Congress returns to Washington in June with only seven weeks to work before leaving again for the August recess. Below we consider what Congress is likely to accomplish, and how its actions (or inactions) are likely to affect the markets over the summer and into the fall.
Following are the immediate actions on Congress’ plate:
- Debt Ceiling Increase: In mid-March this year, total federal government borrowing reached the limit authorized by Congress. Since then, the government, unable to borrow, has limped along using tax receipts and money in accounts it does not need right away. But tax receipts this year have slowed, as investors are putting off recognizing gains in anticipation of lower tax rates next year. To avoid a potential default on U.S. debt, Treasury Secretary Mnuchin has asked Congress to raise the debt ceiling before leaving for its August recess. Under the Senate filibuster rules, 60 votes are required to pass legislation raising the debt ceiling. Because the Republicans hold 52 Senate seats, Democratic support is needed. Many Republicans want to add riders to the debt ceiling bill that curb future spending and the permissible uses of borrowed funds. Democrats, in contrast, want a “clean” bill that raises the ceiling without condition. Ultimately, Congress almost certainly will raise the debt ceiling to avoid a national default, but getting there could be messy.
- Government Funding:Congress has funded the federal government through September 30, the end of the current fiscal year. To avoid a government shutdown on October 1, Congress must appropriate additional funds to run the government before that date. Like legislation to increase the debt ceiling, funding legislation requires 60 votes in the Senate to overcome a filibuster. Thus, some Democratic support will be necessary. Republicans are calling for increases in military spending and deep cuts in domestic spending. President Trump also is demanding funds to build a wall on the U.S.-Mexican border. Democrats have indicated they will oppose these objectives. Reaching a compromise will require serious effort. We see a short-term government shutdown in early October as a distinct possibility.
- Health Care Reform: The Senate is set to begin consideration of the House-passed American Health Care Act (AHCA), the Republican alternative to the Affordable Care Act (ACA, or Obamacare). Procedural rules permit Senate Republicans to pass much of the AHCA with a simple majority, so (unlike for the debt ceiling and funding legislation discussed above) Democratic support is not required. Nonetheless, forging agreement among the Republican factions will be difficult. As a whole, Republicans in the Senate are more moderate than their House counterparts. Republican Senators are concerned that the AHCA is projected to impose cost-prohibitive premium increases on some Americans with pre-existing health conditions while also forcing millions of poor families off the health insurance rolls. Finding a legislative solution that threads the needle between House conservatives and Senate moderates might be a bridge too far.
- Tax Reform:Businesses are eagerly awaiting the passage of tax reform legislation that will simplify the tax code and reduce tax rates. Procedural rules permit Senate Republicans to pass tax legislation with a simple majority. Thus, Republicans are free to fashion tax legislation without concern about garnering Democratic support. But passage of sweeping reform legislation still is no easy task. Most legislators insist that tax reform not reduce significantly the revenue the government derives from the tax system. Most observers believe that reform can achieve this “revenue neutrality” only by joining lower tax rates with a broadened tax base, achieved by eliminating or curtailing existing deductions and exemptions. But every deduction and exemption provides a benefit to a particular group or economic sector. Once a tax bill identifies a deduction or exemption as a candidate for change, industries adversely affected push back strenuously, threatening Congress’ will to enact reform.
The markets reacted excitedly to President Trump’s election victory last November, anticipating that the new Administration’s initiatives – fiscal stimulus, business tax reform, and reduced federal regulation – would boost economic growth and corporate profits. But, as Congress has failed to pass significant legislation during the first five months of Trump’s presidency, markets have become warier, concerned that the Republicans are struggling to implement their policy goals.
In the coming months, we believe markets will focus substantially on the prospects for tax relief legislation. If Congress struggles to pass legislation to raise the debt limit and fund the government, markets could react negatively, surmising that Congressional failure to undertake such basic tasks suggests an inability to deal with the more complex matter of tax reform. This phenomenon was apparent last March, when Republican struggles to pass replacement health care legislation led to the largest one-day drop in the markets since the election. Investors were concerned not so much with the content of the health care bill as they were with whether the failure suggested that Congress will be unable to agree on tax cuts as well.
We believe this extrapolation from the debt ceiling and government funding legislation to tax legislation is misplaced. The former legislation requires Democratic concurrence to pass the Senate. Tax legislation does not, and thus can be passed solely with Republican support.
We continue to believe that Congress is likely to pass tax relief legislation this year. If the Republicans are unable to agree on full-scale tax reform, we believe that Congress will abandon the sweeping goal of simplification to pass streamlined legislation that simply reduces tax rates. It would be too embarrassing for the Republicans, having assumed control of Congress and the White House with the promise of lowering taxes, to fail to pass any tax relief legislation at all this year. There is even a reasonable chance that lower tax rates could apply in part retroactively to the beginning of 2017. (There is a risk that tax cut legislation standing alone will not be revenue neutral and thus could lead to higher deficits down the road, retarding future economic growth. Our guess is that consideration is too long term to affect market approval of business tax relief.)
We suggest that a market retreat this summer in the face of Congressional failure to agree quickly on debt limit and funding legislation could well be a temporary and thus a buying opportunity. We expect Congress will enact some form of tax relief legislation by year-end, satisfying the markets’ craving.
Andrew H. Friedman is the principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He and his colleague Jeff Bush speak regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. They may be reached at www.TheWashingtonUpdate.com.
The authors of this paper are not providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.
Copyright Andrew H. Friedman 2017. Reprinted by permission. All rights reserved.
The opinions expressed in this article are the author’s own and may not reflect the view of M Holding Securities or WealthPoint, LLC.