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What The Senate's Healthcare Fiasco Means For Trump Policies: Goldman Explains

Now that Trump's hope to replace Obamacare is dead indefinitely following last night's mini rebellion in the Senate , and only the possibility of repeal remains although even that is not likely, pundits are asking what this means for Trump's overall agenda, and whether it will accelerate or further delay (or block outright) the implementation of any other Trump proposal, chief among which is budget resolution, increasing the government debt ceiling and passing tax reform. Regarding the latter, the stakes are especially great because as Bank of America explained earlier, "there is a general consensus that without tax reform the GOP could lose their majority in the House."

Still, for a market that has gotten used to ignoring everything out of Washington, if not virtually all newsflow, the reaction will likely be delayed because as BMO's Ian Lyngen writes, investors will likely “start looking at the issue more closely in the coming weeks, but don’t expect any visceral market response till the 11th hour from either Congress or the markets." Still, they warn that “the broader implications of this health-care failure may reverberate a bit more over time than markets may be currently assuming."

So while we wait for the market response, what happens next? Overnight Goldman's chief political analyst Alec Phillips writes that while Congress may still pass a health bill, it just won't be this one and notes that the "enactment of much more narrowly-focused health legislation is still possible this year, in light of problems facing the individual insurance market for 2018."

What is more interesting are Phillips' thoughts on the previously discussed GOP Budget which was released this morning, and about which he says that despite recent legislative setbacks, Goldman "continues to believe that a tax bill is more likely than not to become law in 2018, though there remain many unanswered questions."

Finally, the impact on debt ceiling negotiations, where as the CBO recently calculated the Treasury will run out of cash in mid-October. Here Goldman appears unduly optimistic, writing that "while there has been some discussion of a debt limit increase prior to the August congressional recess, we continue to believe an increase is much more likely to be approved in late September or very early October, potentially in combination with enactment of spending authority for FY2018, which will be necessary to avoid a partial shutdown of the federal government." On this topic, Bank of America released an interesting take on the upcoming negotiations, seen through the perspective of Game Theory, saying that "the risk is increasing that a Game of Chicken will be played out in Washington this September, with serious market consequences"  and warns that only a crisis "will bring about tax reform which in turn will be followed by a resumption of the Trump trades."

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Here is Goldman's full take, from Alec Phillips

The Fiscal Policy Outlook: Still Waiting

Healthcare: Congress May Pass a Health Bill, Just Not This One

Enactment of a broad health reform bill like the House-passed Affordable Health Care Act (AHCA) or the Better Care Reconciliation Act (BCRA) pending in the Senate looks unlikely this year, but some type of health legislation still looks possible before year end. Senate Majority Leader McConnell has announced a delay of this week’s planned procedural vote on the BCRA, as a result of Sen. McCain’s (R-Ariz.) expected absence. The delay was a setback but the effort faces bigger challenges; as it currently stands the bill is short at least four votes—Senators Collins (R-Maine) and Paul (R-Ky.) announced their opposition last week, and Senators Lee (R-Utah) and Moran (R-Kan.) announced their opposition late on July 17. Additional opposition looked likely once the Congressional Budget Office (CBO) released a revised estimate of the effects of the bill: Senators Flake (R- Ariz.) and Heller (R-Nev.) are expected to face potentially competitive elections in 2018 and had not committed to support it, while Sens. Capito (R-W.V.), Murkowski (R-Alaska), and Portman (R-Ohio) are also publicly undecided and represent states that expanded Medicaid under the ACA, which the BCRA would repeal.

That said, passage of some type of health legislation within the next several months is still possible, for three reasons: First, while the BCRA looks unlikely to pass the Senate in its current form, it is still possible that Senate Republicans could agree to a different approach. For example, legislation that preserves more of the existing subsidies (to address concerns among centrist Republicans) in return for increased state regulatory flexibility (to address conservative Republicans) might be able to win broader support. However, with limited time to develop a new approach, the probability of such a strategy coming together is fairly low.

Second, a fallback bill that stabilizes the individual insurance market for 2018, among other changes, might pass if a broad bill does not. For example, it is possible that such legislation could be added to the legislation Congress is likely to consider over the next few months to extend various expiring health programs, such as the Children’s Health Insurance Program (CHIP, which expires September 30), or as part of a broader fiscal deal around the deadlines this fall, discussed below.

Third, the political debate over ACA repeal is unlikely to end even if the current legislative effort fails. As discussed below, if the forthcoming budget resolution instructs congressional committees to cut spending and cut taxes, as looks likely, there may be an effort to revisit the cuts to Medicaid and repeal of some of the ACA taxes later this year or in early 2018 as part of the tax reform process. We are skeptical that such an effort would succeed, but it is at least possible.

The Budget Resolution: Looking for Tax Reform Clues

This week’s release of the House Republican budget resolution, expected Wednesday July 19, is likely to provide some clues regarding the shape of tax reform. The budget resolution is a non-binding outline of spending, revenue, and debt levels that guides congressional consideration of fiscal issues over the coming year. The budget resolution is typically of little interest to market participants, but it should be of greater interest this year because it sets the terms of the “reconciliation” process that Congress will use to consider tax reform. Specifically, tax legislation passed via reconciliation cannot increase the deficit by more than the amount the budget resolution calls for.

While no details have been released yet, we expect the House resolution to call for roughly “revenue neutral” reform, meaning no substantial effect on the budget deficit. However, “revenue neutrality” would be judged after accounting for two factors: dynamic scoring, which accounts for economic effects of fiscal legislation, and a “current policy” baseline, which excludes the cost of extending expiring tax provisions. Together these factors could make room for “revenue neutral” legislation that actually reduces revenues by several hundred billion dollars over ten years.

By contrast, we assume a net tax cut of $1 trillion over ten years. The White House has advocated reforms that would reduce revenues much more—the Tax Policy Center recently estimated the one-page proposal the White House released in April would reduce receipts by at least $3.5 trillion over ten years; some Senate Republicans in the Senate appear open to a smaller amount of deficit expansion.

Our expectation is that the eventual reconciliation instructions that Congress approves several weeks from now will be somewhat more generous than what House Republicans are likely to propose this week. Nevertheless, the fact that Republican leaders appear undecided on whether the tax bill should meaningfully reduce tax receipts suggests little chance that a multi-trillion dollar tax cut will be enacted and adds to our belief that the size of the eventual tax cut will be fairly modest, even if tax reform is not actually revenue neutral.

Tax Reform: Still More Questions than Answers

Despite the various legislative delays and setbacks, we continue to expect tax legislation to become law in early 2018. Over the next several weeks, the “big six” negotiators—House Speaker Ryan, Senate Majority Leader McConnell, House Ways and Means Committee Chairman Brady, Senate Finance Committee Chairman Hatch, Treasury Secretary Mnuchin and National Economic Council Director Cohn—hope to reach an agreement on a basic shared framework for tax reform which can be turned into a formal legislative proposal by September. Our expectation is that this process is likely to take somewhat longer, and that the formal release of a detailed tax proposal is more likely to occur in October, after the deadlines noted above have passed.

However, at this point, a number of basic questions remain unanswered. The most basic two questions are whether tax legislation will be revenue-neutral and whether the changes will be permanent. These issues are linked, since under congressional budget rules tax cuts passed through the budget reconciliation process cannot last beyond the budget estimate window, which has traditionally been ten years. House Republican leaders have been the most insistent on revenue-neutrality, while the White House’s position appears to be most open to an expansion of the deficit. As noted above, our expectation is that the tax bill will ultimately result in a modest net tax reduction of around $1 trillion over ten years. If so, this might involve permanent corporate reforms combined with a corporate rate reduction and personal tax cuts that expire after ten years.

Other aspects of the debate have become somewhat clearer. With little apparent support in the Senate or the White House, the border-adjusted tax (BAT) appears very unlikely to be discussed much further and is unlikely to be included in tax legislation, in our view. An outright repeal of interest deductibility also appears too controversial, though it is possible in our view that an incremental limitation on interest deductibility might be included. Without the revenue from repealing interest deductibility, it will be difficult to finance full expensing of business investment, but we expect that partial expensing (i.e., bonus depreciation) for equipment is likely to be included. The corporate tax rate is the hardest to predict, but our expectation continues to be that a rate in the mid- to high 20s is the most likely outcome, if lawmakers hope to make their corporate reforms revenue neutral (and permanent).

The Debt Limit: Probably a Late September Event

Treasury has asked Congress to lift the debt limit before the August recess, but has also indicated that it could continue to meet its obligations through at least early September if the limit is not raised sooner. We continue to project that the Treasury is likely to have sufficient borrowing capacity until the first days of October (i.e., October 2 or 3), but agree with the Treasury’s assessment that the cash balance could decline to an uncomfortably low level in early September, prior to the influx of corporate tax receipts around the September 15 tax filing deadline.

While there has been some discussion of passing a debt limit increase prior to the August recess, this seems fairly unlikely to us. In theory, congressional Republicans could address the debt limit in one of three ways. First, the debt limit could be coupled with spending cuts and passed via the reconciliation process using only Republican votes. However, this would require the budget resolution (noted above) to be finalized, a process which will probably take several more weeks.

Second, a debt ceiling hike could be added to a popular or must-pass measure; Senate Majority Leader McConnell has raised the possibility of attaching it to an upcoming bill to fund a veterans’ benefit program, for example. While it is possible that the strategy could succeed, most such bills are nevertheless likely to come with their own political complications (the veterans’ measure, for example, has some Democratic support in concept but there are disagreements over certain aspects). Third, a “clean” debt limit increase would probably have adequate support to pass, in light of likely Democratic support, but Republican leaders are unlikely to allow a bill with significant Republican opposition to pass until the deadline is much closer, i.e., September.

The most likely scenario, in our view, continues to be that the debt limit will be raised around the end of September or early October, potentially in a broader fiscal agreement that extends federal spending authority past the end of the fiscal year on September 30, and raises the debt limit.