas. Yet the GOP is also weighing a minimum tax on future profits earned overseas that would apply if companies generate much of their overseas income in tax havens. While multinationals already are signaling strong opposition to the idea, expect the opposition to intensify if Republicans try to attach a minimum global tax to a temporary corporate tax cut.
Congress also is struggling to find ways to offset the cost of individual tax cuts, as some leading Republicans in Congress have wavered about eliminating the deduction for state and local income taxes, which would raise $1.3 trillion over the first decade. There's been talk of preserving the deduction for households making under $400,000, which would only save about one-third as much. Meanwhile, charities and real estate companies are gearing up to fight the GOP plan to double the standard deduction because it threatens to erode the value of deductions for home mortgages and charitable contributions.
RELATED:
S&P 500 Futures Jump after Senate OKs Budget Resolution Paving Way For Tax Cuts
This Is Why Trump's 20% Corporate Tax Rate Isn't Going To Happen
$100 Billion Question: Will Trump Let Alphabet, Pfizer Keep Tax Havens?
Stocks To Buy And Watch: Top IPOs, Big And Small Caps, Growth Stocks
