To anyone following tax or health care reform it must sound like a broken record every time the word reconciliation is mentioned. Nearly every mention alludes to the Senate rules that allow a simple majority vote, with qualifiers that proposed legislation be revenue-neutral or deficit neutral, and that compliance with the “Byrd rule” is maintained. While making a semi-accurate account of the process, the context of reconciliation rules is left unadorned if not incomplete. A comprehensive explanation of the reconciliation rules with a focus on their shaping of the American Health Care Act (AHCA) will help to shed light on how they might affect tax reform.
Senate Procedural Rules
Most bills in the Senate require a simple majority to pass; that is, one half plus one of the members voting. However, unanimous consent is required to end debate on an issue to proceed with a vote. Such consent to end debate can nevertheless be overruled with a three-fifths vote, thereby ending the tactics of a so-called filibuster. Under these rules, the bar is set higher to end debate than it is to pass an underlying measure. That is where budget reconciliation comes into play.
Budget reconciliation is used to make a budget resolution law. A budget resolution is a nonbinding fiscal blueprint set by Congress under a simple majority vote, with no filibuster allowed. When a budget resolution sets directives to promulgate its measures using reconciliation rules, debate time is specified and capped; consent is not needed to proceed with a Senate vote. This means measures subject to the reconciliation rules need only a simple majority to pass in the Senate, but they must meet specific criteria to qualify.
Financial Rules for Reconciliation
To be subject to reconciliation rules, a bill must not increase the federal deficit beyond the “budget window.” This is a chosen period covering the next five to 10 years. Ten years is most often selected (and is assumed in this article). Revenue neutral and deficit neutral jargon often is used interchangeably to describe compliance with this rule, even though those terms do not mean the same thing and do not appropriately describe such compliance.
A revenue neutral measure is one that leaves the total amount of tax revenue unchanged; provisions that cost money must be matched dollar-for-dollar by revenue raisers. One way that this can be done in the tax world is by simultaneously lowering rates and eliminating deductions. A deficit neutral measure is one that does not change the total mix of spending and revenue over a given period. There is no requirement that a reconciliation bill be revenue neutral in any way. Absolute deficit neutrality is not a requirement under reconciliation either. Reconciliation instead requires that a measure must not add to the federal deficit for more than 10 years.
The Bush tax cuts from the early 2000s were passed using reconciliation and are a prime example of this rule. The Bush tax cuts increased the deficit for 10 straight years, but were made to expire thereafter because they could not continue to add to the deficit beyond that point.
Another way to comply with this rule is to increase revenues at some point before the end of the window, thereby allowing the totality of a reconciliation measure to remain permanent law. The AHCA used this trick by keeping the Cadillac tax on certain high dollar insurance plans, but delaying it an additional five years.
The “Byrd rule” encompasses the aforementioned financial rules, and places some additional limits on what can be passed under reconciliation. First, it generally prohibits matters that do not relate to a change in the level of spending or revenue. It also prohibits committees within Congress from adding provisions outside their jurisdiction. This is why the AHCA was split into two bills initially so that the House Ways and Means and the House Energy and Commerce Committees could consider their jurisdictional matters, after which the bills were recombined into one larger bill. The Byrd rule further prohibits most changes that affect Social Security.
Understanding reconciliation allows us to turn to how these rules shape tax and health care legislation. Reconciliation directives in a budget resolution can include up to three sets of directives per fiscal year: one for changes that increase or decrease spending, one for revenue, and one for the debt limit. In practice the directives generally combine spending and revenue increases or decreases into one set of instructions.
So you may be wondering how Congress plans to tackle health care reform and tax reform in the same year if only one set of instructions is provided for the year. The answer is that Congress failed to pass a budget resolution in 2016 for fiscal year 2017, so in January 2017, Congress passed budget resolutions for fiscal years 2017 and 2018 which both included reconciliation instructions. This allows Congress to pass two reconciliation measures during 2017, but it must pass a law pertaining to the fiscal year 2017 instructions before that fiscal year closes Sept. 30, 2017. Another attempt at reconciliation is possible during the following year, but would be complicated as 2018 is an election year for the House and roughly one-third of the Senate. This likely impacted the accelerated timing and demise (for now) of the AHCA.
How Reconciliation Affects Legislation
Notwithstanding time pressures, reconciliation rules restricted what could be included in the health care bill and are expected to guide tax reform significantly due to the deficit rules.
The deficit rules of reconciliation were never really an issue for the AHCA because spending cuts to Medicaid and the Affordable Care Act’s (ACA) premium assistance subsidies were projected to outpace revenue losses from tax cuts. However, complaints from the House Freedom Caucus, which played a major role in blocking the AHCA, posed a significant challenge to compliance with reconciliation rules. The Caucus members wanted the bill to strip out regulations that affected the insurance industry, which House leadership initially resisted because they seemingly did not relate to spending, revenue, or the debt limit. Despite continued concern, House leaders eventually promised to include these provisions in the bill.
This would have required the Senate Parliamentarian to determine whether these provisions violated the Byrd rule. The Vice President, acting as President of the Senate, could have overruled this determination, a move unprecedented in the Senate’s history. Ultimately, this did not come to bear as the AHCA vote was cancelled in the House.
The nature of tax reform legislation usually limits its components to either spending or revenue, so those rules are not a concern. But tax cuts will increase the deficit without some kind of offset, so to be made permanent, they must not do so beyond the 10-year window. The AHCA’s repeal of the ACA health care taxes would have helped to strike this balance. For instance, a goal of 33 percent as the top individual tax rate requires a 10.4 percent rate cut without the AHCA’s repeal of ACA taxes, but only requires a 6.6 percent rate cut if the AHCA had already dispensed with the first portion.
This equates to about a trillion dollars of tax cuts that would have occurred over a 10-year period under the AHCA that instead must be achieved through tax reform to achieve the goal. Spending cuts or additional revenues are therefore necessary to counterbalance this trillion dollars to comply with the deficit rules. Spending cuts would be challenging, as this amount would be about 2.3 percent of all federal spending (not including interest) over 10 years. If so-called mandatory spending cannot be touched, a trillion dollar cut amounts to 7.7 percent of the remaining non-interest discretionary spending. And if military spending (part of discretionary spending) is left unchanged, a trillion dollar cut would be approximately 17.9 percent of the remaining non-military, non-mandatory spending. This is money that goes to schools, roads, research, foreign aid, and other programs.
The practical difficulty of spending cuts is matched by the political difficulty of revenue (tax) increases. Tax increases can be obtained by curtailing tax deductions and credits, which is referred to as “broadening the tax base.” This does not affect all sectors equally. A wasteful loophole to one observer may be perceived as a well-deserved tax break to another. As some taxpayers achieve lower effective tax rates with these items, a decrease to the maximum tax rate has no bearing. Other taxpayers who are subject to the maximum tax rate and who cannot to take advantage of these items will be impacted greatly by a decreased tax rate. Thus, broadening the tax base creates winners and losers, even with a rate cut.
Challenges that beset the AHCA under the reconciliation rules also present potential difficulties for permanent large scale tax reform. It is possible that these difficulties may compel Congress to follow the model set by the Bush tax cuts, and set temporary measures with the hope that political pressure will lead to future legislation to make tax cuts permanent, regardless of the 10-year effect on the deficit. For more information on reconciliation rules, please contact your local CBIZ tax professional.
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