November 21, 2017

After a grueling 24-hour markup session (spread over four days), the Senate Finance Committee on November 16 approved a draft plan for tax reform and restructuring that would increase federal deficits by over $1.4 trillion over the coming decade.

The legislative text of the bill as approved by Finance is here and a section-by-section summary is here.  (The budget score of the approved bill is here.) The Senate is expected to consider the bill on the floor next week and then sent to conference with the companion bill (H.R. 1) that passed the House last week.

As described in ETW last week, there are a few provisions in the Senate bill relating to transportation and infrastructure. The new section numbers for those sections are:

• Section 11048 (preventing bicyclists from excluding any bike commute money provided by employers from their income as a fringe benefit from 2018 through 2025)
• Section 13304(c) (presenting employers from deducting the cost of transportation fringe benefits provided to employees)
• Section 13532 (prohibiting new “advance refunding” municipal bonds);
• Section 13822 (clarifying that provision of aircraft management services is not considered to be provision of air transportation for purposes of the 7.5 percent ticket tax and the passenger segment fee).

The summary list of amendments disposed of during the Finance markup indicates that party-line discipline ruled throughout. Two amendments were offered by Democrats dealing with infrastructure:

• Cardin (D-MD) amendment changing the two-tier rate of the deemed repatriation provision of the Chairman’s Mark (described in section IV.A.3 of JCX-51-17) to a 7% rate for illiquid assets and a 14% rate for liquid assets and requires that the revenue raised by the provision, as modified, be directed to a newly-created Multi-Modal Trust Fund. The revenue in the Multi-Modal Trust Fund will be designated for infrastructure improvements. Failed by a party-line vote of 12 yeas, 14 nays.
• Casey (D-PA) amendment providing $500 billion in 100% tax credit bonds which shall be allocated to states and municipalities to finance a variety of infrastructure investments. Failed by a party-line vote of 12 yeas, 14 nays.

Sequestration worries. The tax cut debate last week on the House floor and in Senate committee was affected by a new letter from the Congressional Budget Office discussing the immediate fiscal consequences of enactment of such a gigantic tax cut. CBO estimates that if such a bill were enacted next month, without any other kind of budgetary fixes, many non-defense programs such as Build America Bonds, $739 million per year in highway funding, and other mandatory (non-appropriated) accounts could be eliminated in January.

This is true, but something that Congress can (and probably will) avoid triggering. Background:

The most important thing to keep in mind: sequestration is a tool, not a policy. Sequestration is the tool used to enforce some other kind of budget policy. When it was first written into law in 1985, sequestration was supposed to enforce a policy of annual deficit targets. But today, there are no more deficit targets, and there are three different policies that are enforced by sequestration:

1. the annual caps on discretionary appropriations,
2. the cumulative effects of pay-as-you-go (PAYGO) budgeting that constrains mandatory spending and tax law changes, and
3. the deal struck in summer 2011 that established a Joint Select Committee on Deficit Reduction, tasked with finding $1.2 trillion in deficit reduction over ten years.

The way sequestration works is that the law forces the Office of Management and Budget to make a calculation of the amount of savings needed to enforce a particular policy, and then sequestration is imposed to save that amount of money by across-the-board spending cuts in the percentage necessary. In the case of PAYGO policy, the law requires OMB to update its estimates of the cumulative cost of new laws changing mandatory spending or taxes at the end of each session of Congress, average it over 5-year and 10-year “scorecards,” and then impose sequestration in any amount by which those new laws have increased deficits.

The current PAYGO scorecard shows that the cumulative effect of laws passed by this Congress and previous Congresses was to reduce deficits over the 2018-2027 period to the point that the rolling 10-year average is $14.1 billion to the good (no sequestration necessary).

But if Congress enacts a bill like the Senate tax bill that, according to JCT, increases deficits by $1.414 trillion, the cost of that would be divided up and put on the PAYGO scorecard. So $141.4 billion in deficit increase would be added to the 10-year PAYGO scorecard for fiscal 2018. OMB would then subtract the current $14.1 billion positive balance, leaving it $127.3 billion in the red, and a new round of sequestration would be ordered in that amount for FY 2018.

There is over $715 billion in mandatory funding subject to sequestration in 2018, almost all of it non-defense (since the defense budget is funded almost entirely through annual discretionary appropriations). $127.3 billion out of $715 billion would be a 17.8 percent across-the-board cut in every such account and program – draconian, but not always fatal.

However, at least $638 billion of that funding subject to sequestration is Medicare that is subject to a special rule – it can’t be reduced by any round of PAYGO sequestration by more than 4 percent. That would save $25.5 billion this year. The other $102 billion in 2018 PAYGO sequestration would have to be taken out of the other programs, which only total less than $80 billion in total funding. So if a $1.4 trillion tax bill triggered a $127 billion per year PAYGO sequester, that would effectively zero out all of the non-Medicare programs subject to sequestration. The transportation and infrastructure accounts subject to sequestration include:

• The $739 million per year in federal-aid highway contract funding exempt from obligation limitation
• The portion of Essential Air Service subsides funded from overflight fees ($116 million assumed in FY18)
• The $250 million per year in Transportation Security Administration mandatory funding for airport EDS systems
• PHMSA emergency preparedness grants ($28 million per year)
• Payments on Build America Bonds funded from the 2009 ARRA stimulus law – $3.9 billion estimated in 2018.

We’ve already had one round of sequestration in 2018 – the sixth annual installment of Joint Committee sequestration took effect October 1 (see the OMB notice here with all the calculations) which reduced Medicare by 2.0 percent and which reduced all of the other non-defense mandatory programs that are not exempt from sequestration by 6.6 percent. Any PAYGO sequestration would be on top of that (we think- it’s a gray area whether the 4 percent cap on Medicare PAYGO sequesters and the 2 percent cap on Joint Committee PAYGO sequesters are cumulative or not).

However, there is a way out: any law imposed by Congress can be amended or repealed by Congress. And all Congress has to do is enact a provision into law that says something to the effect of “any massive tax reform bill enacted in 2018 shall not be entered onto the PAYGO scorecards.” Or legislation could be enacted, after a tax bill is enacted into law but before the end of the session of Congress, to wipe the entire PAYGO scorecard to zero and start over. Congress has done both before (section 32401 of the FAST Act of 2015 had a provision in it that prevented the bill from being entered on the PAYGO scorecard, just to name one example, and the PAYGO scorecard has been wiped at least once before – see Public Law 107-312).

It becomes a political calculus. Historically, conservatives have cared more about low tax rates than they have cared about deficits, and liberals/progressives have cared more about sustaining high levels of social spending than they have cared about deficits. It was the centrists and moderates who cared most about deficits and forced Congress’s sporadic attempts to get deficits under control. (See Wildavsky and White’s The Deficit and the Public Interest for a book-length treatment of this issue.)

Anybody who has even casually looked at Congress in recent years has been able to discern that the center has been hollowed out and moderates and centrists are in short supply in each party. Republicans just adopted a budget resolution by party-line vote that explicitly calls for deficits to be increased by $1.5 trillion over the next decade, as a way to use a budget procedure to let the Senate pass the tax bill with only 50 votes instead of 60. (If the tax bill itself includes a PAYGO fix, it no longer qualifies for the expedited 50-vote process.)

If they can do this and get the tax bill to the President’s desk, Democrats will be forced to ask themselves, “do we really want to let Medicare get cut by another 4 percent and see all of these other domestic programs in education, agriculture, infrastructure, and the environment get zeroed out immediately, just so we can prove that we care about deficits more than the Republicans do? Or will we accept a PAYGO nullification that keeps these programs going and just pretend the tax cut never happened?”