Trump and Harris say they want to cut taxes. Here's why you should prepare for a tax hike.

By Chris Matthews

The bond market will frown on short-term gimmicks that mask tax-cut costs

Whoever wins November's presidential election will be faced with an immediate need to negotiate with Congress over what income-tax rates should look like after the 2017 Trump tax cuts expire at the end of next year.

There are few issues that Republican nominee Donald Trump and Vice President Kamala Harris, his Democratic opponent, are further apart on than tax policy - and the yawning gap between the two parties' positions is one reason Americans should prepare for the possibility that the tax cuts are allowed to expire in their entirety.

The left wing of the Democratic Party, typified by Sen. Elizabeth Warren of Massachusetts, sees this outcome as preferable to extending the law as written.

"It is better to walk away and let the Trump tax cuts expire than to sign our names to that kind of wealth transfer to help multimillionaires and billionaires at the expense of working families," Warren said at a Senate Banking Committee hearing on tax reform last month. "But that doesn't have to be where our 2025 tax fight ends. I believe we can do better than that."

The willingness to walk away and let the tax cuts expire will give Democrats leverage, Warren told Tax Notes, to strike a deal that keeps the 2017 tax cuts for families making less than $400,000 and to cut them further for families with children, as Harris has pledged to do.

But there's also a not-insignificant chance that a strategy of brinksmanship goes off the rails and leaves most Americans with higher tax rates starting in 2026.

Henrietta Treyz, economic-policy analyst at Veda Partners and a former Senate Budget Committee staffer, estimated in an interview with MarketWatch that the chances of this happening are still low - no more than 15%, by her estimation.

Nevertheless, she sees the chances of a divided government in Washington as very high - and with partisan gridlock comes unpredictable outcomes.

Treyz's base-case scenario is that Harris wins the White House, with Democrats taking control of the House and Republicans controlling the Senate.

In such a scenario, "I think Harris's entire presidency is consumed by this conversation" as Senate Republicans rediscover their dedication to budget discipline.

"While putting together any tax package next year will be difficult, divided control of government will be the most challenging scenario for lawmakers to navigate," wrote analysts at Beacon Policy Advisors in a Friday note to clients.

Trump wants to make the 2017 tax law permanent while also repealing the cap on state and local tax deductions that helped pay for it. He also wants to eliminate taxes on tips and Social Security income, and further reduce the corporate tax rate to as low as 15% for companies that produce goods domestically.

All told, these provisions would cost upwards of $8.5 trillion over 10 years, according to an analysis by the Tax Foundation.

Harris wants to raise taxes on corporations and families making more than $400,000, while extending the Trump tax cuts for families making less than that amount. All told, she hopes to raise more than $4.1 trillion in taxes while cutting them elsewhere to the tune of $2.4 trillion over 10 years, the Tax Foundation said.

"Finding consensus on a bill that can pass the upper chamber under divided government will be a slow process given the wide delta between the parties' positions," according to Beacon Policy Advisors.

In a scenario where Democrats control the White House and Republicans the Senate, the top candidates for tax increases are corporations and owners of small businesses making more than $400,000, according to Jorge Castro, a former IRS official who has also worked for tax-writing committees in the House and Senate.

"Republicans on the Hill, especially on the House side, have been very vocal and very public about the likelihood of having to raise the corporate rate," Castro, now a tax-policy lawyer at Miller & Chevalier, told MarketWatch.

Limiting a deduction for pass-through businesses could also be on the table, but probably not congressional leaders' first option for raising revenue, since "the small-business message is always very strong on Capitol Hill, and members of Congress are going to want to go to bat for that sector," he added.

Veda's Treyz predicts that the most likely outcome for a Harris administration is to agree to extend the entire law for two years, just as former President Barack Obama did with the Bush tax cuts in 2010.

Simply kicking the can down the road, however, comes with its own dangers, given that the federal budget deficit is already at record levels for a nation not in recession or at war.

"Wall Street is starting to understand all the gimmicks that are being used" to mask the true size of a tax deal, like making the 2017 tax cuts expire at the end of 2025 to keep down their total cost, Treyz said.

A bond-market BX:TMUBMUSD10Y revolt is most likely in the event that Trump wins the White House but Democrats win back the House, which Treyz puts the likelihood of at as high as 40%.

In that scenario, she sees a tax bill costing $3 trillion over 10 years as "entirely possible," even if such a move dwarfs any single-bill spending Congress has contemplated in its history.

The limiting factor here may just be what the bond market is willing to swallow.

"The politics here are going to be that Democrats are going to get Trump to blow out the deficit, show that Republicans are unserious about fiscal restraint and then use that as a campaign cudgel," Treyz said.

But given that Wall Street will now be more conscious of the real budget cost of a short-term deal filled with gimmicks, she said, "a $3 trillion deal might significantly move the bond market."

-Chris Matthews

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10-05-24 0900ET

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