In two weeks, the American people will vote for the Congress that takes office in January and on the makeup of more than a majority of the nation's state houses and state legislatures. Although a wide range of outcomes remain possible, both current polls and historical data suggest that the most likely outcome at the federal level is a Democratic majority in the House of Representatives and a narrow continued Republican majority in the Senate.

The following analysis of tax policy in the upcoming lame duck session and the incoming 116th Congress, assumes the most likely mid-term election outcome according to current polling, and is based on extensive discussions with key members and staff in the tax policy area from both parties in the House and Senate.

Although it has been uncommon for one party to have control of the White House as well as both Houses of Congress for more than short periods of time (often just two years following a presidential election), the last two major fiscal reforms enacted in the United States, the Affordable Care Act (ACA) in 2010 and the Tax Cuts and Jobs Act (TCJA) in 2017 were both enacted under one-party rule using procedures that essentially cut the minority party out of the legislative process. The expected 2018 ascendancy of Democrats to a majority position in the House of Representatives restores the more common arrangement in which both parties have influence and partial control over the legislative agenda.

In the past, divided government was often productive because it forced both parties to compromise and produced bipartisan legislation. The Tax Reform Act of 1986, for example, was the product of a Republican President and Senate and a Democratic House, and was passed with bipartisan support. By contrast, the ACA and the TCJA are partisan reforms that the then-minority party in Congress had no stake in and no reason to defend in the future. The key issue both in the upcoming lame duck session and in the 116th Congress is whether party leaders in Congress are willing and able to reestablish a measure of bipartisan cooperation in a political environment that is far more polarized than in 1986 or at any other time in recent history.

The likely incoming Chairman of the Committee on Ways and Means, Richard Neal (D-MA), has described himself as a legislator from a previous era in which members crossed the political aisle regularly to achieve results. Neal, who first was elected to Congress 30 years ago after serving as mayor of Springfield, Massachusetts, has a reputation of working constructively with his Republican colleagues and a willingness to compromise in order to get legislation passed.

In the event they gain a House majority, and depending on the size of that majority, Democrats are expected to name eight or more new members to the Ways and Means Committee, and Mr. Neal has indicated that he is seeking to name experienced legislators with a profile similar to his of working constructively to enact legislation, and that he will not name freshmen members to the Committee. As to his own politics, Mr. Neal has a generally liberal voting record and supports the Democratic House leadership with few exceptions. He favors tax simplification, the elimination of the individual alternative minimum tax, which he believes disproportionately harms lower-income taxpayers, and favors closing tax loopholes that encourage US companies to shelter income overseas (a view which appears not to have changed significantly following the TCJA). He has been the author of proposed legislation to close the so-called foreign reinsurance loophole. Mr. Neal led the Democratic opposition to the TCJA in the Ways and Means Committee.

Mr. Neal, who is likely to have a key role in the consideration of new trade agreements, including revisions to NAFTA, has voted against providing both Democratic and Republican presidents so-called fast-track authority to negotiate trade agreements with foreign nations without allowing amendments in the Congress, and also voted against the original NAFTA.

However given that new trade agreements under this Administration are likely to be more protectionist, it is possible that Mr. Neal and many of his Democratic colleagues may be more willing to support them.

I. THE LAME DUCK CONGRESS

Although Republicans will remain in the majority in the lame duck session, if Democrats win a House majority in the mid-terms, they will have far greater influence given that no legislation can pass the Senate currently without the support of at least nine Democrats. In effect, if the incoming House Democratic leadership and its Senate colleagues choose not be cooperative in lame duck, presumably because they would prefer to wait until 2019, they could block any legislation from being enacted. However, there are indications that Democrats favor a robust lame duck agenda.

Besides funding for the United States government beyond December 7, there are a number of other issues that could be considered, including:

  • the Retirement Enhancement Savings Act (RESA), which has strong support in the Senate, some provisions of which were included in the Tax Reform 2.0 legislation that passed the House just before the pre-election adjournment
  • extensions of close to 30 popular tax expenditures (credits and other incentives) that have strong support in the Senate and among House Democrats.There appears to be a consensus in the Senate to extend all of these, while current Ways and Means Chairman Kevin Brady has said that he is willing to extend only some of them
  • both tax and non-tax related provisions to assist individuals and businesses affected by recent weather related disasters
  • technicalcorrections to the TCJA and
  • modifications to some TCJA provisions that are unpopular with stakeholders, especially in the international area, and that are unlikely to be addressed in regulations.

There are indications that Senate leaders in both parties will support the inclusion of a year-end tax bill in the final legislative package for the year which could include many of these items, without any offsets. Mr. Neal has indicated that he would be willing to support a year-end tax bill to clear these issues off the table so that he can get a fresh start in 2019 on his own legislative agenda.

The lame duck session is expected to start on November 13 and run until the second or third week of December.

II. THE 116TH CONGRESS

The soon-to-be outgoing 115th Congress took office in January 2017, with House and Senate Republican leaders and a newly elected President all in agreement that tax reform would be their top priority. The 116th Congress begins January 2019 with a clear tension between newly empowered Democrats who will demand to try and roll back the tax rate cuts and other reforms (especially the elimination of the deduction for state and local taxes in the TCJA) and those who will want to find common ground with the Republican Senate and the President, knowing that a major rollback of tax reform is likely to fail.

This tension will take place following a campaign in which Republicans chose not to highlight tax reform and projections of a national debt of unprecedented magnitude (over $1 trillion a year over the next decade, potentially resulting in debt equal to GDP by 2030). While the Republican Senate and the President are expected to vigorously defend it, the TCJA will be at the center of debate throughout the upcoming 116th Congress.

Over the course of this debate, Republicans are likely to argue that the TCJA needs time before its effects can be fully realized and felt at the individual level, that the rising national debt is a product of programmatic overspending and will ultimately be tempered as a result of greater long-term economic growth stemming from TCJA reforms.

Conversely, Democrats will continue to argue that the TCJA reforms were a direct causation of much of the debt, and were disproportionately skewed to benefit corporations, and were unfair to working class families. For the first time since taking office, the President may face a power center (ie, the House of Representatives) controlled by the opposite party, and only time will tell whether he decides that bipartisan compromise on some tax issues to produce successful legislative accomplishments is worth it, if it means avoiding two years of inaction.

Procedural and organization issues, however, will dominate early in 2019. One of the reasons likely incoming Chairman Neal would prefer to dispose of pending tax issues in the lame duck session is the fact that, having been out of power in the House of Representatives for eight years now, Democrats will need to organize themselves as the majority party once again in the House, and the new Ways and Means Committee will need time to prepare to legislate. While in the minority, Democrats had much smaller staff and space allocations than did the majority Republicans, which is the normal course for minority versus majority party staff/budget allocations. Mr. Neal will need to hire and orient a much larger staff who may or may not have yet had Committee experience in order to handle his new responsibilities and carry out the new Committee agenda.

While it is generally assumed that the Senate leadership in both parties is likely to see few changes, there could be challenges to the current Democratic leadership in the House, while the current Republican Speaker, Paul Ryan (R-WI), has announced his retirement from Congress. Mr. Neal has been a close ally of Democratic Leader Nancy Pelosi (D-CA), who remains the most likely choice for Democratic speaker position. Paul Ryan, who previously served as Chairman of the Committee on Ways and Means, had a strong interest in tax policy; none of the likely candidates to serve as Republican leader in the 116th Congress are expected to share Ryan's focus on tax issues.

Although the Senate Finance Committee will see less changes than Ways and Means with Republicans remaining in the majority, the one very significant change will come as a result of the retirement of Chairman Orrin Hatch (R-UT). It is widely expected that Senator Charles Grassley (R-IA), the current chairman of the Committee on the Judiciary, will exercise his right under Republican committee rules to become chairman of the Finance Committee for the two-year duration of the next Congress. Grassley's expected ascendency to the chairmanship is not anticipated to significantly change the approach to tax policy on the Republican side of the aisle, and having been the Committee's chairman previously, the transition will likely be smooth.

Both the ACA in part, and the TCJA were passed under budget reconciliation procedures that required a simple majority in the Senate to proceed (rather than the usual 60-vote margin), and while it is not impossible, it appears unlikely that Democrats will agree to use reconciliation in the new Congress. Instead, any new tax legislation will have to clear the 60-vote margin, empowering Senate Democrats along with their House majority.

The expectation is that Senate Republicans and the President will seek to protect key aspects of the TCJA, especially the reductions in rates, both on the corporate and individual side, as well as the structural reforms, especially the sweeping changes to the international tax regime. At the same time, there will be major pressure from some members of the House Democratic Caucus to reverse course on the corporate tax rate cut, as well as reversing course on the reduction of the individual tax rate at the top few higher income brackets.

Mr. Neal has indicated that he intends to govern with an understanding of the limitations that divided government will impose and seek instead to find common ground with Republicans in the Senate and with the President.

III. KEY ISSUES LIKELY TO TAKE PRIORITY IN THE NEXT CONGRESS

Infrastructure

Mr. Neal has had preliminary discussions with senior Administration officials on the possibility of cooperating on a major infrastructure program, an issue that neither the President nor Congress had the bandwidth to tackle alongside prioritization of both health care and tax reforms during his first two years in office; the desire to do infrastructure has growing bipartisan support. During the 2016 transition, the President-elect specifically proposed a plan to create a trillion dollar infrastructure bank funded partially through a Federal contribution, most likely in the form of tax credits.

Prospects for the success of the Trump proposal, or any infrastructure package, will certainly be determined by demands that an infrastructure package be fully or partially offset. That has been the case for every recently proposed infrastructure package, presenting a substantial and, to date, insurmountable challenge to success. Democrats are likely to call for cost offset of any package through increases in the individual and/or corporate tax rates, while conservatives may demand that the offset be in the form of spending cuts. A compromise might also be found in some combination of the aforementioned funding offset approaches.

Modifications to the TCJA

While there have been growing demands that the Treasury Department address many of the TCJA's perceived shortcomings via regulation, particularly in the international provisions, senior officials appear reluctant to make major decisions on policy substance where Congress was otherwise silent. As a result of the regulatory pathway looking less ripe for substantive policy changes, there are growing demands for legislative adjustments to be made on various provisions of the TCJA.

Prospects will likely depend on whether the Administration and Republicans in Congress are willing to make concessions to Democrats, possibly in healthcare or social welfare spending, or perhaps even concessions within the TCJA itself in the form of increasing the corporate and/or top individual income bracket tax rates.

While Chairman Neal may be himself disposed to consider repairing the TCJA where needed, he will most likely be faced with an uphill battle in any attempt to do so; given that no Democrats voted for the TCJA, his caucus will likely demand a high price in the event Mr. Neal wants to be constructive in a bipartisan fashion on this issue.

Tax Reform 2.0

The package of additional tax reforms passed by the House in September contains extensions of the individual tax cuts enacted in 2017 otherwise set to expire at the end of 2025, some tax relief for start-ups, and parts of RESA.

Prospects for success vary depending on the issue. RESA has strong bipartisan support and is likely to be included in a year-end tax package in the lame duck session, while Democrats will be reluctant to extend the individual tax cuts absent a concession from Republicans to raise the highest rates (basically the type of concession that President Obama secured in 2012 relative to the 2001 Bush tax cuts). If RESA is not included in a lame duck tax package, it almost certainly will be considered in 2019.

Tax extenders

Congress recently extended 30 or so popular tax expenditures through the end of 2017 and a smaller number through the end of 2019. There will be an effort in the lame duck session to extend the provisions that expired at the end of 2017 for an additional two years (2018 and 2019), but it appears unlikely that those provisions set to expire at the end of 2019 will be extended during the lame duck period. As a result, proposals to extend these provisions will be considered in 2019.

Prospects for the extenders are greater with Democrats in control of the House, but members will have to resolve whether to offset the cost of extending the provisions in an environment of growing deficits.

Multiemployer pension plans

In the Budget Act of 2018, Congress created the Joint Select Committee on Solvency of Multiemployer Pension Plans with a mandate to report recommendations by the end of 2018. Those recommendations are expected to form the basis for legislation to be considered sometime in 2019.

Deficit reduction

The growing national debt is likely to be a major challenge in the next Congress, with Democrats putting the blame on the TCJA and Republicans on spending. The possibility of a compromise involving both some spending cuts and tax increases (most likely not through rate increases) could pose challenges to the business community.

The wild cards

This President has shown an ability to shift his position and political alliances with relative ease, and, when necessary, to compromise with Democrats; the budget deal he reached with Congress early this year resulted in large part from a deal struck with Democratic leaders Charles Schumer and Nancy Pelosi.

It is certainly possible that the product of a divided government over the next two years will be deep gridlock with few legislative accomplishments beyond temporary spending plans and "message" legislation aimed at the 2020 general elections.

On the other hand, a President with a reputation for making deals who has noted that he has contributed to and negotiated with politicians from both parties both nationally and locally throughout his business career, along with party leaders potentially in an environment that requires compromise, could produce some surprising results in 2019 before the 2020 election cycle takes hold.

And in that scenario, some compromises on aspects of the TCJA could emerge and are worth watching very closely.