Nothing erodes the power of a bully as much as a victory by those he threatens. Nothing erodes the reputation of a negotiator as much as a failure to succeed in cutting a deal he dearly wants to complete. Which is why President Trump enters negotiations over tax reform in a seriously weakened condition. The battle over health care has shown that he has neither the muscle nor the negotiating skill to win over a band of some twenty hard-right Republicans known as the Freedom Caucus to his plan for the reform and replacement of Obamacare. To add to his weakened position, Speaker of the House Paul Ryan, on whom he must rely to round up votes for tax reform, has proved to be unable to deliver the votes he promised the President were in his pocket.
The added problem for Trump is that he had been counting on $1 trillion in savings over ten years from his health-care reform to provide funds to offset revenue lost from cutting corporate tax rates. Even if health-care reform is brought back from the dead, it won't be soon enough to provide the savings needed to fund corporate tax cuts. Under the rules governing tax bills, the reforms, which in this case means tax cuts, must be revenue neutral—cannot increase the deficit. For every dollar in tax cuts he must find one dollar in spending cuts. Meaning that he must gore a rake of oxen, all defended by lobbyists who favor tax cuts, none of whom favors cuts in spending on his client.
So tax reform is hardly the low-hanging fruit it was thought to be only a few weeks ago. It just might prove to be beyond the President's grasp. Which is why investors, once certain that American business would soon have the burden of Obamacare lifted from its earnings statements, and taxes lowered, are now having second thoughts about the ability of share prices to continue their upward trajectory.
There is worse. The president and establishment Republicans are far from agreeing on the changes they want made in the tax code. That is precisely the sort of unreadiness to legislate that doomed efforts to reform health care and makes the success of the first attempt to overhaul the tax code in thirty years even less likely to succeed. Ryan wants to reduce the corporate tax rate from its current statutory rate of 35 percent—after corporations take advantage of various deductions the actual, paid-in rate is more like 28 percent—to 20 percent. Candidate Trump's target was 15 percent. President Trump thought 15 percent-20 percent might be a good idea, until he settled on 20 percent. That was before the $1 trillion in health-care savings evaporated. Now, to avoid increasing the deficit, he would have to settle for 28 percent, the figure President Obama repeatedly proposed and Republicans in Congress repeatedly rejected as not low enough.
This has economists scrambling to re-do the models into which they had plugged a 20 percent rate, and which told them that rates that low, along with other reforms, might increase the growth rate from its current anemic 1 percent-to-2 percent to perhaps as much as 3.5 percent. Not the "5 percent or even 6 percent" Trump saw in his private crystal ball at times, but enough to create jobs, jobs, jobs—assuming that a vast army of appropriately skilled unemployed workers is indeed available in an economy with a 4.7 percent unemployment rate, an assumption much employers with whom I have spoken say is unrealistic.
Ryan is pinning his hopes on a so-called border adjustment tax to produce the revenue needed to allow rates to be cut to 20 percent. That would impose a 20 percent tax on imports, mimicking the VAT that other countries impose on goods they import from the U.S. As things now stand, an American-made Cadillac shipped to Germany is burdened with a 20 percent VAT when it is marketed, but a made-in-Germany BMW hits the U.S. market virtually free of duty. A border tax adjustment would level the playing field. Trump initially found the plan too complicated, then endorsed it, and now says he is uncertain.
That new-found uncertainty comes after the president met with CEOs of the big importers such as Walmart. They threatened to raise prices by 20 percent if such a tax were adopted, which would hit Trump supporters where it hurts—in their pocketbooks. This was slightly disingenuous, since the tax would apply to the price retailers paid for imported goods, not the higher price at which they sell them in their stores. Still prices would go up, unless profit margins come down, or economists are to be believed.
Economists claim that the cost increases resulting from the border adjustment tax would be offset by a 25 percent increase in the value of the dollar, a result of reduced imports. The stronger dollar would lower the dollar cost of goods that Walmart and other retailers purchase abroad. Senators from about half dozen states in which Walmart's 1.5 million employees are key voters—natural lobbyists for their company's position—are unwilling to stake their political lives on the accuracy of economists' models, and will vote against any reform incorporating a border tax. Most observers say the border adjustment tax is dead, a position with which Ryan disagrees.
Republicans also cannot agree:
* Whether to structure tax cuts to benefit high earners who will invest their windfalls, or middle-class families who will spend the proceeds;
* Whether to increase the tax take by eliminating the deductibility of interest on debt, a favorite perk of property developers such as you-know-who;
* Whether to follow the lead of most countries and tax only profits earned in the U.S., thereby making exports more profitable and ending the need to chase the earnings of such as Apple all the way to Bermuda or Dublin.
* Whether to push for immediate expensing of items that are now capitalized.
The odds right now are that Trump will get some reduction in the corporate tax rate, and perhaps some cut in personal tax rates, but nothing on the scale he had hoped. That might not be his last defeat.
With the economy at close to full employment, hot enough for the Fed to begin raising interest rates, and the deficit as yet untamed, traditional deficit-averse Republicans are markedly unenthusiastic about a big spending program. To them, a budget-busting infrastructure programme sounds rather like Obama's stimulus bill. Which might prompt Democrats to favor it. Reports are rife of an administration effort to seek the cooperation of Democrats from now on, rather than try to round up support from deficit-averse Republicans.
Trump now knows that he faces a three-party congress: Democrats, Republicans and the Freedom Caucus, with the balance of power resting with the latter. If he can't get the caucus' twenty votes, and his tweets attacking it and its individual members suggest he has written them off, he might just find the support he needs from moderate Democrats, if such there be in a party lurching left to appease its Warren-Sanders wing. That would be an artful deal indeed.